Power Law

The power law is a key mental model for venture investing. 

The power law states that the majority of the returns will come from just a few of the investments.

Similar to the Pareto principle, 20% of the deals will account for 80% of the returns.

In venture capital, the power law requires that each investment have the ability to pay back the entire fund as only a few will have outsized returns.

The returns from those winning investments will cover the losses from all the rest.

This is different from other investment classes which produce returns based on the normal distribution.

As an investor in the venture space, you must be willing to suffer many losses for only a few wins.

It can be hard to select upfront which ones will have outsized returns. 

Some use an index strategy to place investments trying to include as many deals as possible.

Once invested, it’s best to support all the companies in your investment portfolio.

 

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Hall T Martin is the director of Investor Connect, which is a 501(c)(3) nonprofit dedicated to the education of investors for early-stage funding. All opinions expressed by Hall and podcast guests are solely their own opinions and do not reflect the opinion of Investor Connect. This podcast is for informational purposes only and should not be relied upon for the basis of investment decisions.