RRR--Rule of Investing

RRR...the first thing that comes to your mind might be the 2022 Indian-language epic movie with impressive special effects and choreographed dance moves, which won the Oscar for best music recently.?I am a huge fan of the movie, but sorry to disappoint you, this article is much less dramatic and potentially more practical if you are an entrepreneur or an investor.?This article walks through Kind Capital's investment philosophy and capital strategy.?After a decade leading deals for the W.K. Kellogg Foundation and Lumina Impact Ventures, I'll summarize the RRR Rule of Investing as a culmination of lessons learned and refinement of how Kind Capital picks investments.?While this article will focus on investments, the RRR Rule of Investing concept can also be applied to grant funding.?

Investors get bombarded by requests for funding, there never seems to be a shortage of ideas or requests.?As a former limited partner (LP), I’ve reviewed many pitch decks from funds.?Some venture capital fund decks claim to invest in only 1 out of every 100 pitches they see; others go as far as claiming to invest in only 1 out of every 1,000 pitches to signal how selective they are with their investing criteria as a signal of pride to impress the potential limited partners.?Any LP impressed by such selectivity is either na?ve or doesn’t fully understand what a good investor does.?I don’t say that to insult those of you who are limited partners in these so-called “highly-selective” investors, I’ll elaborate on why it’s a bad metric to consider when investing in funds, or at least should be weighted less as a factor.?

The diagram above shows the typical investment funnel.?On the left, VC Firm 1 screens 1,000 companies but invests in only one at the end of the funnel, while VC Firm 2 initially screens only 20 companies before selecting one investment. ?On the surface, VC Firm 1 is much more selective because it invests in just 0.1% of all the companies it sees, while VC Firm 2 invests in 5% of the investments it sees.?However, such a comparison would be like comparing apples to oranges.?Let’s say VC Firm 1 is a Pre-Seed and Seed stage fund, investing more generally with no particular sector or geography limits.?Thus, it must have a wider funnel at the top because numerous investment opportunities could qualify.?In contrast, VC Firm 2 might be a specialized biotech fund that only does US-based Series B and C deals, the investable market is much narrower.?As such, VC Firm 2 might be even more selective than VC Fund 1 because there aren’t as many US-based biotech companies at the Series B and C stages—lots of biotech companies don’t make it to that stage so you have a survivorship bias.?Saying it a little differently, let’s say the one pre-Seed investment in VC Firm 1’s portfolio happens to be a US-based biotech company that gets to a Series A stage; the likelihood of that investee making it to Series B is yet another challenging funnel for it to get through.?So, by the time a company gets to a Series B to be at the top of the funnel for VC Firm 2’s funnel, it would have already gone through lots of other funnels just to get to that point.?That is why it is na?ve to compare VC Firm 1 and VC Firm 2’s deal funnel. ?

Looking at it another way, what if VC Firm 2 has 500 companies at the top of the funnel? Does that mean it is even better and more selective in its investment process??Not necessarily.?It might simply be getting lots of bad deals coming to it because entrepreneurs don’t know what actually fits the fund’s investment criteria.?As a result, VC Fund 2 might be wasting time screening deals that are not remotely related to its investment strategy.?So, the next time a VC fund brags about how many deals they see, keep a slightly cynical view of why they see so many deals.?Quality over quantity is key.

To be fair, if VC Firm 2 only sees two deals at the top of the funnel and selects one out of the two to invest in, that isn’t ideal either.?It implies that the fund is not good at sourcing deals and may not have the right pipeline. ?As a limited partner, you want to see a balance of a strong deal pipeline with a methodically repeatable and successful investment process in selecting which deals to invest in, which is not necessarily well-represented by the investment funnel conversion ratio…a 5% conversion ratio may be better than a 0.1% conversion ratio.?

Understanding that, let’s now discuss the RRR Rule of Investing we deploy at Kind Capital. I share this in hopes that entrepreneurs are better equipped when contacting us (or other investors, for that matter).?Entrepreneurs need to understand an investor’s strategy and philosophy just as much as an investor needs to understand the entrepreneur’s business model during due diligence.?Our RRR Rule of Investing shows the three pillars of our approach in the following diagram. ?During due diligence, we dig into many other factors, but the RRR Rule of Investing is the top-of-the-funnel filter.?

For Kind Capital to invest in a specific opportunity, we want to ensure we provide the right capital.?If you want debt funding or a loan, our fund would not be the right investor as a pure equity investor.?Our Kind Capital Securities division can help you raise capital from other investors but understand that our fund is exclusively an equity investor.?We also do not provide grant funding, despite having many grant funder relationships.?

Secondly, is this the right time for us to consider your company as an investment??If you are at a stage of development where you are looking for pre-Seed or pre-IPO, we are not the right investor.?That doesn’t mean we can’t help find others who are a better fit, but we know where we can be most helpful to entrepreneurs as investors, which tends to be companies at the Series A through Series C stage. ?Related to this is the timing of a transaction.?During the market’s peak, I heard some VCs were getting deals done in two weeks in some of the more competitive processes.?As much as we understand the sensitivity to timing for deals, we have a thorough vetting process and want to make sure we really understand you and your company, just as we hope you would want to know us.?Two weeks is insufficient even if we dropped everything to focus exclusively on vetting one specific investment opportunity.?This is one reason Kind Capital would not be the right investor for highly competitive processes as we will not compromise on our diligence processes just to meet a deadline. Entrepreneurs whom I had invested in from my prior roles used to hear my pitch: we are cheap, we are slow, and we may be more difficult to work with for compliance reasons (when I represented foundations).?This typically turns away some of the highfliers or entrepreneurs who didn’t understand the value we brought to them as an investor; some of the highfliers have flamed out either doing a down round or wound down. I’m proud to say that the entrepreneurs who took an investment from me serve as references for other entrepreneurs, and our best investments tend to come from referrals.?

Lastly, the third “R” for right relationships is a critical screen for us.?There are two aspects to this.?Firstly, are we the right partner for you beyond the capital you seek? ?We are mission-driven investors backing scalable, impactful companies that can scale rapidly that are not capital-intensive. ?As such, we will not back entrepreneurs with questionable integrity and not aligned with our values no matter how great the potential financial opportunity is; our brand and integrity are assets to those we partner with, not just to us.?Secondly, what relationships in our network can be brought to add value to your company??Kind Capital is not a passive investor, so once we make an investment, we are your trusted partner for success, bringing our full intellectual and network resources to support you.?If you are looking for a check with no engagement, there are certainly other investors who write bigger checks and are happy to leave you alone but it’s not Kind Capital.?

In summary, the RRR Rule of Investing is how we build our funnel of investments.?The intersection of the right capital, at the right time, with the right relationships that we can bring to support an entrepreneur’s success is the sweet spot for the end of the funnel.?Entrepreneurs need to due diligence their investors as much as investors due diligence them.?If you don’t make it through one investor’s funnel, you might be a great fit for another investor’s funnel; the key is not to force yourself through a funnel that you know is not the right fit because it will only lead to uncomfortable and difficult situations in the future.?No one likes to be in a bad marriage, and investments are like a long-term relationship between investors and their investees. ?Sometimes investors change their funnel criteria when a sexy opportunity comes along that other investors are chasing so that it can get through their funnel, this rarely ends well. ?Being disciplined and committed to your investment strategy is what your limited partners subscribed to when they gave your fund capital to manage.?Changing your strategy to accommodate a hot deal would feel like a bait and switch.?If I were an LP, I’d be very suspicious the next time you came asking for more capital because I wouldn’t trust what you told me you would invest in, even if you got lucky with an investment from bending the rules of your investment thesis. ?As those who have worked with me know, I’m not a fan of surprises.?A disciplined, repeatable, methodical strategy will deliver more consistent returns than surprises from luck.?Luck is bi-directional, it can benefit you one day, then bite you the next.??