Any investment decision is a calculation of expected value. Expected value = odds means the certainty of making money from investment).
If you invest in a Pre-IPO project, the winning rate is 30%, and the odds are 3 times, then the expected value is 0.9, which is lower than 1, then this project is not worth investing in; if you invest in an early stage project, the winning rate is 2%, and the odds are 60 times, the expected value is 1.2, then this project can be considered for investment.
Based on the odds and winning rate, four quadrants are formed. Different investors have different choices about odds and winning rates.
All investors are looking for investment opportunities with high winning rates and high odds, but such opportunities are too scarce in the market. An investor is very lucky to encounter such a project in his life.
Most people have to make a choice between odds and winning rate. The nature and preference of the fund determine its choice.
-01-USD funds prefer high odds, and RMB funds prefer high winning rates.
Generally speaking, US dollar funds are betting on odds. If a fund invests in 30 projects, it doesn’t matter if 29 of them die, as long as one project can make a lot of money. In the past, US dollar funds basically adhered to this concept to find targets. The industry must be extremely large, the ceiling must be extremely high, and the team must be extremely good. Only in this way can a project with a huge market value be built, and this project with a huge market value can Save the entire fund (Figure 1). Therefore, in the past Internet and mobile Internet era, Sequoia defeated JD.com, Meituan, Pinduoduo, and ByteDance; Morningside (Wuyuan) defeated Xiaomi and Kuaishou; Hillhouse defeated JD.com… The investment myth of an era.
The balance of RMB fund decision-making is tilted towards the winning rate. We don’t seek to make a lot of money, but we seek to make money. As long as the winning rate is high enough, it doesn’t matter if we make a little less. So if you look at the number of IPO projects of Shenzhen Venture Capital and Dachen, they rarely capture high-odds projects such as JD.com, Meituan, and ByteDance.
Different investment philosophies lead to completely different results.
-02-Early-stage funds prefer high odds, late-stage funds prefer high winning rates
Early-stage projects are inherently risky, have low success rates, and naturally require high odds (Figure 2). Later-stage funds are more mature and the possibility of IPO is also greatly increased.
In fact, most of China’s local investment institutions started from PE, whether it is Shenzhen Venture Capital, Dachen, or Tongchuang Weiye and Dongfang Fuhai. Therefore, even though the investment stage of these institutions has moved forward greatly today, their underlying decision-making Genes are still affected by PE logic.
US dollar funds have been working in China since the early days, such as IDG, Matrix Partners, Sequoia, and GGV.
-03-From the era of high odds to the era of low odds
From 2000 to 2020, in China’s venture capital market, odds selection obviously had the upper hand and was believed by more market investors.
However, since 2021, the odds and winning rate of venture capital have changed. The most fundamental reason is that the era of high odds has passed and now we have entered the era of low odds.
The underlying logic behind the high odds of the Internet and mobile Internet is that winner takes all. In a market, the winner can account for more than 80% of the market share, or even monopolize the market share, so it can form a super company. Apps in the Chinese market today are basically They are all dominated by one company, such as QQ, WeChat, Weibo, Didi, Douyin, Xiaohongshu, Bilibili, etc. Except for a few industries such as e-commerce with a scale of more than 10 trillion yuan, there are several listed companies competing. Basically.
The underlying logic of winner-take-all is that the marginal cost of serving users is zero and there is a network effect.
But in today’s science and technology field, on the one hand, although there is a certain scale of cost advantage, the marginal cost of serving users will not drop significantly; on the other hand, it is difficult to form a monopoly unless an absolute patent monopoly barrier can be formed. The reality is that it is difficult to form a monopoly in almost any industry. An industry with a certain scale, such as over 10 billion yuan, can spawn no less than 10 listed companies. The first company has 20% of the market share, the second 10%, and each company can have more than 5,000 yuan. profit, you can become a listed company.
Most of the customers in the hard technology field are in the B-end market. Customers in the B-end market need to consider various dimensions when making decisions, such as product quality, price, account period, logistics, after-sales service, customer relations, etc. Unlike the C-end market, you just need to make good products. Because of this, it is difficult for the B-side to monopolize the market. Currently in the field of artificial intelligence, this result has been fully verified. Although the four AI tigers have certain technical advantages, they still cannot break the law of the government and enterprise customer market – “the technical parameters of four 9s and five 9s are not worth four bottles of five bottles of Maotai.”
Without monopolizing market share, it will be difficult to form a huge market value. Without a huge market value, it will be difficult to create super returns, and there will be no high odds.
-04- Based on the logic of high odds, investing in low odds projects will definitely not work.
Times have changed, and the underlying logic of investment must change. If you still use the logic of high odds to invest in companies with low odds, it will definitely not work.
We must clearly realize that in the era of low odds, it is difficult to emerge a company with a market capitalization of 100 billion, and the vast majority of targets are between 1 billion US dollars and 10 billion yuan.
For angel investment, if the winning rate is 2% (actually lower than 2%), then to achieve an expected value greater than 1, the odds must be more than 50 times. Then if the company’s market value is 10 billion yuan, including the dilution of multiple financings , only if the valuation during angel round investment is less than 100 million yuan, it is a worthy investment target. In the article “Deducing the Valuation Bubble in the Primary Market from the Market Value of Listed Companies”, the author analyzed in detail the returns of investors in different rounds based on the market value of listed companies at different valuations. When the market capitalization is 5 billion yuan and the angel round valuation is 40 million yuan, the return multiple of the angel round is 60.68 times.
But at present, there are not many angel investments in the market with valuations below 100 million yuan. Even some projects with angel round valuations of 1 billion yuan are still being grabbed by many investors. Obviously, it is difficult for these investments to obtain reasonable expectations.
In actual investment, we often see that many angel investment projects only have 10 to 20 times the expected return, but they are still invested by investors. Is there a 10% winning rate for such projects that earn 10 to 20 times? If not, what gave you the courage to invest?
The MOIC (gross investment return multiple) of Pre IPO projects in the market today is only about 2 to 3 times, but there are still many investors investing. If the winning rate cannot be higher than 30 to 50%, such projects actually have no investment value.
-05-High valuation is difficult to change the winning rate, but lowering the odds is not an option.
The logic of valuation in today’s market has become confusing. 10 years ago we valued based on P/E, and 5 years ago we valued based on P/S. Now the valuations in the market are basically ridiculous. Whether it’s an angel round or late-stage investment, companies are increasingly daring to ask for valuations, just because there are always stupid money willing to take over.
In the field of hard technology investment, in terms of calculation of odds and winning rate, high valuation does not help to change the winning rate; in the 2C Internet era, high valuation still has a certain value, and burning money can accelerate market share and speed up the listing process. ; However, high valuations have greatly reduced the odds of investment. For a project with a future market value ceiling of 10 billion yuan, the original Series A valuation should have been 100 to 200 million yuan, but now it has risen to 560 million yuan. Naturally, in the future The return multiple is greatly reduced.
However, too many investment institutions in the market do not calculate the odds and grab projects at high valuations. In the long run, they can only lose money to LPs.
Investment has moved from an era of high odds to an era of high winning rates. Investment strategies must keep pace with the times, understand the changes of the times, and change the underlying investment logic in a timely manner, so that you can always win.