Venture Capital
Also known as: VC, Venture fund
Portfolios of long shots: most investments die, one pays for everything — the power law as an asset class.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
Venture capital funds buy minority stakes in young companies that mostly have no profits, often no revenue, sometimes no product — in exchange for a share of what they might become. The expected outcome for any single investment is failure; the model works because the rare winner returns 100x or more.
This is the power law in its purest financial form: in a typical portfolio of 25 startups, one or two outcomes determine the entire fund. Half return nothing; the median fund barely beats bonds; the best funds — persistently the same famous names — return multiples of everything else. Access to those names, not analysis, is the scarce resource.
Money flows in stages — pre-seed, seed, Series A, B, C… — each round pricing the company anew, each new investor diluting the old until (with luck) an IPO or acquisition converts paper into cash a decade later.
- Asset class
- Private markets
- Instrument type
- Closed-end fund / startup equity
- Traded
- Not traded; secondaries emerging
- Typical users
- Endowments, funds-of-funds, family offices
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketmatters
- Creditmatters
- Liquiditydecides it
- Fundingdecides it
- Operationalmatters
What decides it here. Most of the portfolio returns nothing and a few positions carry the fund. The value in between is an estimate that nobody has tested.
3 · IntermediateHow it works in practice
Deal machinery
- Preferred stock: VCs buy preferred with liquidation preferences (get paid first, often 1x money back before common sees anything), anti-dilution clauses, pro-rata rights and board seats.
- Valuation vocabulary: "pre-money" + new cash = "post-money"; ownership = investment / post-money. Headline "unicorn" valuations price only the newest, most protected share class — the whole company is usually worth less than shares-outstanding × last-round price.
- SAFEs and notes: early rounds often defer pricing entirely (convertible instruments with caps/discounts).
Fund economics
2/20-style fees on ~10–12 year funds; reserves held for follow-ons (doubling down on winners is where returns concentrate). DPI (cash actually distributed / paid-in) is the honest metric; TVPI (paper + cash) flatters the interim years — "TVPI is vanity, DPI is sanity."
The cycle
2020–21: ZIRP-fueled mania — record rounds, instant unicorns. 2022–24: repricing, down rounds, and a quiet graveyard. The recurring lesson: entry valuation matters even when the asset is a dream, and vintage-year diversification is the only defence against timing the mania wrong.
4 · AdvancedPricing & valuation
Valuing the unvaluable
Startup "valuations" are negotiated prices of option-like preferred stock, not DCF outputs. Rigorous approaches treat the capital structure as a stack of call options on exit value (each preference tier a strike), valued with backward induction or simulation; the practical industry substitutes comparables (revenue multiples by stage/sector) and the round market's clearing price.
What the symbols mean
- Cthe price of a call option
- Va value
- Kthe strike: the price written into the contract
- rthe interest rate, per year
The power-law mathematics
Empirical exit distributions fit \(P(X > x) \sim x^{-\alpha}\) with \(\alpha\) near 2 — variance barely finite, means driven by tails. Consequences: portfolio size matters (too few shots → likely zero winners), follow-on concentration into winners is optimal, and fund returns are unforecastable from anything but access. Manager persistence is real in VC (unlike most asset classes) — success begets deal flow begets success.
Marks, secondaries and the truth
Interim NAVs are last-round prices — stale the moment markets turn. The growing secondary market in startup shares and LP stakes provides the honest price signal (2022's 30–60% secondary discounts told the story a year before official marks did). Tender offers and structured secondaries are becoming the exit valve as IPO windows shorten.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Venture Capital in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Venture Capital beside any other instrument →
Where this instrument shows up elsewhere
- EasyVenture CapitalIndustryFunding companies that mostly will not work, in sizes chosen so that the ones that do can pay for all of them
- MediumWhat is private equity?QuestionsBuying whole companies with borrowed money, improving something, and selling in five years
- MediumWhich Desk Trades WhatPrepEleven trading seats and six that sit next to them: what each one actually touches, the single number it lives by,…
- HardSecondariesIndustryBuying a fund stake from somebody who wants out before the fund ends — pricing an asset whose value is an opinion