The power law is a statistical concept that describes the relationship between the frequency of an event occurring and the magnitude of that event.
Why It Matters
Your job as a Startup wanting to secure capital from a Venture Capital Fund is simple. Using the Power Law, convince them that your startup will be one of the 5% of companies that make 95% of their profit!
How Does The Power Law Work In Practical Terms?
In the context of venture capital, the power law is often used to describe the distribution of returns for startup investments. It suggests that a small number of startups will generate the majority of the returns for a venture capital firm, while the vast majority of startups will generate little or no return. This means that venture capital firms need to be highly selective in their investments, as they are looking for the startups that have the potential to generate outsized returns.
Venture capital firms use the power law to guide their investment decisions by trying to identify the startups that have the greatest potential to become “unicorns,” or companies that have reached a valuation of $1 billion or more. These firms will often use a variety of tools and techniques, such as market analysis, financial modeling, and competitive analysis, to try to identify the startups that have the greatest potential to become unicorns and generate outsized returns.
It’s worth noting that the power law is just one factor that venture capital firms consider when making investment decisions. They also consider factors such as the quality of the founding team, the size and growth potential of the market, and the scalability of the business model. Ultimately, venture capital firms are looking for companies that have the potential to become dominant players in their respective markets and generate significant returns for their investors.
By understanding the power law and the distribution of returns in their portfolio, venture capital firms can make informed decisions about which start-ups to invest in and how much to invest.
About the Author:
James Spurway is an Angel Investor, Mentor, Advisor, Speaker, former Commercial Pilot, and Author who specialises in raising debt and equity capital. He strives to model diversity, equity, and inclusion in the founders he agrees to invest and work with. He has paused his angel investing activity to focus on raising his first US$ 50M venture capital fund, which will invest in startups that can accelerate the achievement of net zero emissions. James spent the past 33 years living in Hong Kong, Vietnam, Germany, Switzerland, Monaco, the USA, Thailand, the Philippines, Singapore, and Australia, his country of birth. In that time, he started 10 businesses, exited from seven, shut down two, and kept one. He has invested in a total of 50 startups since 2001 and had six successful exits.