Power law in VC: how startup returns add up

Brian Nichols is the co-founder of Angel Squad, an angel investing community where aspiring and active angels learn from Hustle Fund’s approach, review curated deal flow, and connect with peers.

An investor can lose money on several startups and still earn a positive portfolio return. That can feel strange when you're used to judging success by how often you get something right.

The power law helps explain that pattern. Understanding it means looking at the size of each outcome, the dollars you invested, and what you eventually get back.

What is the power law?

In venture capital (VC), the power law describes the way a small number of exceptional startup investments can account for a disproportionate share of a portfolio's value. Many other investments may return little or nothing. Most of your bets could fail.

Commonfund's historical venture analysis found that a handful of companies contributed disproportionate value in its own investment history. That describes a historical sample, not a fixed success or failure rate for your next ten investments.

The practical implication is to think about investments together. Our co-founder and general partner Elizabeth Yin writes in Democratizing Knowledge (2021), “Don't try to pick a co. Select a portfolio.”

A large winner can cover other losses. Whether it does depends on how much you invested in it and how much it returns.

The mistake new investors make

Counting successful companies tells you less than you might expect. Two portfolios with the same starting budget can produce very different outcomes.

For a simplified, hypothetical comparison, imagine investing $5,000 in each of ten companies on June 11, 2025. Each portfolio has $50,000 invested and is fully liquidated on June 11, 2035. These are illustrations, not projections or a recommended portfolio size.

All proceeds are realized cash, with no remaining holdings, interim distributions, or follow-on investments. The multiples are gross, before fees, carry (a manager's share of profits), and taxes. A 5x investment multiple means receiving five times the money invested, including the original capital.

• Nine 5x outcomes and one total loss: Each winner returns $25,000. Total proceeds are $225,000, divided by $50,000 invested, for a 4.5x gross portfolio multiple.
• One 100x outcome and nine total losses: The winner returns $500,000. Divided by the same $50,000 invested, that's a 10x gross portfolio multiple.

The second portfolio has fewer winners and more money back. Its 100x investment produces a 10x portfolio outcome because it received one-tenth of the starting capital.

The portfolio math still works

Under those same hypothetical assumptions and liquidation date, eight investments returning 2x and two returning zero produce $80,000 in proceeds. Divide by $50,000 invested and you get 1.6x gross. That arithmetic works in venture, too.

Add all the proceeds and divide by all the capital invested. With unequal checks, an investment's contribution depends on its share of the total invested capital. With equal checks, averaging the investment multiples gives the same answer.

The power law describes uneven outcomes. It doesn't exempt a portfolio from arithmetic or guarantee that an outlier will arrive.

More investments can provide exposure to more possible outliers. Under a fixed budget, they also mean smaller checks. Your selection quality, available deals, shared risks across companies, and money reserved for follow-on rounds all affect the tradeoff.

What it means to be a power law winner

A company's valuation growth and your investment multiple are different quantities. Dilution occurs when new shares reduce your percentage ownership.

Here's another simplified, hypothetical example, with an investment on June 11, 2025 and a cash exit on June 11, 2035. Assume a $5,000 equity investment at a $5 million post-money valuation, meaning the company's valuation immediately after the financing. That buys 0.1% ownership, with no additional checks.

Suppose later share issuances halve that ownership to 0.05%. A $500 million equity exit then produces $250,000 for your stake, or 50x gross. A $1 billion equity exit produces $500,000, or 100x gross. Both assume the stated equity value is distributed proportionally to shareholders, with no debt deductions, preferential payouts, or transaction costs.

The valuation grew 100x or 200x, respectively. Your diluted investment returned 50x or 100x gross, before fees, carry, and taxes. Net proceeds are the cash you keep after applicable fees, carry, and taxes.

An unsold stake valued at that amount is a paper value, not cash proceeds. These multiples also say nothing by themselves about annualized performance. Receiving money after ten years differs from receiving it after two.

Why can't we just pick more winners?

Product-market fit means a product satisfies strong demand in its market. Predicting who will find it, and how large that business can become, is difficult at the early stages.

Even serial entrepreneurs who know how to run a business, hire, and manage teams face that uncertainty. Operating experience helps them execute and interpret evidence. It doesn't guarantee they can predict which combination of product and market will take off. Timing and luck matter, too.

That leaves room for diligence. Customer demand, retention, distribution, and the founders' ability to learn give you evidence to assess. They don't make an early-stage outcome certain.

It boils down to this

Our view is to pursue exposure to plausible outliers within a budget you can afford to lose. A high hit rate alone doesn't tell you what the portfolio will return. Neither does a long list of startup investments.

As Elizabeth Yin puts it in Democratizing Knowledge, “Decisions are never in isolation - they are a comparison game.” Check sizes, new investments, and follow-ons compete for the same finite dollars. Our portfolio construction session explores those decisions further.

Private placements can be difficult to sell and may require an indefinite holding period, as the U.S. Securities and Exchange Commission's private-placement bulletin explains. More checks don't remove that risk or guarantee a profitable portfolio.

To learn how we evaluate early-stage companies and compare your reasoning with other investors, apply to Angel Squad.

This material is educational and is not investment, legal, tax, accounting, or valuation advice. Startup investments are speculative, illiquid, and long-term; you could lose your entire investment. Past results and current paper values do not guarantee future results. Actual outcomes depend on governing documents, fees, carry, taxes, capitalization tables, valuation policies, and exit timing. Consult the governing documents and seek independent review from qualified investment, legal, tax, accounting, and valuation advisers.