Why you need to diversify when investing in startups

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Experienced startup investors like Fred Wilson and Dave McClure, who respectively run a leading VC firm and the largest startup accelerator, recommend making smaller bets in more startups to maximize odds of including one of the great “Thunder Lizards” like Uber or Airbnb in your portfolio.

Anecdotally angels agree that startup outcomes tend to be binary, with most failing to return at least a 1x return, or invested capital, and a very few delivering extraordinary returns. Incredibly, the big winners overshadow the losers so much so that they make angel investing an attractive as an asset class.

Others like Alex LaPrade have taken a data-oriented approach and analyzed how diversification affects expected portfolio returns from the largest and most reliable dataset, the Kauffman Foundation’s Angel Investor Performance Project (AIPP).

The chart above shows the results of LaPrade’s Monte Carlo simulation of investing in the 1,137 startups with exits from the AIPP dataset at various portfolio sizes. At only 1 or 2 startup investments, an investor’s chances of merely breaking even are at 83%. But increase portfolio size up to 20, and that same investor gets a nearly 99% chance of break even and 67% chance of achieving a greater than 3x return. At the extreme, investing in 500 startups increases the investor’s chance of break even to a near certainty, and chance of at least a 3x return to 96%.

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