Figure 1 J curve of successful venture capital For most funds, this exponential growth will never happen. Venture capitalists mistakenly expect the return of venture capital to be normal distribution: hopeless companies will close down, medium-sized companies will be flat, and the return of good companies will double or even quadruple. Assuming this humble model, investors have made various investment portfolios, hoping that the returns of successful companies can offset the losses caused by failed companies. But the method of "casting a net to pray" usually loses everything. This is because the return of venture capital does not follow the normal distribution, but follows the power law: a few companies completely beat all other companies. If you value casting a net instead of just focusing on a few valuable companies in the future, you will miss these rare companies from the beginning. Figure 2 clearly shows the difference between reality and misunderstanding.

Figure 2 Relationship between company ranking and return on investment

The performance of our founder's fund explains this distorted model: in 2005, Facebook, the best performing company in our portfolio, had a higher rate of return than the other companies we invested in combined. Palantir, the second-best performing company, brings more returns than all companies except Facebook combined. This highly unbalanced model is not accidental: it has happened to other funds. The biggest secret of venture capital is that the best investment return of a successful fund is equal to or greater than the sum of all other investment objects.

This allows venture capitalists to sum up two very strange laws. The first rule is to invest only in potential companies whose profits can reach the total value of the whole investment fund. This rule is terrible, it excludes most possible investments at once. This rule leads to the second rule: because the first rule is too strict, no other rules are needed. Think about the consequences of breaking the first rule. Andriessen horowitz Investment Fund invested $250,000 in Instagram in 20 10. Two years later, when Facebook bought the company for $65.438 billion, andresen had earned $78 million-in less than two years, he got a return of 365.438+02 times! This amazing return has also earned it the reputation of the best company in Silicon Valley. But strangely, this is far from enough, because Andriessen Holovitz's fund size is $65.438+0.5 billion: if only a check of $250,000 is written, the company will have to find 654.38+0.9 Instagram to make ends meet. This explains why investors always invest more in companies worth investing in. Venture capital funds must find a group of companies that can successfully leap from 0 to 1, and then do their best to support them. Of course, even the best venture capital company will have a "portfolio". Our founder's fund only focuses on about five or seven companies, and we think these companies will be worth billions of dollars in the future. If we only focus on diversified hedging strategies, then investing is like buying lottery tickets. Why can't people see the power law? Why can't professional venture capitalists see the power law? First, it takes some time for the power law to be clearly displayed. Even technology investors usually live in the present and cannot predict the future. Imagine that an investment company has invested in 65,438+00 companies that have the potential to become monopolists-this is already a rare and quite disciplined portfolio. Those companies are very similar in the early stage before exponential growth, as shown in Figure 3.

Figure 3 Initial investment In the next few years, some companies will fail and some will succeed; Valuation will also change, but the difference between exponential growth and linear growth is not obvious.

Figure 4 Medium-term investment But after 10 years, the portfolio will no longer be divided into successful investment and failed investment, but only into a major investment and other investments. But the results of power law, no matter how obvious, cannot reflect daily experience. Because investors spend most of their time on new investments and taking care of start-ups, most of the companies they participate in are obviously ordinary. The difference that investors and entrepreneurs can perceive every day partly comes from the difference of success, not the difference of absolute advantage and failure. No one wants to give up an investment. Venture capitalists often spend more time in the most problematic companies than in the most successful ones.

Figure 5 Investment Maturity If investors who specialize in the index growth of start-ups ignore the power law, it is not surprising that others ignore it. Power law is widely distributed and obvious, but it is ignored. For example, when most people outside Silicon Valley think of venture capital, a group of weirdos may appear in their minds-just like ABC's "Shark Pool" program, except there are no commercials. After all, less than 1% of newly established companies in the United States can get venture capital every year, and all venture capital accounts for less than 0.2% of GDP. However, the results of these investments have promoted the development of the whole economy disproportionately. The employment opportunities created by companies supported by risk insurance funds account for 1 1% of all employment opportunities of private companies. Indeed, 12 large technology companies are supported by venture capital funds. The total value of these 65,438+02 companies exceeds $2 trillion, exceeding the sum of all other technology companies. The law of life is not only important to investors, but also important to everyone, because everyone is an investor. As long as an entrepreneur spends time managing a start-up, he is making an important investment. Therefore, every entrepreneur must think about whether his company will be successful and valuable in the future. Similarly, everyone is an investor. You choose a career because you believe that the job you choose will become very valuable in the next few decades. The most common answer to the question of how to ensure future value is diversified investment portfolio-"Don't put all your eggs in one basket", and everyone is told not to put all your eggs in one basket. We have said that even the best venture capitalists will list their portfolios, but investors who know power law will list as few companies as possible. The idea of portfolio comes from folk wisdom and financial practice, but these ideas think that the most favorable way is to spread the bets. The more companies you invest in, the less risk you will take in the uncertain future. But life is not the portfolio of the founders of startups or any individual. An entrepreneur can't "diversify" himself: he can't run more than a dozen companies at the same time and expect one of them to stand out. In order to diversify life, it is impossible for individuals to keep more than a dozen occupations with similar possibilities at the same time. What the school teaches us is just the opposite: institutionalized education teaches undifferentiated common sense. Everyone in the American education system has not learned to think in terms of power law. Every middle school has a 45-minute class no matter what class. Every student advances at the same speed. In college, model students persist in learning other unpopular skills in order to ensure their future development. Every university believes in "Excellence", and the hundreds of pages of alphabetical curriculum randomly given by the education department seem to ensure that "what you do is not important, what matters is that you do well". It doesn't matter what you do. This is a complete mistake. You should pay full attention to what you are good at. Before that, you should think carefully about whether this thing will become valuable in the future. This idea is used in startups, that is, even if you are talented, you don't have to start your own company. There are too many people running their own companies now. People who know power law will be more hesitant than others when starting a business: they know that joining a fast-growing first-class enterprise will lead to greater success. The law of power means that the differences between companies will dwarf the differences in roles within companies. If you start your own business, you own 100% of the shares. Once the company goes bankrupt, you lose everything. On the contrary, if you only own 0.0 1% of Google, the final return will be incredible (more than $35 million). If you have started to run your own company, you must keep in mind the law of power and run the company well. The most important thing is unique: one market may be better than all other markets. Timing and decision-making should also follow the power law, and some critical moments are far more important than any other. However, you can't trust a world that denies power law and prevents you from making accurate decisions with it. The most important thing is often not obvious at a glance, even like a secret. But in the world of power law, if you don't seriously think about where your actions will put the company on the 80-20 curve, you really can't afford the consequences.