Early stage investment is a risky bet.
It is asymmetrical: i.e. you can lose all your investment, but you could also gain a multiple out of it.
SO WHATS THE POWER LAW FOR INVESTING IN THE STARTUP?
So the Best investments are worth exponentially more than the better investments. And the better investments are exponentially worth more than merely good investments.
In Power Law investments, a typical portfolio is filled with home run investments (Huge Capital Gains in short period of time).
Investors should only invest in few companies giving promising returns and can give at least 10X returns.
To put it more simply, put your investments only in startups that can return your whole fund.
As part of my team's research on investment, we analyzed around 1808 investments in startups to evaluate the actual power of power law.
As it happens though, the research shows contrary to the power law of investment in few companies.
Although Peter Theil loves power laws and is making the most returns out of it, (He made around $1.1 Billion from only $0.5 Million investment in Facebook, a 2200x Return) the power law returns simple means only top quartile VC’s (Like that of Peter Thiel’s) beat the market.
After selecting the funds that follow Power Law of investing in only in few startups in order to earn exponential returns, we saw that 74% of the VC funds return were even less than the market return i.e. the return an investor would typically get when the funds are invested in market or somewhere other than the startup. And 50% of the funds were even giving negative returns.
Let alone the desired rate of returns from Investment in Startups, the law does not even justify the returns when compared to market.
Only Top-Quartile VC’s make the most of Power Law returns.
It takes a top-quartile VC funds to outperform early stage venture market.
In other words, if we expect investors to continue to follow power law, then the market returns will continue to outperform majority of the investors return on portfolio of startup investment as per the past data.
Your opinions that you have been, have the potential, or currently are among the top-quartile investors could be a folk-wisdom as per the date we produced.
While the views might be contrary, or this kind of strategies might work for you, it depends upon the in-depth analysis of your portfolio and the kind of investments you are planning to make to design a best strategy for your funds.
What are your thoughts on the power law return? Would love to know in comments..!
Image Source: Google, Angel list