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Peter Thiel in Zero to One: > The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of t

Peter Thiel in Zero to One: > The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined. > This implies two very strange rules for VCs. First, only invest in companies that have the potential to return the value of the entire fund. This is a scary rule, because it eliminates the vast majority of possible investments. (Even quite successful companies usually succeed on a more humble scale.) This leads to rule number two: because rule number one is so restrictive, there can’t be any other rules.

ssharp 11y ago
Do most VC's think this way and is this actually a "rule", meaning it's the way you succeed? I'd think VC investing is like most other types of investing where you can take on different strategies depending on your goal. Some investors will take large risk in order for large reward, where other investors would rather take lower risk for a higher probability of some positive return.
- supster 11y ago
  Yeah I feel that tends to play out based on what class of VC you are. E.g. seed/angels -> high risk / big portfolio (100s startups) / huge win-loss multiples (but invest small $) traditional VCs/Seed A-C -> medium risk / moderate portfolio size (10s) / medium win-loss multiples (but invest medium $$) growth private equity -> small risk / small portfolio (singles) / small win-loss multiples (but invest huge $$$) Of course the divisions are arbitrary and some investors put money in all categories, but I feel like the above holds true in general.
- karmacondon 11y ago
  I think it's a "rule" as opposed to a strategy like "don't sacrifice your pieces in exchange for nothing" is a rule in chess. It's possible to succeed without following that guide line, but it's very difficult. VC firms produce modest returns for a very high risk. You've probably only heard of one out every hundred companies that have been venture funded. Low risk investments just don't produce enough return.
- nostrademons 11y ago
  I think the problem with taking the moderate-risk-for-moderate-reward strategy, as an early stage investor, is that a large number of your investments are going to fail anyway. And the returns of a company are not linearly correlated with its apparent risk at the early stage: a company might appear 2x as risky, but end up with 200x the returns if it succeeds. Early-stage investors that try to invest further down the risk/reward curve may find that the decreased risk doesn't end up making up for the decreased rewards, and so the fund as a whole becomes unprofitable. Larry Page was fond of saying that it's actually easier to work on big problems than on little problems, because a.) there's less competition and b.) you can get people to help you. I'm not sure that's actually true anymore - now that everyone wants to be Google - but it's illustrative of the non-linearity of returns.
  - dataisfun 11y ago
    As an investor, I can say you nailed it with this explanation.
Chris2048 11y ago
> only invest in companies that have the potential to return the value of the entire fund No it doesn't. If the investment is likely to break even it makes no difference, or can at least reduce losses. So long as there is a certain, critical number of potential high-earners, compared to total investment, you're ok.
dean 11y ago
> only invest in companies that have the potential to return the value of the entire fund I have a feeling this is much, much easier said than done. How do you even determine "potential" of a startup, when, according to Paul Graham, "the best ideas look initially like bad ideas".
- CptJamesCook 11y ago
  Of course. After all, Fred Wilson refused to invest in airbnb even when Paul Graham begged him to.
- deleted 11y ago
  [deleted]
- skewart 11y ago
  It's incredibly hard to identify successful companies early on. But following Thiel's rule isn't actually all that hard. The key is to look at the total addressible market for a company or product. It has to be large, or growing quickly, or both. For example, AirBnB might have looked like a bad idea, but the hospitality market is huge, so if it did work out then they could grow to become a giant company. On the other hand, you could create a transformative product for blind people, and build a business around it that makes you a multi-millionaire. But VCs will never invest in your company because there just isn't a big enough market. You might 3x or 5x an investment but you'll never deliver the kinds of giant returns VCs need in order to make their LPs happy. Of course, I'm talking about traditional VC firms - like the one the blog post's author runs. There are all kinds of investors out there with different motivations.
  - addicted 11y ago
    When Facebook came around, wouldnt the addressable market have looked tiny? Basically US based college campuses. Or was Zuckerberg already envisioning opening it up and spreading it far beyond college (and maybe high school) campuses?
    - skewart 11y ago
shubhamjain 11y ago
Which brings to another unspoken rule of investments in general - "Looking at the history, every good investment looks good and every bad investment looks bad". Everything is explainable that occurred in the past but not with the information that was available at that time.
TeMPOraL 11y ago
Is it a secret though? I thought it's 101 of startups-VC interactions, and I learned it by reading pg's essays in about the same time I first learned what a "startup" is. I.e. the whole thing works because some people with money do high-risk investments in which nine companies out of ten fail, but the tenth one pays them back more than they invested in all of them together.
- gist 11y ago
  > Is it a secret though? It's a secret to the majority of the people that are the market for a book like that. As opposed to those of us who are on top of startups who found out that information many many years ago.
  - tedmiston 11y ago
    Well, he also uses secret throughout the book to mean "an idea that's not commonly accepted".
- sharkweek 11y ago
  But then you get the counter argument from people like Dave McClure who speak pretty actively against this style for most investors, implying they should be investing in way more companies at earlier stages (also I highly suggest avoid calling it a "shotgun" approach unless you want to piss him off). There's a reason 500 Startups [edited out "he" and replaced with firm name - although he is also a prolific individual angel] tops the league tables for most active early stage investments every year, because they believe a lot of VCs are wrong. Active investments by VCs since JAN2015 - http://imgur.com/QxVJVgZ http://imgur.com/QxVJVgZ
  - pyb 11y ago
    What's his track record?
    - sharkweek 11y ago
      Good question - we don't have much IRR data on 500 Startups' funds (most of them are still open), but they never have trouble raising more money for new funds, so I assume their LPs are happy.
andylei 11y ago
isn't this a self fulfilling prophecy? if i only invest in all-or-nothing startups, doesn't that mean that my returns are going to look like i only invested in all-or-nothing startups?
- morgante 11y ago
  It's almost impossible to have a different VC model though. If you want to remove the variability in your outcomes, you have to do substantially more due diligence on each investment and decline a lot more. When your model depends on each investment doing okay instead of a few home runs, there's a lot more pressure on each investment to not fail. Eventually this forces you to only accept the least aggressive plans and you become a bank.
disposeofnick9 11y ago
Yup, VCs tend to favor go-big-or-go-home ventures. There are also lots of seemingly tiny things that can be made bigger too... and those are better pitches/founders to astute investers like Thiel whom realize small people are all talk and big people understate themselves. Reminds me of running into some tipsy Sequoia guys the night before the WhatsApp announcement... no lie, I knew who they were and what happened (figure it was a gigadeal) the second they walked in to a certain donut shop. It's definitely party-worthy when the fund is above water and all other exits are IRR gravy.

ssharp 11y ago

Do most VC's think this way and is this actually a "rule", meaning it's the way you succeed? I'd think VC investing is like most other types of investing where you can take on different strategies depending on your goal. Some investors will take large risk in order for large reward, where other investors would rather take lower risk for a higher probability of some positive return.

supster 11y ago
Yeah I feel that tends to play out based on what class of VC you are. E.g. seed/angels -> high risk / big portfolio (100s startups) / huge win-loss multiples (but invest small $) traditional VCs/Seed A-C -> medium risk / moderate portfolio size (10s) / medium win-loss multiples (but invest medium $$) growth private equity -> small risk / small portfolio (singles) / small win-loss multiples (but invest huge $$$) Of course the divisions are arbitrary and some investors put money in all categories, but I feel like the above holds true in general.
karmacondon 11y ago
I think it's a "rule" as opposed to a strategy like "don't sacrifice your pieces in exchange for nothing" is a rule in chess. It's possible to succeed without following that guide line, but it's very difficult. VC firms produce modest returns for a very high risk. You've probably only heard of one out every hundred companies that have been venture funded. Low risk investments just don't produce enough return.
nostrademons 11y ago
I think the problem with taking the moderate-risk-for-moderate-reward strategy, as an early stage investor, is that a large number of your investments are going to fail anyway. And the returns of a company are not linearly correlated with its apparent risk at the early stage: a company might appear 2x as risky, but end up with 200x the returns if it succeeds. Early-stage investors that try to invest further down the risk/reward curve may find that the decreased risk doesn't end up making up for the decreased rewards, and so the fund as a whole becomes unprofitable. Larry Page was fond of saying that it's actually easier to work on big problems than on little problems, because a.) there's less competition and b.) you can get people to help you. I'm not sure that's actually true anymore - now that everyone wants to be Google - but it's illustrative of the non-linearity of returns.
- dataisfun 11y ago
  As an investor, I can say you nailed it with this explanation.

Chris2048 11y ago

> only invest in companies that have the potential to return the value of the entire fund No it doesn't. If the investment is likely to break even it makes no difference, or can at least reduce losses. So long as there is a certain, critical number of potential high-earners, compared to total investment, you're ok.

dean 11y ago

> only invest in companies that have the potential to return the value of the entire fund I have a feeling this is much, much easier said than done. How do you even determine "potential" of a startup, when, according to Paul Graham, "the best ideas look initially like bad ideas".

CptJamesCook 11y ago
Of course. After all, Fred Wilson refused to invest in airbnb even when Paul Graham begged him to.
deleted 11y ago
[deleted]
skewart 11y ago
It's incredibly hard to identify successful companies early on. But following Thiel's rule isn't actually all that hard. The key is to look at the total addressible market for a company or product. It has to be large, or growing quickly, or both. For example, AirBnB might have looked like a bad idea, but the hospitality market is huge, so if it did work out then they could grow to become a giant company. On the other hand, you could create a transformative product for blind people, and build a business around it that makes you a multi-millionaire. But VCs will never invest in your company because there just isn't a big enough market. You might 3x or 5x an investment but you'll never deliver the kinds of giant returns VCs need in order to make their LPs happy. Of course, I'm talking about traditional VC firms - like the one the blog post's author runs. There are all kinds of investors out there with different motivations.
- addicted 11y ago
  When Facebook came around, wouldnt the addressable market have looked tiny? Basically US based college campuses. Or was Zuckerberg already envisioning opening it up and spreading it far beyond college (and maybe high school) campuses?
  - skewart 11y ago

shubhamjain 11y ago

Which brings to another unspoken rule of investments in general - "Looking at the history, every good investment looks good and every bad investment looks bad". Everything is explainable that occurred in the past but not with the information that was available at that time.

TeMPOraL 11y ago

Is it a secret though? I thought it's 101 of startups-VC interactions, and I learned it by reading pg's essays in about the same time I first learned what a "startup" is. I.e. the whole thing works because some people with money do high-risk investments in which nine companies out of ten fail, but the tenth one pays them back more than they invested in all of them together.

gist 11y ago
> Is it a secret though? It's a secret to the majority of the people that are the market for a book like that. As opposed to those of us who are on top of startups who found out that information many many years ago.
- tedmiston 11y ago
  Well, he also uses secret throughout the book to mean "an idea that's not commonly accepted".
sharkweek 11y ago
But then you get the counter argument from people like Dave McClure who speak pretty actively against this style for most investors, implying they should be investing in way more companies at earlier stages (also I highly suggest avoid calling it a "shotgun" approach unless you want to piss him off). There's a reason 500 Startups [edited out "he" and replaced with firm name - although he is also a prolific individual angel] tops the league tables for most active early stage investments every year, because they believe a lot of VCs are wrong. Active investments by VCs since JAN2015 - http://imgur.com/QxVJVgZ http://imgur.com/QxVJVgZ
- pyb 11y ago
  What's his track record?
  - sharkweek 11y ago
    Good question - we don't have much IRR data on 500 Startups' funds (most of them are still open), but they never have trouble raising more money for new funds, so I assume their LPs are happy.

andylei 11y ago

isn't this a self fulfilling prophecy? if i only invest in all-or-nothing startups, doesn't that mean that my returns are going to look like i only invested in all-or-nothing startups?

morgante 11y ago
It's almost impossible to have a different VC model though. If you want to remove the variability in your outcomes, you have to do substantially more due diligence on each investment and decline a lot more. When your model depends on each investment doing okay instead of a few home runs, there's a lot more pressure on each investment to not fail. Eventually this forces you to only accept the least aggressive plans and you become a bank.

disposeofnick9 11y ago

Yup, VCs tend to favor go-big-or-go-home ventures. There are also lots of seemingly tiny things that can be made bigger too... and those are better pitches/founders to astute investers like Thiel whom realize small people are all talk and big people understate themselves. Reminds me of running into some tipsy Sequoia guys the night before the WhatsApp announcement... no lie, I knew who they were and what happened (figure it was a gigadeal) the second they walked in to a certain donut shop. It's definitely party-worthy when the fund is above water and all other exits are IRR gravy.