Peter Thiel in <i>Zero to One</i>:<p>> The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.<p>> This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments. (Even quite successful companies usually succeed on a more humble scale.) This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.
I raised a small seed round (200k) on my first company. At that time I felt like it was a staggering amount of money. The company didn't work and out we pretty much lost all of it. For the longest time, I felt really guilty about how I had lost my investors money.<p>I have a little more perspective now and realize that it was practically insignificant to my investor.<p>Ah well.
Can someone help me do some math here? Take these sentences:<p>"It was all about five investments in which we made 115x, 82x, 68x, 30x, and 21x."<p>"In our 2004 fund, we invested a total of $50mm out of $120mm of total investment in our nine losers. "<p>OK so in the 2004 fund we have $70mm being invested in companies with rates of return between 21x and 115x. Let's be conservative and say the total return on that $70mm was 50x. That means 70mm --> 3.5B. If we assume that's the total return on the fund we get 120mm --> 3.5B.<p>I am now going to assume these returns were realized over a period of 10 years. So that works out to about 40% gains each year (compounded 10 times).<p>Is USV really making 40% every year for a decade? Are other VCs doing that well? I knew these funds were good investments but I didn't realize just how good.
This can also be a good rule of thumb for entrepreneurs investing in ideas or potential new features, or even for ordinary employees managing their careers.<p>You can get surprisingly far in life simply by cutting your losses early. If you majored in art history, got to junior year, and then suddenly realized there are no jobs available - switch your major! Or transfer, if you have to. If you hate your job, find another one! If your skillset is out of date, learn whatever the new hotness is. If you picked a dead-end field that's being disrupted by a new industry, switch to the new industry.<p>Many people <i>don't</i> do this, because of a couple of cognitive biases: sunk cost fallacy and fear of the unknown. But they ignore that they've learned new information in whatever their old role was, and that the future is usually much longer than the past.
This also explains why VCs look to fund billion dollar opportunities even if they look a little risky. VCs are in the game for big exits and that's how the math works out.<p>Something to keep in mind when you're planning to raise money.
It would be awesome to see a list of the winning companies and the approximate multiple on invested capital returned for each of them, along with which companies fizzled out.<p>Not expecting to ever see that, but it would be interesting to learn which ones they thought would be huge successes and what the eventuality was.
It's risk/reward. Whether a VC fund, NYSE, or government security, you can risk more for greater reward. This does not mean, as the article implies, that you should. It depends on the individual and the purpose of the investment. I can probably make a lot more money investing in a riskier company, but I am also more likely to lose some or all of my investment.<p>If I am considering investment in a fund that expects a 40% annual return, I should remind myself that if it was a sure bet, then enough people would be investing in it to drive the price up and the return down. There are plenty of investors as smart as me, and many of them are willing to do more research than I am.
The Babe Ruth Effect in Venture Capital<p><a href="http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/" rel="nofollow">http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture...</a>
> I am a big believer in “loving your losers” in the sense that you should not orphan them and you should work hard to get to the right outcome.<p>From the guy who talked about cutting off losers early a paragraph ago.
My 'fantasy VC' scorecard since 2008 is nearly perfect, having hypothetically put money into snapchat, air BNB, Uber, and Facebook. Picking the future winners from the losers seems very easy, but the problem is if everyone did this strategy many companies would go unfunded. Just simply funding companies that are already big and growing rapidly and riding the momentum, seems to guarantee the most consistent returns. Investing in tiny startups seems not worth it since the expected value is not high enough and the liquidity is probably poor.
Note: Ben Graham wrote about all these decades ago. (It doesn't make this article less true, etc. -- just if you're interested in these basic rules of investing, then read 'The Intelligent Investor'.)
Why would anyone feel guilty about losing money from a VC?<p>In the end, it's a venture capital FUND: risk and return are inherent to this. It's not the VC's money, but a collection of GPs (themselves have thousands of individual investors).<p>Your loss is already accounted for in their portfolio. Otherwise, they're not doing it right.