Venture Portfolio Returns Explained
A diversified portfolio can maximize the potential for “big wins” while mitigating some of the risks of investing in private companies.
For investors who are new to venture capital, it is important to keep in mind that the magnitude of returns within a portfolio are not evenly distributed. A successful venture portfolio operates on a power law scale, in which the vast majority of the portfolio’s returns are earned from a small number of investments. These few companies are the “big wins” that typically drive the profits of the fund.
This is known as the 80-20 rule: roughly 20 percent of the companies within a portfolio generate roughly 80 percent of the returns. An extreme example of this phenomenon can be seen with First Round Capital, a lead investor that we have co-invested previously. In 2010, First Round invested $510,000 into Uber’s seed round paying $0.009 a share at a $4M valuation.1 Post-IPO, the value of that stake increased to $2.5B — a 4901x return!2
A well-diversified venture portfolio can enable investors to participate in incredible growth stories while mitigating some of the risks of investing in companies before they go public.
1Alumni Ventures did not exist when Uber was created and has not invested in Uber.
2This is an abnormally outsized win, and most venture investments will not have a return of this magnitude.