Surge for Power Law Returns
Can we get infinitely high returns from early stage startups? Early “accelerator stage” investment is a brutal business where most investments go to a total loss. And yet, early stage startup investment can deliver high returns on average. The trick comes from “power law returns”. A small number of companies will do well. Actually, a very small number of companies will do very, very well.
The math of power law returns holds out the theoretical possibility of unbounded investment returns, for large portfolios of early stage investments.
Does this work in practice? Y Combinator makes money by investing very early, and expanding their batch sizes up to 400. They can harvest about 1% as “unicorns” — companies that achieve a valuation of $1B. Their portfolio demonstrates the extreme nature of power law returns, with most returns coming from the biggest wins at $10B+ valuations.
Abe Othman combined the power law theory with real world data from more than 3000 Angellist deals. He delivered this graph. The blue line represents his model of returns from Angellist deals, sorted by time from founding. The green area represents startup investing nirvana with indefinitely high returns.
According to this analysis, “Infinite mean returns” are possible in a portfolio that buys investments less than 5 months from founding.
Infinite mean return is associated with “infinite variance”, which means that all of the returns will be concentrated in one company. A large portfolio increases the probability of capturing returns. In the green area, you can increase expected returns by increasing the size of the portfolio.
Othman also found that in winning deals, companies gain value very quickly at first.
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Othman suggests buying every “credible” deal, as early as possible.
Surge is designed for power law returns
We designed Surge to be a machine for harvesting power law returns from startups.
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Do you think we should package this opportunity? I propose a “Zero Day Fund” that will take early whitelisted stakes, in exchange for doing due diligence and other work to improve the fundability of the deal. Then, it will share the good deals as “featured” deals.