Diversification and the Potential for Outsized Returns

seedinvest.com

We’ll start with a simple premise that is widely agreed upon: some startups will make it big while most will fail. If we were to borrow concepts from the world of statistics, startup investments are not “normally distributed.“ That is, instead of following the type of bell curve depicted below to the left, startups appear to follow more of a “Power Law” distribution.

While not everyone agrees on the nuances per se, it’s commonly accepted that the majority of your returns will be concentrated in just a select few startups while the majority of your startup portfolio investments will return at best what you invested (and more often than not even less than that).

This is a critical concept for those who have or are looking to add venture capital to their existing portfolios. If you invest in too few startups, you are statistically less likely to be invested in one of the few “winners” whose outsized returns are crucial to offsetting the myriad losses you are almost guaranteed to experience.

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