If you’ve ever heard about venture capital (VC), you’ve likely come across stories of big successes: companies like Uber, Airbnb, and Spotify that have transformed industries and made their investors millions or even billions. But what’s surprising to most people is that for every massive success, there are dozens — if not hundreds — of companies that fail or never achieve massive growth.
This phenomenon is best explained by a concept known as the Power Law. It’s a term that venture capitalists (VCs) and startup investors use to describe how investment returns in the startup world are highly skewed. Essentially, a small number of companies make the vast majority of profits, while most others end up as minor successes or complete failures.
What Is the Power Law?
The Power Law refers to the idea that in many systems, a small number of things — whether they’re companies, people, or events — create the majority of value or wealth, while the rest create far less. In venture capital, this concept means that a few startups will generate the vast majority of profits for investors.
In the world of startups, only a tiny fraction will end up being what investors call a “home run” — those rare companies that become unicorns (worth $1 billion or more) or decacorns (worth $10 billion or more). The rest, unfortunately, don’t even come close.
The Numbers Behind the Power Law
In venture capital, the numbers don’t lie. A typical VC fund might invest in 100 startups, but only 1 or 2 of those companies are likely to generate the bulk of the returns.
In fact, research shows that roughly 75-80% of startup investments will either return nothing or a modest return — if they don’t fail completely. However, the remaining 20-25% will often be the ones that succeed wildly. Even more striking, just 1% of the companies in a portfolio might generate the majority of the fund’s profits.
So, the idea behind the Power Law is that venture capital investors are willing to take big risks in hopes that the rare few will pay off — and pay off big.
Real-Life Examples of the Power Law in Action
Let’s take a look at some famous venture capital investments to see the Power Law in action:
Sequoia Capital invested early in Google, a company that became one of the world’s most valuable companies. Their initial $12.5 million investment in 1999 is now worth over $50 billion. That’s a 4,000x return — an example of a home run.
Andreessen Horowitz invested in Facebook back in 2009, with a $40 million investment. Today, Facebook (now Meta) is worth more than $700 billion, providing a massive return for the firm.
But what about the others? For every Google or Facebook, there are plenty of startups that never make it or fail to achieve massive growth. In fact, studies suggest that a large percentage of venture investments will either lose money or return only a small profit. But the Power Law keeps venture capitalists in the game, always searching for that one big winner.
How the Power Law Affects
Understanding the Power Law is crucial for founders too, not just investors. The concept is simple: building a successful startup is hard. And even if you have a great product, excellent team, and plenty of support, the odds of achieving a massive outcome are low. But that’s also part of the reason why VCs love to back riskier ideas — because the payoff from one successful investment can make up for the many failures.
Understanding the Power Law gives founders an advantage. It demonstrates to investors that you’re participating in a game worth their attention. Since venture capitalists are willing to finance bold and risky ideas in hopes of achieving one huge success, you don’t need to prove that you’ll become the next Google. It’s sufficient to show that your startup has the potential for this. This very potential itself can secure financing – even if your company never achieves market leadership.
Conclusion
The Power Law is a fundamental concept that explains the highly uneven distribution of returns in venture capital. In the startup world, it’s difficult to predict which companies will succeed, but the winners bring such enormous profits that they fully compensate for numerous failures.
Prepared by Navruzakhon Burieva
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