How to use past investment mistakes to make better decisions?

  • February 13, 2023

Failure is an inevitable risk in every business venture. Capital markets are especially susceptible to risks that can have a long-term financial impact on investment firms and the companies in their portfolios. The magnitude and relevance of this impact are decided by how well a firm can anticipate and mitigate investment risks by staying on top of global market trends. An important part of risk mitigation is having pre-defined risk management measures in place. But how does one come up with such measures? Is there a standard course of action that a VC firm should follow in case of risk exposure? 

Not quite! Every VC is susceptible to unique investment risks that depend on its portfolio, risk appetite, and investment philosophy, among other things. The key here is to use accumulated data to spot trends and actively determine the pain points in your investment philosophy. Analyzing your previous deals can help you uncover the areas of vulnerability in your investment strategy and proactively fill these gaps by enforcing corrective measures. 


Return on failure (ROF)

A Harvard Business Review article titled Increase Your Return on Failure explores the fascinating concept of ROF, which can help VC firms cope with mistakes better and actively learn from them. The article critiques the ‘risk-averse’ nature of most VC operations and deems it an obstacle to innovation. To combat this problem, VCs can look to actively learn from their failures by treating them as opportunities for generating valuable investment insights. In this concept, Return On Failure would be a ratio where the numerator is the estimated value of the insights and assets a VC ‘gains’ from the failure and the denominator would be the net value of all assets invested in the process. Optimizing this ratio can allow VCs to derive value from failures and counterbalance the losses incurred due to them. 



One way of optimizing the ROF on an opportunity can be to minimize the number of assets invested in it. VCs often tend to pass on high-risk investment opportunities to avoid possible losses. However, this practice goes against the philosophy that failure is an inevitable part of running a VC firm. Instead, firms can look to derive a high ROF on these opportunities by controlling how much time and money is spent on them. Let’s understand this better with the help of an example. 

Let’s imagine a VC firm comes across a fintech startup called X which has a credible organizational and financial structure in place. However, global trends suggest that fintech companies could soon face financial troubles which could last at least four to five quarters. While it would be an instinctive move to pass on the investment opportunity, the VC firm decides to use the global financial climate to its advantage. The firm negotiates a higher equity share in X for a much lower-than-expected price citing high investment risks. This allows the firm to successfully add a credible fintech startup to its portfolio and learn more about the financial and organizational challenges involved. VCs can then use this opportunity to draw valuable, data-driven insights and use them across future fintech investments. In this scenario, an increased investment risk allows VCs to acquire a high-value startup for a much lower-than-expected price, boosting the ROF generated by the deal. 


Tips for effectively learning from past investment mistakes 

Here are a few tips that can help VCs actively derive value and learn from investment debacles of the past. 

  • Have dynamic data analysis processes in place 

    One of the most effective ways for VCs to learn from past investment mistakes is by analyzing historical data. Each lead that passes through a VC pipeline goes through several organizational processes like due diligence, screening, partner review, and ROI projections. All of these processes work in tandem as part of the VC’s decision-making process. If the investment fails to pay off, it can be difficult for the VC to figure out exactly where their decision-making went wrong. While it is necessary to have thorough investment processes in place to ensure appropriate risk mitigation, these complex processes can make it difficult for VCs to diagnose operational errors. Having dynamic data collection and analysis processes in place can help VCs analyze a deal at each step and find out exactly where they went wrong. They can then use this information to spot operational trends and take active measures to change them in due time. Data can be collected from a VC pipeline in the form of KPIs.

  • Convert data into actionable insights 

    Data collected from VC processes doesn’t hold any value in its raw form. This is because raw operational data is often prone to errors and discrepancies and is generally difficult to interpret. This data only becomes useful once it is passed through extensive filtering and standardization processes. A comprehensive data analytics model for VCs can help them derive actionable insights. This also saves VCs the time and trouble it would take for employees to sit and decipher the data themselves. Actionable insights allow VCs to take immediate action and fix operational pitfalls before they affect too many incoming deals. These insights can then also be used as a historical reference for comparing data and conducting a time-based analysis of VC processes. 

  • Make everyone on your team aware of the concept of Return On Failure 

    As mentioned earlier, most VC firms choose to adopt a risk-averse investment philosophy after building a sizable portfolio. While this can help them avoid significant losses, it also hinders innovation and growth. Not adapting to changing markets can render VCs and their referral networks obsolete after a point of time. This makes it important for firms to adopt a progressive investment philosophy that doesn’t see risk as an evil but rather as an inevitable part of the investment lifecycle. Seeing failures as learning opportunities can help firms avoid getting stagnant and make the most of every opportunity that comes to them. Return On Failure is a revolutionary concept that everyone on your team should be aware of. Introducing and normalizing them to the concept over a period can help them change the way they spot and assess investment risks. This can help usher in a more progressive investment culture at your firm. 

  • Conduct company-wide failure reviews 

    Another part of developing an organically progressive investment culture at your firm is communicating the learnings from each failure to every employee. Company-wide failure reviews help instill confidence in employees and make them understand that all failures do not necessarily translate to a loss of value. They also help every employee understand where investment processes can go wrong and what role they play in it. When used correctly, failure reviews can prove to be an effective company-wide practice that helps VCs communicate the valuable insights derived from each failure to every employee in the firm. 

     


Using investment mistakes to understand businesses better 

Investment mistakes can be the result of an insufficient or impractical understanding of the businesses you invest in. Each market sector is subject to its unique investment risks that can often take time to understand for VCs, especially if they have no prior experience with companies from that sector. Failed deals can be a great opportunity for VCs to examine the inner workings of a particular market sector and develop future investment plans based on them. This allows firms to derive great value from failed deals and use the resulting knowledge to foray into new market sectors. Failures, when aptly handled and analyzed, can become a great tool for helping VCs scale up by investing in new types of investment opportunities. 


Using Zapflow for analyzing past mistakes 

Unlike other CRM tools, Zapflow is a complete deal management solution that is tailor-made to help VC firms operate more effectively. Zapflow helps VCs monitor each lead closely and collect key information throughout the deal pipeline. Once collected, this information can be thoroughly analyzed and presented in easy-to-read performance reports on the platform itself. 

Zapflow helps investment teams gain greater visibility into their processes, allowing them to identify and rectify mistakes much faster. It also helps teams conduct detailed data analyses and use them to learn from past mistakes more effectively. In all, Zapflow is a state-of-the-art business intelligence tool that is specially designed to allow investment firms to capture valuable data and use it to generate the maximum possible return. 

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