Venture Capital

Venture capital funds young companies in exchange for minority equity stakes, accepting that most investments will fail outright.

The mathematics are unusual: returns follow a power law, where one or two positions in a portfolio generate most of the fund's return and the rest contribute little or nothing.

• Build a portfolio large enough for outliers to appear
• Underwrite the team and market more than current financials
• Take minority stakes with governance rights rather than control
• Reserve capital for follow-on rounds in companies that work
• Accept a long holding period before liquidity

Venture funds need companies capable of returning the whole fund. A business that could become solidly profitable at modest scale is often a poor fit — not because it is a bad business, but because it cannot produce the outcome the fund's model requires.

Understanding that constraint explains a great deal of otherwise puzzling investor behaviour.