A Tale of Two Squirrels: The Not So Simple Math on Venture Portfolio Size
Matt H. Lerner
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I’m not remotely an expert in this world other than as an employee who has toiled from the inside of more than a couple venture backed companies being charged to try to drive such returns.

Math and portfolio theories aside, what strikes me is how this analysis implicitly demonstrates the incentive conflict that venture investors and eary employees have — often placing founders squarely in the middle.

The point becomes clear when you consider the poor alignment along the “live-changing” outcome dimension. For a the middle of the bell-curve of these 100–200 companies in this analysis, an exit resulting 5–10x venture return (a “ground rule double” for the venture investor) would otherwise result in potentially life-changing equity gains for dozens of early stage employees (a “homerun”). To be clear, for the venture investor, a 5–10x return is nice but not good enough when they know they need a 50x return to change their lives.

Herein lies the disconnect.

When one tribe may be ready to reap a harvest which can fund a down-payment and pay for college tuitions, the other pushes for “going big” — increasing burn rates, increasing capital requirements, growing equity positions to increase the risk/reward treshold. While investors can rely on a portfolio of bets that might come in, employees are all in on one bet.

If you play craps (or roulette), it’s a lot better to have a bank roll to place bets all over the board, rather than having all of your money on any single one number.

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