Good VCs and the Power-Law Rule

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Last month, Kleiner Perkins finally added Uber to their portfolio. Uber joined their Digital Growth Fund alongside other winners like Facebook, Groupon, Twitter, and Zynga [1]. And before you point out that 50% of those companies are shit, remember that the important part is that KPCB got out at IPO. (oh, I guess they held on to some common stock)

KPCB participated in Uber’s $1.2B Series D round at a valuation of $17B. The fund also did not invest in Facebook or Twitter until fairly late in the game. Does this A-list portfolio make Kleiner Perkins a good VC firm? Is Mary Meeker, who leads the Digital Growth Fund, a good VC?

power law startup

VCs expect their investment returns to take a power law distribution, where a stake in just one company achieves a valuation greater than the entire fund [2]. Not only do VCs usually exercise their pro rata rights in up rounds, but startups that have up rounds tend to attract bigger and better investors, accumulating advantage and cementing future success.

VC firms also take a power law distribution. A firm that makes a good early investment (eg, Kleiner Perkins with Google) will have an easier time raising future funds and gain access to better deals. A company like Uber has its choice of investors. It wasn’t trying to fill board seats, but a bank account, and went for the biggest VC names in the industry.

3 percent of the venture capital firms generate 95 percent of the industry’s returns, and the composition of the top 3 percent doesn’t change much over time [3].

Good VCs don’t have to pick good companies to invest in; Good companies choose them as investors.

References:
1. Kleiner Perkins profiting from digital growth deals –Fortune
2. Venture Capital and You –Peter Thiel CS183
3. Why Angel Investors Don’t Make Money … And Advice For People Who Are Going To Become Angels Anyway –TechCrunch

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