It depends on the goals and risk tolerance of the investor, and of course how confident the VC is that they can beat the odds and select and/or create winners above the industry average across whatever portfolio size they choose. One is not necessarily better than the other. The risk/return profiles are simply different. The expected returns are the same for VC portfolios of different sizes. So who is right: Thiel or AngelList? It depends. So what would these statistics look like, for example, if a VC believes that each investment they make has twice the odds of generating a 10X+ return when compared with investments made by an “average” VC? The probability of this “twice-as-good” VC with a portfolio of eight companies having a less than 1X fund declines from 28% to 21%, while the probability of them having a 5X-or-greater fund increases from 10% to 18%. The greater the “edge” the VC is assumed to have over the industry average, the more the above curves will shift. Implicit in Peter Thiel’s recommendation is that a small, concentrated portfolio helps a VC to increase the odds that each of their few investments is one of the winners. There are only so many high quality opportunities most VCs can find and manage. Instead, there will be an inverse correlation between the quality of each investment and portfolio size. This later assumption is almost certainly not true for most venture funds. The above conclusions assume that the venture portfolios were selected and managed by an “average” VC, and there is no difference in the average quality of the investments as a function of portfolio size. While smaller venture portfolios have a higher probability of an overall loss, they also have a higher probability of hitting the ball out of the park. In other words, for a venture portfolio of eight companies, the probability is five times greater both that it will return less than 1X, and that it will return greater than 5X, versus a portfolio with one hundred companies. However, the probability of Thiel’s smaller portfolio generating an overall return of 5X+ is 10% versus just 2% for the larger portfolio.
To illustrate, the graph below plots the probabilities of portfolios at each portfolio size having a gross return of 5X or greater (the green line) and less than 1X (the red line).įor example, at Thiel’s recommended portfolio size of eight, the probability of the overall fund generating a loss is 28% versus only 6% for a portfolio of 100. The entire band of potential outcomes shrinks as portfolio size increases. However, there’s more to the distribution of venture returns than just mean and median returns. The above graph supports Abe’s argument that the power law leads mathematically to the benefits of larger portfolios, all else equal.
For those interested in learning more about the math behind this convergence, it results from the Central Limit Theorem. Median returns increase as a function of portfolio size because the distribution of venture returns is right-skewed. Median returns nearly converge with mean returns by the time a venture portfolio reaches one hundred companies. However, the median (50th percentile) returns for a fund, which a fund is more likely to achieve in practice, does increase with portfolio size. For the portfolios at each portfolio size, we calculated both the average and median (50th percentile) return.Ī larger portfolio alone does not impact average, or expected, returns. To create the graph below, we created tens of thousands of portfolios by randomly selecting investments for each vintage since 2000 with portfolio sizes ranging from 1 to 100 companies (a “Monte Carlo” analysis).
venture financings and outcomes in the industry. We’ve built the most complete database of U.S. We thought you might find interesting analyses we’ve conducted over the years to help answer this question. Abe Othman, Head of Data Science at AngelList, countered in his excellent blog post here using AngelList data that the math behind the “power law” instead suggested VCs should have much larger portfolios to make sure they have a sampling of the winners. Highly successful investor Peter Thiel advised VCs to only invest in “seven or eight promising companies for which you think you can get a 10X” return. venture fund? Peter Thiel of Founders Fund and Abe Othman of AngelList arrive at very different conclusions. What are the implications for the optimum portfolio size for a U.S. venture is a hits driven business, and we’ve previously published data quantifying how right-skewed the distribution of outcomes is.
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