In 2006, Elon Musk wanted to raise money for Tesla. Kleiner Perkins, an American venture capital firm, priced the electric vehicle company $50 million. Musk later went for another investor which closed a deal at $70 million.
By November 2021, that car company was worth $1.24 trillion. Today, it is worth about $1.01 trillion. Good People, that is a massive economic-transduction, unleashing wealth for families, people and institutions.
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Power law of Early Stage Investing
The power law in venture capital (VC) is a principle that describes how a small number of investments can generate the majority of returns for a portfolio. This is different from a normal distribution, where returns are spread more evenly.
The power law is a fundamental feature of VC, and is based on decades of historical data. It’s a type of heavy-tailed probability distribution, which means that a small number of occurrences have a disproportionately large impact. In VC, these outliers are often called “home runs”.
Some implications of the power law include:
- A few big winners: A small number of investments can account for the majority of gains in a VC portfolio.
- Enduring many failed investments: The power law helps explain why VCs can endure many failed investments.
- Identifying unicorns: It’s essential for VC funds to identify, assist, and protect their ownership positions in unicorns.
Some strategies for taking advantage of the power law include:
- Looking for opportunities in untapped markets with minimal competition
- Focusing on ventures that could tap into vast markets with the potential to be massive
- Avoiding established incumbents
- Looking for companies that seem out of the ordinary or operate without any apparent past or present competition
- Looking for companies that show robust growth in their early stages
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