By Tren Griffin
1. “The top investment is worth the total amount of all the other projects and more. You’re looking for the one high water mark, not the average. People don’t come to you looking for singles.” Venture capitalists focus on hitting tape measure home runs because that is what overwhelmingly drives investor return. A portfolio of 30-40 bets on startups per fund, with massive potential upside and small downside, will have its financial return driven by 1-3 huge winners and a distribution of overall financial returns that is a power law. Andy Rachleff has a great post on venture capital economics in which he notes: “the industry rule of thumb has been to look for deals that have the chance to return 10x your money in five years. … If 20% of a fund is invested in deals that return 10x in five years and everything else results in no value then the fund would have an annual return of approximately 15%.”
One negative outcome of all the attention given to the financial success of a few massive start up successes is that there are many businesses one can start which do not require venture capital, which many people believe are not fundable or worth pursuing. These non-venture capital-backed businesses can generate attractive financial returns and can, if selected correctly, have a substantially lower probability of failure. This should not surprise anyone, since you simply can’t have the failure rate of venture capital-backed businesses and have the winners return two to five-times invested capital over a similar period. Too many people believe that all startups should raise venture capital and that is a shame, since it is likely that fewer new businesses are created than is optimal for the economy as a result. Bill Gurley has said on this point: “If you want to get to 50 to 100 employees ‘unless you’ve discovered the next Google AdWords,’ you’re going to need outside funding, but that doesn’t mean VC investment is the path for everyone.” Marc Andreessen has pointed out that there are about 200 “fundable” startups per year by top tier venture firms. A healthy economy must generate far more than 200 new business in a given year to grow and create new employment opportunities…….