Published in · 4 min read · Jan 4, 2024
--
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.
