The conventional wisdom of venture capital has become that only 10–15 deals each year matter: the so-called Rule of 15.
This rule emerged from a study done by Andy Rachleff of Benchmark, now teaching at Stanford. In the twenty years between 1985 and 2005, he found that around 15 deals per year got to over $100m of revenue, and these deals drove 90% of all returns to the venture industry. Ok, if that is the case, the smart strategy is to do whatever one can to invest in those deals!
If one could figure out ahead of time which deals are going to be huge, venture capital would be an easy business. We would be living in Lake Wobegon, where all our children are above average. But we don’t live in that world, and it is very hard to pick the select 15 ahead of time.
Andreessen Horowitz (A16Z) figured out you don’t have to figure them out ahead of time; instead, wait and smartly pay-up. They use their large fund size and excellent reputation to put super-sized slugs into emerging winners at high valuations. They win deals by outbidding. Other funds are now following it, leading to a concern of a bubble in high burn rate companies like Uber.
The pay-up strategy smacks of bubble behavior, but is it? If time-to-market cap is now 3x faster than before, due to much larger, frictionless markets, paying up looks cheap in retrospect. The old rules don’t apply.
What if the Rule of 15 is actually a Rule of 50? Jumping into the top 10 deals and pushing them to high burn rates & nosebleed valuations leaves another 40 that provide much better relative value.
Both Paul Graham and Marc Andreessen have pondered whether the current boom will produce many more winners than prior booms, because tech is now serving more than technology for techies. This seems likely.
More prosaically, venture is a cyclical business. In a tech boom, many more than 15 companies run hard towards big outcomes. What was a Rule of 15 (or 10, or 5) in the lean years becomes a Rule of 50 (or 100) in the fat years.
The A16Z strategy was a brilliant move. Given a Rule of 50, what will they do next?