Understanding Power Law in Venture Capital Returns

Ever wondered why VCs are obsessed with unicorns? Imagine a $1M fund split across 10 companies at $100K each. Nine companies fail (the typical rate). One company needs to return the entire fund. If your winner does 10x ($100K → $1M), you break even. Not good enough. If your winner does 20x ($100K → $2M), you get 2x gross returns. barely beat index funds. Still not good enough. This means…. Your winner must do 100x ($100K → $10M) to deliver a 4x net fund return after dilution. This means if you invest at a $10M post-money valuation, you need a $1B+ exit to make the math work. This explains Why VCs don't care about failure rates - the number of failures is irrelevant. Only the size of winners matters 🦄 This is why venture capital is fundamentally different from every other asset class. In surgery, you want 99% success. In VC, you want one MASSIVE success that makes the other nine irrelevant. Of course, I think all my investments are great, and the founders are all exceptional.... But... The power law is the mathematical reality (!!) that explains why unicorns matter more than anything else

From Zero to One: The Power Law of Venture Capital (#7 of 52) Peter Thiel’s Zero to One is more than just a book on startups—it’s a masterclass in how to think differently about building something truly valuable. One of its most profound insights is the Power Law, which governs venture capital and investing in high-growth startups. In most areas of life, results follow a normal distribution—things are fairly evenly spread. But in venture capital, returns don’t follow a normal curve; they follow a power law. A tiny fraction of investments generate the overwhelming majority of returns. One company in a portfolio—think Facebook, Google, or Tesla—will drive more value than all the others combined. This means that: 1️⃣ Big Bets Matter – The best investors don’t just look for good companies; they look for great ones. They don’t spread their capital equally; they double down on the few that have the potential to define the future. 2️⃣ Being Right Once Is Enough – You don’t need to be right all the time in venture investing. You need to be right about one transformational company. The rest of the portfolio may fail, but that single outlier changes everything. 3️⃣ Secrets Create Value – Thiel argues that great startups aren’t incremental improvements on what exists. They go from 0 to 1, creating something fundamentally new. If a startup is merely competing, it’s playing a game of diminishing returns. If it’s building something no one else sees, it has the potential for asymmetric upside. For entrepreneurs, the lesson is clear: Don’t aim for small improvements; aim to build something unique, valuable, and world-changing. For investors, the takeaway is just as critical: Find the handful of companies that defy the odds and bet big when you do. Thiel himself did this with PayPal, Facebook, and Palantir—investments that followed the power law to a T. In startups, venture capital, and even personal growth, the key isn’t to do a little better than others. The key is to find or create something with exponential potential—something that can go from zero to one.

Many startups should never touch VC money. We live in an era where “raising” is seen as winning. But venture capital is very specific tool. VCs invest in businesses that can: • Grow very fast • Serve massive markets • Produce huge exits (think 10x, 20x, 30x+) That’s it. If your business doesn’t fit that formula, it doesn’t mean it’s a bad business. It just means it’s not a venture-scale business. 𝗦𝗼, 𝘄𝗵𝘆 𝗱𝗼𝗲𝘀 𝗶𝘁 𝗻𝗲𝗲𝗱 𝗮 𝟭𝟬𝘅 𝗿𝗲𝘁𝘂𝗿𝗻? 𝟭. 𝗣𝗼𝘄𝗲𝗿 𝗟𝗮𝘄 𝗥𝗲𝘁𝘂𝗿𝗻𝘀 In venture capital, one investment out of ten (or even twenty) tends to drive all the returns. • Most startups fail or break even. • A few do okay. • Only one becomes the “rocket ship.” So that one has to return the entire fund, and then some. For example. If a VC invests from a $100M fund, they’re not aiming to get $150M back. They’re aiming for $300M+ because that’s how they make money after paying back their investors (LPs) and fees. 𝟮. 𝗙𝘂𝗻𝗱 𝗠𝗮𝘁𝗵 Let’s say a VC writes 20 checks for $5M each. They know most won’t make it. So even if 90% fail, they NEED the 1 or 2 winners to make 10–50x returns to: • Pay back the full fund • Generate profits • Justify their strategy to LPs (Limited Partners) 𝟯. 𝗘𝘅𝗶𝘁 𝗘𝘅𝗽𝗲𝗰𝘁𝗮𝘁𝗶𝗼𝗻𝘀 VCs get paid on exits, not revenue nor profit. They’re looking for: • IPOs • Billion-dollar acquisitions • Unicorn status Because only those outcomes can return the kinds of multiples needed. This is the reality of this asset class. High risk, high return. So if your business doesn’t have billion-dollar potential, it might be amazing still, but it’s not a fit for VC. #venturecapital #founders #startups

Great Founders Speak VCs’ Native Language: Power Law Venture capital runs on a blunt truth: one or two companies in a portfolio often pay for every miss. Partners would love to predict exactly which ones. The reality: at the moment of investment, they cannot. No spreadsheet or gut feeling can reveal, with certainty, which new deal will become the outlier. Because foresight is limited, partners lean on proxies: repeat founders, deep domain expertise, market timing, a fast-growing TAM. Those signals matter, yet none offers a guarantee. Plenty of pedigreed teams miss, and plenty of unknown founders break out. So where does that leave you? Whether you meet all, some, or none of those surface criteria, one lever remains fully in your control: the clarity with which you frame the scale of your vision. Show, in power-law terms, how your wedge can mature into a fund-returning platform, and you allow partners to believe you could be one of those companies that return the fund. Translate your vision Feature or category. A feature fixes one pain point. A category redraws the map. Show how your wedge can become industry infrastructure. Market unlocked, not market stolen. Quantify demand you will create, not the share you will take. Expansion math beats zero-sum math. Timing signal. Explain why this is possible only now: technology inflection, regulatory shift, or buyer-behavior change. Platform angle. Preview adjacencies: APIs, data loops, or embedded rails that extend your footprint. Self-test before you pitch If everything works, will the industry call you a standard rather than a supplier? Could multiple billion-dollar businesses branch from this root without rewriting your origin story? If either answer is no, tighten the wedge or widen the vision before booking the next call. Close with conviction Partners know most startups will not move their fund, and they cannot identify the winners with surgical precision on day one. What they can do is look for founders who speak the power-law language fluently: founders who map a credible path from wedge to platform and from platform to portfolio-making return. Confidence here is not bluster. It is clarity delivered in the language the power-law model speaks.

If you want to successfully raise money from venture capital investors, it’s REALLY, REALLY important that you understand the economics of early-stage investing. Because those economics are not at all intuitive and have an enormous impact on what investors are looking for—and whether you should consider VC funding in the first place. Positive returns for early-stage funds almost all come from a small handful of huge winners, not a bunch of small-to-medium wins (this is often referred to as the power law of venture capital). Most founders have a sense of this—of course investors are looking for the next Facebook or Stripe—but sometimes miss a key implication: small-to-medium outcomes can’t return the fund, so investors actively avoid founders aiming for that territory even if they’re building good companies. Say an investor at a $100M early-stage fund invests $500k for 10% of your company. That's a $5M valuation at a stage when typically you have very little to show, so the investor has to believe your company might return the full value of their $100M fund since almost all the companies they invest in at this early stage will ultimately fail. By the time a company reaches an exit, the investor might own closer to 5% (or less) of your company depending on how dilution across multiple fundraising rounds works out (a process which deserves its own post). So, to return a $100M fund, the exit outcome has to be worth $100M / 5% …. That’s $2 billion. And that’s just to break even. The point here is that the investor *can’t* make the economics work with $50M or $100M or $250M outcomes, even if those outcomes like a huge success by most standards. The hit rate for companies in that middle range isn’t high enough to make up in quantity what’s missing in scale. And there’s an opportunity cost—any dollar invested in a company with a capped mid-range outcome is a dollar not invested in a potentially uncapped power law outcome. Here’s the rub for founders: if you’re looking for terms like a $5M valuation at pre-seed, you have to convince the investor that a multi-billion dollar outcome is possible. Not probable, but possible. There are many great businesses to be built that have hundred-million dollar outcomes, but venture funds that offer these sorts of terms simply can’t make them fit into their models. At South Park Commons, we worked our way backward to the terms of our Founder Fellowship from the outsized ambitions of our members. But structuring the SPC fund to support worldbuilders locks us into specific venture economics. If this math doesn't phase you and your ambition is to start a world-changing company, the Founder Fellowship is meant for you. You can read more about it (including our terms) here ➡️ https://lnkd.in/g89WaGGi