Generational technological shifts like AI have often, but not always, led to outsized venture returns in the years following their introduction. What’s the best prediction for AI?

Let’s look first at software. There have arguably been two major technology shifts in software since 1990: the internet boom beginning around 1993, and the cloud/mobile wave in the late 2000’s triggered in part by the launch of the iPhone and the Apple app store in 2007 and 2008.

We thought we’d use our industry-leading database of U.S. venture outcomes to see how venture returns within software fared following the launch of these new technologies.

The graph below plots the gross total multiple for all software investments made in a given year relative to the typical — or median — return for software investments across all of the years below.

Notice how venture returns spiked for new software investments made in the years after the introductions of those key technologies. Specifically, returns spiked for about five years.

Now let’s look at biopharma, depicted in the graph below. The industry experienced outsized returns for about five years after the launch of the gene editing era in the 2010’s enabled by the invention of CRISPR.

A caution, of course, is that it is relatively easy to identify profitable technology shifts after the fact.

Many predicted that the completion of the human genome project in 2003 would similarly lead to the creation of many successful companies and outsized biopharma venture returns. As you can see, this didn’t happen. In fact, returns in the years following 2003 were among the lowest we’ve seen historically for the sector.

The key difference we see between the sequencing of the human genome and the internet boom, the cloud/mobile wave, and gene editing is that the later each led directly to immediate and widespread commercial products with superior properties for users. The sequencing of the human genome was an incredible scientific breakthrough, but it took decades for those breakthroughs to lead to the creation of better drugs or diagnostics, which were many steps removed.

AI appears to us to be much more similar to the internet boom, the cloud/mobile wave, and CRISPR in terms of its immediate and widespread commercial adoption.

ChatGPT launched in November 2022 and experienced one of fastest adoptions of a technology in human history, with over 110 million downloads in just the first 2 months. As points of comparison, Instagram took over two years, Facebook over four years, and Google over six years to reach this level.

While not enough time has passed since 2022 to see the impact of AI on returns, anecdotally, we’re already seeing attractive exits taking place. Two of our companies, for example, have benefited from significant AI-tailwinds: MosaicML and Neon were each acquired for over $1B by Databricks.

So, yes, we are optimistic history will repeat itself with AI. We’d highly value hearing your thoughts on this topic. Please comment!

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. We’re actively investing and would value hearing of any investment opportunities. We co-invest in U.S. venture financings across all sectors and stages in rounds with at least one other outside VC participating. Leveraging our pioneering analytics, we typically make decisions within a few days without repeating any classic diligence. We are flexible on investment size, investing up to $4M in initial investments and up to $10M over the life of the company.

With approximately $500 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in over 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), Bluevine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Janux (JANX), Lever (ACQ: Employ), Mosaic ML (ACQ: DataBricks), Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Neon (ACQ:Databricks), Nerio (ACQ: Boehringer Ingleheim), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

AI and U.S. Venture Returns - Will History Repeat Itself? was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

It’s the longest ever. According to our data, the IPO window for U.S. venture funded companies has never remained so closed for so long.

The IPO window for U.S. venture funded companies began closing in February 2022, just before the Fed began sharply raising interest rates in response to increasing inflation. More than three years later and counting, it remains largely closed.

This is longer than when the IPO window similarly closed following the dot com bust, which lasted for more than 2 ½ years from the end of 2000 through late 2003. The IPO window also largely closed for approximately two years during the Global Financial Crisis.

Can we learn anything about returns in these prior periods that might apply to today? We thought we would use our industry-leading database of U.S. venture outcomes to find out.

In the graph below, we plot the average realized gross multiple for all investments made into companies that exited each year since 2000 (the green dashed line), as well as the percent of exits that were IPOs (the dark blue line). Each of the time periods in which the IPO window remained largely closed for at least a year are shaded light gray.

Note the strong correlation between the two lines. Average realized multiples by exit year industry-wide have been highly correlated with the percent of exits that are IPOs. The fewer IPO exits, the lower the realized returns.

To date, attractive realized returns for our industry have required an open IPO market.

While the above graph shows returns for investments that exited during years with and without open IPO windows, what about returns for new venture investments made in those years?

The graph below plots the same data as the graph above except, in this case, mean realized returns are plotted for all U.S. venture investments made in a given financing year (the purple dashed line) rather than by exit year.

Average returns for new investments have tended to increase over the time period in which the IPO window was largely closed. Note the upward sloping purple lines within each shaded area within the above graph.

There are many similarities between today and these past shaded time periods. For example, each immediately followed years in which U.S. venture firms had raised a lot of capital. They also followed and were during years in which both public equity and later stage private valuations had dropped sharply after having risen to levels widely described as “lofty”. In addition, the total capital invested each year by VCs, and the number of new companies formed, declined significantly during these periods.

These facts are consistent with the hypothesis that one cause of closed IPO windows in U.S. venture is that VC’s and entrepreneurs, when relatively flush with cash and facing declining valuations, focus more of their resources on funding and managing their later stage companies rather than accepting (the reality of?) lower public valuations.

Unlike the earlier shaded time periods, interest rates today are higher and early stage valuations have not corrected as significantly. Each vintage is, of course, unique with no guarantee that history will repeat itself.

However, the inherently cyclical nature of U.S. venture is clear.

As illustrated in the above graphs, each time the IPO window has closed since 2000, boom exit years have followed, with an even higher percent of exits being IPOs and higher realized returns by exit year.

When one window has closed in U.S. venture, so far another one has always opened.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With approximately $500 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in over 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), Bluevine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Janux (JANX), Lever (ACQ: Employ), Mosaic ML (ACQ: DataBricks), Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Neon, Inc., Nerio (ACQ: Boehringer Ingleheim), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

When One Window Closes, Another One Opens? was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

As early-stage VCs and entrepreneurs, most of us accept that we are taking on significant risk in our investments and startups. Drawing from our knowledge of economics, we trust that the greater risk we are taking will result in higher average returns.

But has this occurred in practice? Are early-stage venture investments truly riskier than later stage investments? Do they generate higher returns and, if so, are these returns sufficiently high to justify the added risk?

To help answer these questions, we wanted to share, for the first time, findings from our industry leading database on risk and return by investment stage at the financing level in U.S. venture.

As illustrated in the above graph, U.S. venture returns by stage over the past two decades have followed in practice what is predicted by economics theory: the higher the risk, the higher the average dollar-weighted returns. Both the probability of losing capital and average returns have increased steadily by round stage.

But is the additional average return that early-stage investors receive sufficient to compensate for the added risk? While answering this question definitively is beyond the scope of this short blog, we plotted the same data from the graph above in a different way below to potentially provide some insight on this question.

The green line plots the increase in the percent loss rate for Series A investments compared with each of the later stages. The blue line does the same for the increase in realized returns. For example, when compared with Series B Rounds during this time-period, Series A Rounds had a little more than .7X higher average returns, and an additional ~6% of their financings lost capital.

The increase in returns the earlier the stage in U.S. venture has roughly tracked with the increase in risk (as measured by the loss ratio), suggesting that investors at all stages have been compensated for their risk.

Two questions that came to our mind from the above findings were: how persistent is this risk/return relationship over time, and what are the implications for VC portfolio construction?

To determine how persistent the difference in average returns has been, we plotted below the average dollar-weighted realized multiple for Series A through Series D rounds by financing year since 2000.

While earlier stage investments have almost always produced higher average returns than later stage, that has not been the case in all vintages. Perhaps not surprisingly, those vintages where the relationship has broken down appear to have been during large market resets, such as in the early 2000’s and recently.

Regarding portfolio construction, the above graph also points to the value of time diversification, particularly for early stage investors seeking to ensure their greater risk is rewarded by higher average returns.

Mathematically, VCs can significantly reduce the probability of a loss at the portfolio level by constructing larger portfolios. Large portfolios enable, for example, early-stage VCs to have relatively high expected returns with a reduced probability of loss at the fund level. However, large portfolios come with tradeoffs, including tightening the band of potential outcomes for the fund and reducing the ability to focus on each individual investment. If you are interested in more thoughts on this topic, you might check out our earlier blog titled “Thiel vs. AngelList. Who is Right?”

Correlation Ventures is actively investing across both early and late stages in U.S.-headquartered venture-funded companies within all industry sectors. Please see a summary of our firm below and don’t hesitate to reach out with any potential opportunities.

Methodology Notes: In the above analyses, for simplicity. we used dollar-weighted realized cash-on-cash multiples as the measure of “returns”. However, we also generated similar conclusions when factoring in the time-value of money; for example, using IRR’s or discounted (net present value) multiples.

Regarding the risk of VC investments, once could measure it in various ways, including as the standard deviation in historical returns, or by the covariance with public equities, for example. While the above graphs would look similar if we had plotted these measures, we chose instead to share a measure of risk that is perhaps more intuitive: the percent of investments that are “losers”, i.e., investments that result in a less than 1X return on capital. If we measure risk as the percent of dollars (rather than of financings) that realized a less than 1X return, the risk similarly decreases with stage, although at lower rates (for example, 56% for Series A).

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With approximately $500 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in nearly 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), Bluevine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Janux (JANX), Lemonaid (ACQ: 23andMe), Lever (ACQ: Employ), Manticore Games, Mosaic ML (ACQ: DataBricks), Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

Does Greater Risk Equal Greater Return in U.S. Venture? was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

Do U.S. venture returns follow the famous 80/20 Rule, which asserts that 80% of the outputs often come from 20% of the inputs? We used our industry-leading U.S. venture outcomes database to find out.

The graph below plots the percent of industry profits as a function of the percent of invested capital for all U.S. venture investments made since the early 1990’s.

It turns out that profits are even more concentrated in the hits-driven U.S. venture market than would be predicted by the 80/20 Rule.

Specifically, as shown by the far right bar on the graph, U.S. venture tends to follow something more like a 90/20 Rule, whereby approximately 90% of the industry profits have been generated by 20% of the invested capital.

U.S. venture returns mathematically follow a “Power Law” type distribution. We’ve quantified this highly-right skewed distribution of outcomes in other ways, and discussed the implications, in prior blog posts such as “Venture Capital — We’re Still Not Normal” and “Thiel vs. AngelList. Who is Right?”.

We were struck by a couple of other data points on the above graph that result from this right-skewed distribution. Almost two thirds (63%) of U.S. venture profits historically have been generated by just 5% of invested capital, and a majority of industry profits have been generated by just 3% of investments.

In order to test how stable the 90/20 U.S. Venture Rule is over time, we plotted the percent of invested capital required to generate 90% of the profits during each decade historically.

Although the specific ratio has varied somewhat across venture history, when aggregated across each decade, the percent of investments required to generate 90% of the industry profits has remained within a relatively tight band between 17% to 23%.

When we analyzed individual financing year time series data, we noted an inverse correlation between the attractiveness of a given vintage in terms of ultimate realized returns and the concentration of the profits by invested capital. Specifically, the lower the average returns for a given vintage, the fewer winners there are and the more that the wealth tended to be concentrated, resulting in a lower percent of invested capital generating 90% of the profits. You can see this play out in the graph above, with the 2000’s having the lowest percent of invested capital required to generate 90% of the industry profits.

While the basic conclusion to focus our efforts on our winners is one that most of us have heard many times, and would agree with intellectually, the reality is that many of us end up doing the opposite: spending much of our time on those portfolio companies that are struggling and unlikely to be among our fund-makers.

As we begin a new year, we hope the U.S. Venture 90/20 Rule will provide all of us in our ecosystem — including entrepreneurs, advisers, VCs, and LPs — with a concrete reminder to focus our efforts on those activities that generate the lion’s share of the benefits.

A rule of thumb for VCs is that we should identify the approximately two out of ten investments in our portfolios that remain potential fund-makers and devote the majority of our time, effort, and ideally capital to those.

We’d love to find one of those fund-makers to work on together. If you are an entrepreneur raising or a VC or advisor working with a team that is closing a round, we would value any introductions where we might be helpful as a co-investor.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With approximately $500 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in nearly 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), Bluevine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Janux (JANX), Lemonaid (ACQ: 23andMe), Lever (ACQ: Employ), Manticore Games, Mosaic ML (ACQ: DataBricks), Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

Methodology Notes: The Correlation database consists of the vast majority of U.S. venture financings that have occurred since 1992. Realized outcomes are those investments in companies that have either gone public, been acquired, or gone out of business. For public companies, all VCs are assumed to have exited their positions at the median stock price 6 to 9 months after the IPO, regardless of when they actually exited. Wherever possible, for acquisitions, not yet realized milestone payments are excluded.

The 80/20 Rule for U.S. Venture? Not Exactly. was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

One graph from our proprietary dataset has consistently received the most interest over the years. Some of our VC peers have requested it for their LP communications, universities have requested it for research and course materials, and it’s been published in several books.

We most recently published this graph in a 2019 blog post called “Venture Capital — No, We’re Not Normal.” Particularly given the changes that have occurred in U.S. venture in the past few years, we thought it would be helpful to provide an updated version:

The distribution of outcomes in U.S. venture is still far from a “normal” distribution. It remains highly right-skewed in that a relatively small number of winners drive returns. Less than 4% of the capital invested into venture-funded companies exiting over the last decade generated a 10X or greater multiple, while thirty-seven percent generated a less than 1X return (i.e., lost money).

The distribution is even more skewed when we calculate it by financings rather than dollars. For example, nearly half of financings lost money for investors over the past decade.

So how have these results changed over time, and how do the last few years look in an historical context?

The green line in the graph below plots the percent of invested dollars by exit year that realized a greater than 10X return (the “winners”), while the black line plots the percent of invested dollars that realized a less than 1X return (the “losses”).

Our takeaways from this analysis are:

· Consistent with the experience of many VCs and LPs during the early 2000’s, the “Dot Com Bust” was a challenging time in which to harvest portfolios as there were few winners and the vast majority of invested dollars resulted in losses.

· From the 2008 Financial Crisis through around 2012, the risk/return profile of realized venture investments steadily improved, with the percent of invested capital in winners increasing and in losers decreasing. These statistics have remained relatively constant since then.

· The pandemic years (2020 and 2021) were glaring exceptions. While the economy suffered, venture thrived. These two years were “off-the-charts” in terms of both much higher percent winners, and much lower percent losses, than we’d seen historically.

· The distribution of outcomes that we saw last year, despite feeling like a “reset”, was only a reset when compared with the exceptional pandemic years. The statistics last year were very similar to what saw over the prior decade.

The data for 2023 is too limited so far to draw solid conclusions. However, early indications are that we might see a more significant reset. Also, while not plotted on the graph, we found it interesting that the number of companies that exited peaked during the Dot Com Bust, steadily declined to a low point during the 2008 Financial Crisis, and then has steadily increased each year since then, with 2021 and 2022 being the two largest exit years on record.

U.S. venture continues to be a hits-driven business. Overall industry returns, and most fund returns, are driven by the relatively small percent of outcomes that are the winners.

The math underlying the large right-skewed distribution of outcomes in U.S. venture creates challenges, and opportunities, for all the players in our ecosystem. The challenge for most entrepreneurs is how to beat the odds and be one of those outlier winners. For us as VCs, the key challenge is how to consistently have a disproportionate share of those outliers in our portfolios. For LPs, the challenge is how to select VC funds who are more likely than average to accomplish this feat prospectively.

We’re still not normal but, as author Maya Angelou once said, “If you are always trying to be normal, you will never know how amazing you can be.”

If you are an entrepreneur raising, or a VC or advisor working with a team that is closing a round, let’s connect. Correlation Ventures is actively investing in all sectors and stages in private U.S. headquartered companies.

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Methodology for the above blog: We have spent more than a decade creating what we believe is the most complete database of venture financing-level outcomes in the industry. The first graph in the post above plots the percent of financings and of invested dollars by realized gross cash-on-cash multiple for all U.S. venture-funded companies in our database exiting over the past decade, including those that went out of business, went public, or were acquired. The second graph plots the percent of invested dollars realizing either a less than a 1X, or a 10X or greater, gross cash-on cash multiple by exit year. Public stocks are assumed for these analyses to have been liquidated at the median price six to nine months following the IPO, when investors typically have the first opportunity to liquidate their positions following lockup.

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Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $500 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in nearly 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), Bluevine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Imperfect Foods, Janux (JANX), Lemonaid (ACQ: 23andMe), Lever, Manticore Games, Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

More Stories by Correlation Ventures:

Unicorns are Overrated. Triple Crowns are Better.

When Others Are Fearful…

Should Founders Take the Plunge?

Venture Capital — We’re Still Not Normal was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

“U.S. Venture Activity Slowed More in Q2 as Economic Fears Rose” (VentureBeat 7/22). “The venture reset” (Crunchbase 6/22).

As the country appears to be heading into (or is already in) a recession, many VCs and LPs are pulling back on their investments into U.S. venture.

How have venture investments made during and following past economic downturns performed? We analyzed our industry-leading database of U.S. venture to find out, and to see if we could glean any learnings that would help us as a venture fund better navigate the current economic climate.

We analyzed investments made prior, during, and following the three most recent major recessions: the early 1990s’ Recession (7/90 to 3/91); the early 2000’s Recession (3/00 to 2/01), and The Great Recession (12/07 to 6/09). There was also a short COVID-19 Recession (2/20 to 4/20), but it is still too recent for us to gain meaningful insights regarding how investments made during this period will perform.

The graph below plots average total realized multiples for all U.S. venture investments made during each recession, as well as during the twelve months prior to and following each recession.

As illustrated, U.S. venture investments made during each of the major recessions since the early 1990’s have generated higher returns than the immediately preceding periods. Returns continued to increase further for investments made in the year following recessions.

Is there a difference by stage of investment? The graph below plots the percent change in invested dollars and returns during these recessions, when compared with the prior twelve months, by investment stage.

During recessions, investors pull back investments and returns increase across all investment stages. However, the pullback is most severe and the increase in returns most significant in early stage rounds (Seed and Series A) versus later stage rounds.

The graph below plots similar data but by major industry group.

Consistent with the conventional wisdom that the success of healthcare investments tends to be independent from economic climate, we see no difference on average for returns for healthcare investments made during versus preceding recessions.

Historically, recessions have typically preceded longer more attractive periods for deploying capital in U.S. venture. The graph below plots mean realized gross multiple for all U.S. venture investments by each financing year since 1988. We didn’t plot the data for investments made after 2016 because there is a significant lag in venture outcomes and there are not yet enough realized outcomes to draw meaningful conclusions on ultimate returns. The recessions are labeled with the red arrows. As you can see, invested dollars declined and returns increased during and following each of the most recent recessions.

While there can of course be no assurances that the trends above will repeat in the current economic climate, one general conclusion we’ve observed from analyzing many different relationships in U.S. venture is that history tends to repeat itself. We at Correlation Ventures are actively making new venture investments. We are leaning in versus laying low.

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If you are entrepreneur raising or working with a team that is closing a round, we would value any introductions where we might be helpful as a co-investor.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $475 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in nearly 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), BlueVine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Imperfect Foods, Janux (JANX), Lemonaid (ACQ: 23andMe), Lever, Manticore Games, Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

More Stories by Correlation Ventures:

1. Thiel vs. AngelList. Who is Right?
2. When Others Are Fearful…
3. Venture Capital — No, We’re Not Normal

Lay Low or Lean In? U.S. Venture and Recessions was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

U.S. venture is a hits driven business, and we’ve previously published data quantifying how right-skewed the distribution of outcomes is. What are the implications for the optimum portfolio size for a U.S. venture fund? Peter Thiel of Founders Fund and Abe Othman of AngelList arrive at very different conclusions.

Highly successful investor Peter Thiel advised VCs to only invest in “seven or eight promising companies for which you think you can get a 10X” return. Abe Othman, Head of Data Science at AngelList, countered in his excellent blog post here using AngelList data that the math behind the “power law” instead suggested VCs should have much larger portfolios to make sure they have a sampling of the winners.

Who is right?

We thought you might find interesting analyses we’ve conducted over the years to help answer this question. We’ve built the most complete database of U.S. venture financings and outcomes in the industry. To create the graph below, we created tens of thousands of portfolios by randomly selecting investments for each vintage since 2000 with portfolio sizes ranging from 1 to 100 companies (a “Monte Carlo” analysis). For the portfolios at each portfolio size, we calculated both the average and median (50th percentile) return.

A larger portfolio alone does not impact average, or expected, returns. However, the median (50th percentile) returns for a fund, which a fund is more likely to achieve in practice, does increase with portfolio size. This is a mathematical result.

Median returns nearly converge with mean returns by the time a venture portfolio reaches one hundred companies. Median returns increase as a function of portfolio size because the distribution of venture returns is right-skewed. For those interested in learning more about the math behind this convergence, it results from the Central Limit Theorem.

The above graph supports Abe’s argument that the power law leads mathematically to the benefits of larger portfolios, all else equal. However, there’s more to the distribution of venture returns than just mean and median returns. The entire band of potential outcomes shrinks as portfolio size increases. To illustrate, the graph below plots the probabilities of portfolios at each portfolio size having a gross return of 5X or greater (the green line) and less than 1X (the red line).

For example, at Thiel’s recommended portfolio size of eight, the probability of the overall fund generating a loss is 28% versus only 6% for a portfolio of 100. However, the probability of Thiel’s smaller portfolio generating an overall return of 5X+ is 10% versus just 2% for the larger portfolio.

In other words, for a venture portfolio of eight companies, the probability is five times greater both that it will return less than 1X, and that it will return greater than 5X, versus a portfolio with one hundred companies.

While smaller venture portfolios have a higher probability of an overall loss, they also have a higher probability of hitting the ball out of the park.

The above conclusions assume that the venture portfolios were selected and managed by an “average” VC, and there is no difference in the average quality of the investments as a function of portfolio size. This later assumption is almost certainly not true for most venture funds. Instead, there will be an inverse correlation between the quality of each investment and portfolio size. There are only so many high quality opportunities most VCs can find and manage.

Implicit in Peter Thiel’s recommendation is that a small, concentrated portfolio helps a VC to increase the odds that each of their few investments is one of the winners. The greater the “edge” the VC is assumed to have over the industry average, the more the above curves will shift.

So what would these statistics look like, for example, if a VC believes that each investment they make has twice the odds of generating a 10X+ return when compared with investments made by an “average” VC? The probability of this “twice-as-good” VC with a portfolio of eight companies having a less than 1X fund declines from 28% to 21%, while the probability of them having a 5X-or-greater fund increases from 10% to 18%.

So who is right: Thiel or AngelList? It depends.

The expected returns are the same for VC portfolios of different sizes. The risk/return profiles are simply different. One is not necessarily better than the other. It depends on the goals and risk tolerance of the investor, and of course how confident the VC is that they can beat the odds and select and/or create winners above the industry average across whatever portfolio size they choose.

At Correlation Ventures, we’ve designed our funds with the above statistics in mind. We believe that our proprietary selection model enables us to increase the odds that each investment will be one of the winners, consistent with Thiel’s advice. The scalability of the selection model, however, also enables us to take advantage of the benefits of larger venture portfolios, as recommended by AngelList. We create large diversified portfolios of selected co-investments in order to mathematically reduce downside risk and maximize the likelihood that our overall portfolio realizes its attractive expected return.

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If you are entrepreneur raising or working with a team that is closing a round, we would value any introductions where we might be helpful as a co-investor.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $475 million under management, we’re one of the most active U.S. venture investors. Since inception, we’ve invested in nearly 400 companies. Sample portfolio companies include: AlienVault (ACQ:AT&T), Astra (ASTR), BlueVine Capital, Gabi (ACQ: Experian), IonQ (IONQ), Imperfect Foods, Janux (JANX), Lemonaid (ACQ: 23andMe), Lever, Manticore Games, Personal Capital (ACQ: Empower), PowerVision (ACQ: Alcon), Synthorx (ACQ: Sanofi), and Upstart (UPST). Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, low hassle, and helpful source of co‐investment capital in the industry; for example, typically making investment decisions within days. Correlation is backed by leading institutional investors.

More Stories by Correlation Ventures:

1. When Others Are Fearful…
2. Venture Capital — No, We’re Not Normal
3. Should Founders Take the Plunge?

Thiel vs. AngelList. Who is Right? was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

Warren Buffet famously stated that he actively seeks investment opportunities in times when others are fearful.

Given the understandable fear in our world right now in the face of this global pandemic, we wanted to find out empirically whether or not his wisdom applies to U.S. venture capital investing.

To answer this question, we analyzed our industry-leading database of U.S. venture financings and outcomes, as described in earlier blogs, and public data. We focused on the two most recent major shocks, both of which my co-founder Trevor Kienzle and I lived through as VCs: the Dotcom Bubble Burst followed by the 9/11 Terrorist Attacks (which we’re considering for this purpose as a single shock because they were so close in time), and the 2008 Financial Crisis.

In both cases, the stock market and U.S. GDP growth tanked, sending the country into recession. In the U.S. venture market, not surprisingly, total dollars invested, the number of financings, valuations, and the number of new companies formed dropped precipitously.

In retrospect, was the year immediately following these shocks a relatively good or bad time to be investing in the U.S. venture market?

The graph below plots the percent change in realized multiples and other statistics for the year immediately following, versus the year preceding, each crisis.

As illustrated in the bars on the far right, the Sage of Omaha’s wisdom appeared to have served those investors well who continued investing during the years when others were fearful.

Realized multiples for all VC investments, including investments in first institutional rounds, increased significantly immediately following both the 9/11 Terrorist Attacks and the 2008 Financial Crisis.

As another illustration of this fact, the graph below plots dollar-weighted realized gross multiples for all investments made in each financing year from 2000 to 2011. The red arrows point to the years in which 9/11 and the 2008 Financial Crisis hit. Notably, these events occurred late in the year (September) in both cases, so the returns for the subsequent year are the best indicator in this annual data of the returns to investors who invested through the crises.

As you can see, realized returns shot up in the years following the crises. Why has this been the case?

Our hypothesis is that higher returns following shocks have resulted from a combination of factors, including more attractive terms for investors, unique business opportunities resulting from the large shifts in society created by the shock, greater discipline and capital efficiency in venture-funded teams (that is often sustained well beyond the market recovery), and perhaps a smaller set of quality entrepreneurs and investors who are able to raise and thrive in such an environment.

The historical fact that venture returns have increased following recent crises is, of course, no guarantee that we will see the same result following the current global pandemic and pending recession. Every “black swan” is unique. However, we believe the data suggests that it’s a better bet than the opposite.

Like many of you, we at Correlation Ventures are living through the tremendous challenges faced by entrepreneurs and VCs in this market. This environment, of course, creates large opportunities for some companies, while others are focused on survival, doing whatever they can to extend cash runways to get through the crisis.

We believe that innovators in the venture ecosystem are likely the best chance we have to quickly identify diagnostics and effective treatments and vaccines for this virus, as well as to offer effective solutions to enable us to best adapt to a changing world.

In the face of the current fear, we hope that the statistics above will provide some added impetus to all in our ecosystem — VCs, LPs, and entrepreneurs — to continue to actively invest and innovate through this crisis. The world has perhaps never needed us more.

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Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $360 million under management, we’re one of the most active U.S. venture investors, investing in about two to three new investments a month. Over the last five years, we’ve invested in over 185 companies. Selected portfolio companies include: AlienVault, Bluevine Capital, Galera, Imperfect Foods, Lever, Manticore Games, Optimizely, Personal Capital, Sun Basket, Synthorx, and Upstart. Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, convenient, and reliable source of co‐investment capital in the industry; for example, committing to make investment decisions within two weeks or less. Correlation is backed by leading institutional investors.

More Stories by Correlation Ventures:

1. Venture Capital — No, We’re Not Normal
2. Should Founders Take the Plunge?
3. Move Over Unicorns, Here Are the Winners We Should Most Celebrate in U.S. Venture for 2017

“When Others Are Fearful…” was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

In fact, we are highly skewed.

Most of us know intuitively that venture investing is a hits driven business. A relatively small number of winners drive returns. However, you might be surprised by how skewed the distribution of outcomes actually has been.

The above graph plots the percent of both financings and invested dollars by realized cash-on-cash multiple for U.S. venture-funded companies in our database exiting over the past decade, including those that went out of business, went public, or were acquired.

About half (51%) of all of the capital invested into venture-funded companies exiting over the last decade lost money, while less than 4% generated a 10X or greater multiple. When calculated as a percent of financings, rather than by dollars, the distribution is even more skewed: almost two thirds of financings lost money for investors.

The reason for the difference is that earlier stage rounds — with smaller average round sizes, higher risk, and higher average returns — will have greater influence on the percent of financings statistics, while later stage investments will dominate the percent of dollars statistics.

We were curious as to how the “hit rate” — which we defined as the percent of invested dollars generating a 10X or greater return — has changed over time, and how closely this tracks overall industry returns. The graph below plots the hit rate versus mean dollar-weighted realized multiple for the U.S. venture industry for each exit year since 1990.

Our initial thoughts after seeing this graph were:

1. Wow, we wish we could go back and “party like it’s 1999” (to quote Prince).

2. Mean realized returns and the hit rate have both been steadily rising over the past decade, but only recently reached the levels seen in the years 1990–1992.

3. We were impressed by how closely these lines track each other.

In fact, the correlation between mean realized industry returns and the percent of invested dollars realizing a 10X+ return is .98 on a scale of -1 to 1 (where 1 is a perfect positive correlation, and 0 is no correlation). This implies that VC industry mean returns are highly impacted by the largest returning financings, in effect that returns are “hits driven”.

One implication we see from these statistics for VCs, entrepreneurs, and LPs is that it is rational for many VCs to have a “swing for the fences” strategy where we invest in opportunities that have the potential to be a break-out winners and avoid those where the outcome is capped from the outset.

So, VCs…it’s OK to not be normal.

________________________________________________________________

If you are entrepreneur raising or working with a team that is closing a round, we would value any introductions where we might be helpful as a co-investor.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $360 million under management, we’re one of the most active U.S. venture investors, investing in about two to three new investments a month. Over the last five years, we’ve invested in over 185 companies. Selected portfolio companies include: AlienVault, Bluevine Capital, Casper, Optimizely, Personal Capital, Sun Basket, Galera, Synthorx, and Upstart. Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional venture capital to fill out a round. We offer the most rapid, convenient, and reliable source of co‐investment capital in the industry; for example, committing to make investment decisions within two weeks or less. Correlation is backed by leading institutional investors.

More Stories by Correlation Ventures:

1. Should Founders Take the Plunge?
2. Move Over Unicorns, Here Are the Winners We Should Most Celebrate in U.S. Venture for 2017
3. Too Many VC Cooks in the Kitchen?

Venture Capital — No, We’re Not Normal was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.

A small number of high-profile, venture-backed exits have consumed headlines recently — Lyft, Pinterest, Uber, Slack, and Zoom to name a few — along with the massive financial impact on investors, founders and executive teams. We, at Correlation Ventures, were curious about how frequently entrepreneurs, specifically, reaped the benefits of these life-changing outcomes in venture-funded companies. You might be surprised by how frequent they are.

As venture capitalists, we are inherently dependent on the bold, daring entrepreneurs who are willing to take risks and make sacrifices necessary not only to start a company, but also scale it successfully. In turn, these founders need to be rewarded commensurately. We analyzed our large database of U.S. venture capital outcomes, which we believe to be one of the most complete in the world, in order to quantify how well management teams, defined as the founders and C-level team members, are being compensated upon exit. Our hope is to provide more clarity and transparency on this topic, and to arm potential entrepreneurs with information on the risk/reward tradeoffs of taking the plunge.

In analyzing our dataset — specifically the subset of companies that received venture funding¹ and exited over the last decade — the results were impressive. While 66% of venture-backed startups that exited in the last decade did not return any meaningful capital, 20% generated at least $25M in proceeds for management, 7% generated at least $100M in proceeds for management, and more than a fourth of this subset (or 2% of the total) generating $250M or more in proceeds to management².

While 66% of venture-backed startups that exited in the last decade did not return any meaningful capital, 20% generated at least $25M in proceeds for management, 7% generated at least $100M in proceeds for management, and more than a fourth of this subset (or 2% of the total) generating $250M or more in proceeds to management².

Unlike other analyses of venture-backed company performance, which usually analyze returns from the investor’s standpoint, we’ve looked at returns from the entrepreneur’s perspective³.

An exit for these purposes is defined as one of the following outcomes for a company: an IPO, an acquisition, or an out of business (OOB) event. The graph below shows the distribution of returns to management for all U.S. VC-backed companies in our database that exited in the last ten years (Q3 2009 — Q3 2018). Of course, these results may not be indicative of the next 10 years. The time period we are analyzing is taking place during the longest bull market in history, which has lent itself to an active M&A market and high valuations, in addition to record amounts of capital raised and deployed by venture funds⁴.

We also looked at how management returns varied based on the stage of funding reached by analyzing the percentage of startup exits that returned $50 million or more to management. As shown in the graph below, this percentage increased as the company reached subsequent financing rounds from Series A through Series C, with a slight decline after Series D. This is encouraging, as additional capital raised may also come with management dilution. This could imply that the value creation enabled by invested capital and option pool expansions more than offset the dilution to the team through Series C rounds.

Clearly, there are inherent risks in becoming an entrepreneur and raising capital from VCs. We are not suggesting that everyone is cut out to be a successful founder, nor are we encouraging everyone to start a company. However, there are clearly benefits to society, ranging from companies like Apple that were started in a garage and are now integral parts of our lives, to the 1.5 million net new jobs created in the U.S. per year by companies less than one year old⁵.

…there are clearly benefits to society, ranging from companies like Apple that were started in a garage and are now integral parts of our lives, to the 1.5 million net new jobs created in the U.S. per year by companies less than one year old⁵.

While entrepreneurship isn’t meant for everyone, we are encouraged by the large percentage of venture-backed startups which create significant wealth for management teams. We hope by sharing this research that we can help can arm prospective founders with more information to make an informed decision and “take the plunge” knowing that the potential rewards are great.

1. Companies that received funding from an institutional investor defined by Dow Jones VentureSource as a Venture Capital firm.

2. For the purposes of this exercise, we defined management as founders and C-suite executives.

3. These statistics include empirical, data-driven analysis regarding option pool expansions, liquidation preferences, and venture debt.

4. Tarhuni, Nizar, et al. Venture Monitor 1Q 2019. Pitchbook Data, Inc; National Venture Capital Association (NVCA), 2019, Venture Monitor 1Q 2019, nvca.org/wp-content/uploads/delightful-downloads/2019/04/1Q_2019_PitchBook_NVCA_Venture_Monitor.pdf.

5. Entrepreneurship Policy Digest. The Importance of Young Firms for Economic Growth. Ewing Marion Kauffman Foundation, 2015, www.kauffman.org/-/media/kauffman_org/resources/2014/entrepreneurship-policy-digest/september-2014/entrepreneurship_policy_digest_september2014.pdf.

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We would value any introductions to entrepreneurs raising venture capital where we might be helpful as a co-investor. Correlation offers a dramatically better option for lead investors, syndicates, and companies seeking additional capital. We offer the most rapid, convenient, and reliable source of co‐investment capital in the industry, committing to make investment decisions within two weeks or less.

Correlation Ventures is the predictive analytics pioneer in the venture capital industry and the industry’s leading co-investor. With more than $360 million under management, we’re one of the most active U.S. venture investors, investing in about two to three new investments a month. Selected portfolio companies include: AlienVault (acquired by AT&T), Bluevine Capital, Casper, Imperfect Produce, Optimizely, Personal Capital, Sun Basket, Synthorx (THOR), and Upstart.

More Stories by Correlation Ventures:

1. Which VC Returns Were Higher Over The Last Decade? East Coast or West Coast?
2. Move Over Unicorns, Here Are the Winners We Should Most Celebrate in U.S. Venture for 2017
3. Too Many VC Cooks in the Kitchen?

Should Founders Take the Plunge? was originally published in VC by the Numbers on Medium, where people are continuing the conversation by highlighting and responding to this story.