Explainer: What is the Venture Capital Power Law

In Venture Capital (VC), the Power Law is a concept and approach to shareholder and startup value creation. While some elements of the Power Law are inherent in all VC funds, deployment ranges from extreme to muted. On the extreme end, General Partners (GPs) expect a small percentage of a fund's portfolio (5-10%) will generate massive returns. The remaining companies (~90%) will be allowed to generally underperform, generating moderate gains, small losses, or even write-offs for investors. On the moderate end of the spectrum, a fund operates knowing that not all portfolio companies will generate outsized returns, but they strive for a more even distribution of successes. These fund managers likely do more follow-on and tranche funding and actively provide advisory support and resources to drive value creation across the whole portfolio, knowing the approach will generate better overall outcomes over the long term.  

The degree to which a fund applies the Power Law can signal its priorities, partnership style, diversification strategy, and risk tolerance level. For experienced high-net-worth individuals (HNWIs) and sophisticated registered investment advisors (RIAs), understanding if and how a fund embraces the Power Law can directly impact the returns they capture over the life of a fund. For startups, understanding a VC's track record can indicate how a GP might align with them, provide strategic advisory support, and stay with them through the entire startup journey should they accept funding from the fund. 

Over 90% of wealth advisors are evolving their HNWIs beyond the traditional 60/40 (public equities/public credit) portfolio distribution by integrating alternatives. Many agree that venture is part of a well-constructed HNWI portfolio. It offers access to the innovation economy, long-term growth drivers, and the potential for strong, tax-efficient returns. However, Power Law investing demands long time horizons and large capital pools to serve the needs of individual investors. It is a model better suited to institutional investors and endowments that can lock up capital for decades and reinvest compounded gains over an extended time horizon. Their higher ability to absorb risk reduces the issue of some vintages outperforming and others underperforming. 

In contrast, HNWIs invested in the private markets tend to gravitate to (and need) investments offering two-to-five-year timeframes and focusing more on capital preservation. They often favor alternatives (e.g., real estate and private credit) that can provide steady performance with slightly lower upside and less tax efficiency. Those who integrate venture into their capital allocation plan have the potential to generate 20%+ annual returns – provided they can manage a higher level of illiquidity (five-to-seven years on average) as well as more volatility. This potential is especially true for HNWIs who integrate venture funds managed by GPs that 'play' the Power Law. 

VC exposure must look different to work well for individuals. The most effective strategies for HNWIs favor firms that practice business building, disciplined capital deployment, and active support across the portfolio. These firms do not subscribe to the Sand Hill Road mindset of swinging for one unicorn and tolerating broad failure. Instead, they seek to increase the batting average across the portfolio and the firm—driving consistency over extremity and focusing on achieving the best possible outcomes for every participant. ‍

This explainer argues why the Power Law – in its truest and generally extreme form – is not appropriate for HNWIs. It offers historical context about how the approach became a guiding framework for many large VCs, gives real-world examples to illustrate its impact, and advocates for a less extreme approach that combines business-building strategies, a broader base of winners, and flexible structures that support long-term wealth generation.  ‍

The Power Law in VC as Theory 

In the context of VC, the Power Law is both theory and equation. As a theory, it says that the distribution of returns across an investment portfolio is tilted, with a small number of investments generating most of the returns and the remaining investments breaking even or losing money. BIP Capital CEO Mark Buffington explains it this way: ‍

"The Power Law of Venture Capital is the theory that an exceedingly small number – as little as 5-10% of an investor's venture capital investments – will yield the vast majority (90-100%) of returns from venture investing. But the Power Law, as practiced by most venture capitalists today, is BS. The best venture capital firms consistently see higher return attribution from a much higher percentage of investments. Sadly, the deteriorating definition of the Power Law of Venture Capital has been used, particularly by institutional investors, to justify continued investment into inferior funds." 1 

Particularly in its extreme use cases, the Power Law in a VC portfolio eschews a "normal" (bell-curve) distribution where outcomes cluster around an average for an extreme Pareto-like distribution model. Instead, the Power Law distribution pattern shows that returns are expected and allowed to be uneven. 

As the fat-tail distribution model shows, a small percentage of investments generates most of the returns. The rest (upwards of 90%) yield modest or no returns – by design. 2  Plotting returns for a VC fund ascribed to the Power Law shows that most of the portfolio's investments cluster near zero, and a minimal number of outliers shoot up exponentially. Their typical portfolio of 100 startups would show:  

• 60-70% of the companies would return little or nothing 
• 20-30% of the companies would return 1-5X their investment 
• ~5% would return 10X, 50X, or even 100X  

Power Law VCs use this distribution to justify huge valuations for companies with expected unlimited upside potential. The logic says that one "home run" can return more than all other deals combined, and history has shown a few cases where this has been true.  Declaring it a measure of historical value, some old-guard Sand Hill VCs claim the "great" funds not only have more home runs, but their home runs are bigger those accomplished at 'lesser' funds. 3 That doesn't matter for most individual investors, however, because they do not have access to these deals, and even if they do, the cost of taking part in the deal is prohibitively high. 

Peter Thiel's investment in Facebook is a rare, historical example of an outlier home run worth more than most deals combined. The $0.5M deal grew to roughly $1.1B – a 2,200× return. 4 Thiel articulated the allure of this big swing, saying, "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." 5 ‍

The Mathematical Explanation for the Power Law in VC  

The mathematical explanation for the Power Law shows that the probability of an outcome is proportional to a power of that outcome's size. The equation describes the probability that a venture capital investment (X) will yield a return greater than x.

In VC, α (alpha) is typically between 1.8 and 2.0, meaning very high returns are rare but impactful. The higher the return multiple, the less likely it is to occur—but the few that do drive most of the total gains, which is how many VCs justify the approach. ‍

History of the Power Law in U.S. VC 

Some degree of Power Law distribution has been inherent in venture investing since its start. The Power Law gained prominence over the last two decades as a mental model and has gained widespread use in recent history. In the mid-2000s and 2010s, leading U.S. venture capitalists began openly discussing and embracing the Power Law paradigm. Union Square Ventures' Fred Wilson wrote a blog in 2009 analyzing what he perceived to be a "1/3, 1/3, 1/3" pattern in VC portfolios. His theory was that approximately one-third of investments fail, one-third barely break even, and one-third produce most gains. In this early examination of Power Law thinking, Wilson figured out that for a VC fund to deliver a 3X return (overall), the successful third of the companies must return about 7–10X each and generate double-digit multiples to compensate for the underperforming companies. 5 

Not long after (2014), Mark Andreessen pulled back the curtain on VC, revealing that about 4,000 tech startups apply for funding every year. Of those, only ~200 get funded by 'top' VCs. And of those 200, about 15 generate 95% of the returns. In other words, he found that significantly less than 1/3 of the portfolio produced most of the returns. In fact, that outlier group was only about 7% of the portfolio, which is more in line with the modern Power Law distribution model. Andreessen's point was that the huge wins matter most, and the success of a fund depends on finding these minority blockbusters among the many ventures capitalized by a VC. 6   

Other investors moved that notion of the Power Law further. The term "Unicorn" quickly embedded itself in the VC lexicon, reflecting the obsession with rare, massive outcomes. 6 More VC investment strategies shifted to adopt a model of focusing fewer, high-conviction bets on ideas with billion-dollar potential or broadening their funnel to try to ensure they would not miss the next home run. 

Today, whether they embrace Power Law as their core investment principle or not, virtually every U.S. VC fund acknowledges this distribution of outcomes as a core reality. The mindset permeates decision-making – from how portfolios are constructed to how teams evaluate potential portfolio company startups by assessing whether a prospect could be "a 10X–100X company"). The rise of mega-funds launched to back future giants has epitomized the trend of doubling down on Power Law outcomes. Even the current focus on "unicorn counts" as a success metric for funds stems from the framework. For many large, legacy VC firms, it's believed that without at least one unicorn, a large fund will struggle to produce top-tier returns. 4 ‍

Nuances of Power Law Applications 

The Power Law has profound implications for how GPs, LPs, and portfolio companies manage capital and operate over time. Its statistical and mathematical structure can inform strategy-building. As Mark Buffington explains in The Power Law of Venture Capital: Fact vs Fiction, those strategies have real, material implications for venture funds, founders, and investors. ‍

Venture Funds and Their Investors (LPs)  

As you've read, some GPs use the Power Law to justify a high-risk investing approach by highlighting the high-reward outcomes. The distribution model confirms the belief that VCs can expect and absorb a high percentage of failures in a portfolio because one "home run" can more than cover other losses. 5 That mentality can help prompt VC teams to pursue more innovative, bolder ideas because they don't need every deal to succeed. Reputationally, this approach supports a VC's ability to grow brand equity among "desirable" institutional and ultra-high-net-worth investors and founders. Their approach is to emphasize their exclusive list of outsized winners, ensuring their performance outshadows and distracts from a much longer list of losses. With these brand implications, Power Law VCs tend to concentrate most of their resources on their most promising portfolio companies (e.g., extra funding and support) and less capital and minimal support to the riskier bets. 

The model has obvious issues. Most notably, it can skew portfolio batting averages over time. Failing to land an outlier will cause poor total returns for a portfolio or vintage. Looking at batting average as a measure of VC performance, data suggests an index of all venture deals would outperform about 75% of VC funds precisely because many funds miss the few big winners. 4 

The dynamic puts immense pressure on VCs and LPs to get into the top deals. There's a "fear of missing out" (FOMO) in the industry – if you're not an investor in the next big unicorn, your fund may lag, lowering its ability to continue to attract investors and capital. 7 Some of the excessive pre-money valuations that have plagued the sector over the past decade are partly to blame on venture firms overpaying for hot startups, over-concentrating investments in 'hot' companies, and engaging in herd behavior (chasing the same perceived future unicorns as other VCs).  ‍

Venture-backed Startups 

For VC-backed founders, the Power Law can be a double-edged sword. On the one hand, if a Power Law-oriented investor perceives that the company could be their "home run," the founder is more likely to garner an outsized valuation, capital injection, resource allocation, and brand amplification. Their investors may be more inclined to patiently allow them to endure losses as part of their growing pains. Many of today's iconic startups (e.g., Uber and Airbnb) benefited from VCs' willingness to "swing for the fences" and support their full startup journey – including their challenges and setbacks. Founders who can leverage this opportunistic dynamic are well-positioned to achieve massive scale quickly.  

There are downsides to a winner-takes-all mindset. If a VC expects a startup to produce exponential outcomes, the founder and their leadership team may feel compelled to pursue unsustainable growth strategies. They may experience intense pressure to grow faster than is reasonable or sustainable, often leading to strategic overreach and causing the company to burn capital at a rate that outpaces business. The pressure to hit total market dominance has caused many otherwise promising companies to fail when they could have become solid, enduring mid-sized businesses if given proper funding and consistent support from their VC partner.  

The bottom line is that while the prospect of being a Power Law winner can unlock outsized support (financial and advisory) for a few startups, most (approximately 90%) do not meet the high bar set by Power Law VCs. That large majority ends up on the losing side of the bet. ‍

Individual Private Market Investors (LPs) 

Sophisticated individual investors who invest in venture capital know that the asset class can generate outcomes that other alternatives can rarely match. The tradeoffs are access and risk. LPs can assess the degree to which their VC partner ascribes to the (high-risk) Power Law by evaluating the performance of portfolio companies, vintages, and funds over time. The data is critical to helping an HNWI align their investment goals with their wealth needs and risk tolerance. 

As is the case for the GPs, LPs can multiply their capital many times over if a fund makes a savvy investment in an early-stage company that becomes an outperformer (e.g., Facebook). HNWIs who have the resources and net worth to invest millions in a basket of promising startups can take enough 'shots on goal' to increase their odds of capturing an outlier return (or a few). It's worthwhile noting that less than 6.6% of U.S. households have this level of investable capital.13  Trying to pick a few startup investments will almost inevitably result in a loss of money. As with funds, investors' playing' the Power Law should try to put their capital into a large portfolio to harness its benefits.  

Overseeing a fund diversification strategy is one of the many ways wealth advisors are particularly valuable. They have the sophistication to understand the implications of a firm's historical performance. They may also have more access to the data to guide their clients in absorbing write-offs and long investment timelines as they pursue a windfall.  

It's worth reiterating that top-tier VC firms with strong networks have historically captured extreme outlier deals. An individual investor, particularly in a market outside the major investment hubs, might struggle to access an investment with one of these top-tier firms without access to an elite fund or syndicate. ‍

Cautionary Tales & Key Learnings 

Legacy Funds like Sequoia, Andreessen Horowitz, and Softbank have built their reputations on a string of outlier hits (e.g., Google, YouTube, Instagram, Airbnb) In each case, the huge success generated profits large enough to cover many past and future misses – giving public validation to the Power Law. However, when misapplied or taken to extremes, the Power Law can backfire with catastrophic ramifications for everyone involved.  

Concentrating too heavily on one "home run" can be disastrous if the startup stumbles, does not fulfill its massive pre-money valuation, or takes too long to reach a profitable exit. Moreover, too much Power Law thinking and consequential herd behavior can contribute to market bubbles – as was the case in the late 2010s when venture funding surged into on-demand services and fintech. Dozens of startups were dubbed "the next Uber for X" or "the next Facebook," attracting capital well beyond their fundamentals. When only a couple achieved breakout status, the rest struggled or shut down, leaving investors with losses. 

Notably, VC investors have varied tactics to cope with the Power Law. Some, like Peter Thiel, advocate extreme selectivity – "only invest in companies that have the potential to return the value of the entire fund." 8 Others, like Dave McClure (founder of 500 Startups), argue that it's impossible to predict which startup will be the big hit, so it's better to invest in a way that uses statistics to catch one by sheer volume. While that "spray and pray" strategy can work simply due to volume, it can dilute ownership stakes to the extent that the "home run" does not move the needle.8  Andreessen Horowitz has blended the approaches by raising multiple funds (seed, venture, growth) to place many small bets in high-potential early-stage companies and then investing tranches to double down on winners as they emerge.  ‍

The tranche-based model is closest to how BIP Capital works. But distinctively, BIP Capital does not ascribe to the expectation that outliers will drive returns. Outcomes result from thoughtful capital allocation and post-capital value creation efforts tailored to the specific needs and opportunities of the portfolio company. ‍

A Less Extreme, More Broadly Beneficial Approach 

Despite its risk to everyone involved, the Power Law is a defining framework for U.S. venture capital. VCs use it to mathematically explain and justify seeking "unicorn" startups, structuring portfolios around one or two likely "winners," and accepting high failure rates (even though those failures affect their portfolio founders and LPs negatively).  

From a strategic perspective, the Power Law pushes investors to be bold in backing ideas that could change industries and thoughtful in ensuring the overall approach can withstand the many misses on the way to a hit. For founders, it means aiming high and understanding VC backers' expectations. It reinforces the importance of diversification and access to top-tier opportunities for individual investors. (That alone means that Power Law investing is unsuitable for most HNWIs who participate in venture capital.)  

For most HNWIs, a more appropriate VC approach focuses less on big swings and more on healthy, consistent return percentages over seven to ten years. Even if the returns are not 'outlier' levels, in aggregate, they can result in significant outcomes over time. 

Evergreen VC structures have become a particularly appealing venture capital option for many HNWIs and wealth advisors. Over the past decade, the aggregate AUM of Evergreen funds has more than quadrupled to $430B.14 The asset class provides a list of structural benefits, including removing the time constraints of traditional VC funds, allowing capital to flow in and out over time, which equips LPs to invest opportunistically in portfolio companies to raise the chance of optimal outcomes. For HNWIs, Evergreen funds provide a higher level of continuous exposure to the venture market with lower investment minimums, allowing for more fund diversification and liquidity opportunities. Together, these features can mitigate the risks of binary outcomes and generate stronger returns over time.  ‍

Join us for an educational webinar and Q&A session focused on Evergreen funds. Find the full schedule and registration links here. 

Bibliography

1. Mark Buffington, The Power Law of Venture Capital: Fact vs Fiction, BIP Ventures Blog
2. Jori Karstikko, Understanding VC Power Law, Rundit (2024)
3. Chris Dixon, The "Babe Ruth Effect" in VC, a16z (2015)
4. Abe Othman, AngelList Data on Power-Law Returns, AngelList Blog
5. Aram Attar, Understanding the Power Law: Do Venture Capitalists Take Enough Risks?, The VC Factory
6. Tren Griffin and Marc Andreessen, 12 Things I learned from Marc Andressen: Marc Andreessen on Power-Law Returns – a16z (2014)
7. Nivi, Angel Investing Lessons – Venture Hacks (2019)
8. Peter Thiel, "Secret" of VC Returns, via Zero to One (2014)  
9. Fred Wilson, The Venture Capital Math Problem, AVC Blog (2009)
10. Sequoia's WhatsApp $60M → $3B return, via The Art Of Making Good Investment Decisions In VC, Forbes (2023)
11. SEC - Investor Qualifications  
12. iCapital – The Future is Evergreen