What are the two biggest problems for venture capitalists? originally appeared on Quora - the place to gain and share knowledge, empowering people to learn from others and better understand the world.

Answer by Patrick Mathieson, venture investor @ Toba Capital, on Quora:

One of the biggest challenges I've seen is deciding how to allocate time and follow-on capital to the portfolio companies that aren't doing particularly well.

"Rocket ship" portfolio companies are comparatively easy. Attend every board meeting; recruit the best people you know to work there; give them as much follow-on capital as they can handle; stay the heck out of the way. As an investor, your attention and capital naturally gravitate to these companies. To make a crude analogy: Michael Phelps' parents presumably didn't need to think too hard about whether or not to support their young son's swimming habit*. The resources of the family naturally gravitated towards making him successful.

*(not that the investor-entrepreneur relationship is the same as a parent-child relationship... like I said, crude analogy.)

Figuring this out for struggling companies is much trickier. You, of course, want to be a supportive investor -- but sometimes this is easier said than done. Struggling companies usually need a lot more help than the rocket ship companies; this often leads to a situation where an investor finds herself spending 80% of her time on the troubled companies and 20% on the rocket ship companies, even though the former will drive 1% of her returns and the rocket ships 99%. Are you as an investor OK with this time/returns imbalance? What about the people in your network -- are you going to send them to your middling companies, or your best companies? Is it fair to encourage the best people you know to join a company that will achieve a mediocre outcome at most? And what about follow-on capital: Will you continue financing a company that's having a lot of trouble getting traction, when that same dollar could yield a super high return in your #1 most successful company? Is that fair to your LPs? What if the reason for the company's struggles is mismanagement or poor execution (as opposed to things outside the company's control)? Or --even worse-- poor business ethics? (yes, VCs aren't the only ones who can act like dicks.) Are you obligated to fulfill your duties as a "supportive investor" and continue funding a company that's shown little/no ability to turn capital into progress?

Back to the crude analogy: Your son insists on competing on the local swim team, but he can't figure out how to swim and needs to be CPRed twice a week by his instructors. How "supportive" will you be towards his swim habit?

I don't want to make it seem like this happens all of the time; Yet, it does happen all of the time. The entire VC model is predicated on a wide distribution of outcomes within a given portfolio, and every portfolio has its "failure rate". Yes, how an investor treats her worst-performing companies is a better test of her integrity/character than how she treats her best companies -- this is totally true. At the same time, VCs serve multiple constituencies: What's good for one company might be bad for the LPs. What's good for the LPs might be bad for the employees and founders. Sometimes what's good for the founders is bad for their employees. Sometimes one VC is incentivized to sell a company early, whereas another VC has the exact opposite incentives. What to do then?

You won't see VCs acknowledge any of this on their websites, but if you speak to them in private they'll tell you that figuring out how to appropriately (humanely AND profitably) deal with the "dogs" of their portfolio is something they think about endlessly.

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Published on: May 5, 2017