How venture capital funds make money: why one big win pays for all the startups that fail
Why most startups backed by venture capital fail, and their investors expect it
A venture capital fund bets on many startups at once, and it knows that about half of them will lose money. Its investors know it too. Who would put their savings into a bet like that?
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1
For five years, Miva meets hundreds of founders. She picks 20 startups, yours among them, and puts $2 million into each. The rest she keeps for later. The startups a fund holds are its portfolio.
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2
Then she tells Rono, calmly, that about half of them will probably bring back less money than she put in. Some will close and bring back nothing at all.
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3
She is not being gloomy, only honest. A firm that puts money into many venture funds, and so sees their results, looked at just over 7,000 venture investments made from 1985 to 2014: about half brought back less than the money put in.
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4
Young companies are bets on things that do not exist yet. Many never find enough customers, run out of money and close. And nobody can tell in advance which ones: if Miva could, she would skip them.
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5
Rono does the math, and it does not add up. If half the bets lose, how can the fund still bring back several times the money, as Rono expects?
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