MONEY MAKES MONEY.
“For whoever has will be given more, and they will have an abundance. Whoever does not have, even what they have will be taken from them” (Matthew 25:29).
Albert Einstein made the same observation when he stated that compound interest was “the eighth wonder of the world,” “the greatest mathematical discovery of all time,” or even “the most powerful force in the universe.” Whichever version you prefer, you can’t miss his message: never underestimate exponential growth. Actually, there’s no evidence that Einstein ever said any of those things-the quotations are all apocryphal. But this very misattribution reinforces the message: having invested the principal of a lifetime’s brilliance, Einstein continues.
Whatever Einstein did or didn’t say, the power law-so named because exponential equations describe severely unequal distributions-is the law of the universe. It defines our surroundings so completely that we usually don’t even see it.
The power-law becomes visible when you follow the money: in venture capital, where investors try to profit from exponential growth in early-stage companies, a few companies attain exponentially greater value than all others. Most businesses never need to deal with venture capital, but everyone needs to know to understand: exactly one thing that even venture capitalists struggle to understand, we don’t live in a normal world we live in a power law.
THE POWER LAW OF VENTURE CAPITAL
Venture capitalists aim to identify, fund, and profit from promising early-stage companies. They raise money from institutions and wealthy people, pool it into a fund, and invest in technology companies that they believe will become more valuable. If they turn out to be right, they take a cut of the returns-usually 20%. A venture fund makes money when the companies in its portfolio become more valuable and either go public or get bought by larger companies. Venture funds usually have a 10-year lifespan since it takes time for successful companies to grow and “exit.”
But most venture-backed companies don’t get acquired; most fail, usually soon after they start. Due to these early failures, a venture fund typically loses money at first. VCs hope the value of the fund will increase dramatically in a few years’ time, to break even and beyond, when the successful portfolio companies hit their exponential growth spurts and start to scale.
The big question is when this take off will happen. For most funds, the answer is never. Most Startups Fail, and most funds fail with them. Every VC knows that his task is to find the companies that will succeed.
However, even seasoned investors understand this phenomenon only superficially. They know companies are different, but they underestimate the degree of difference.
The error lies in expecting that venture returns will be normally distributed: that is, bad companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x. Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers.
But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all. This is because venture returns don’t follow a normal distribution overall. Rather, they follow a power law: a small handful of companies radically outperform all others. If you focus on diversification instead of single-minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place.
WHAT TO DO WITH THE POWER LAW
The power law is not just important to investors; rather, it’s important to everybody because everybody is an investor. An entrepreneur makes a major investment just by spending her time working on a startup. Therefore every entrepreneur must think about whether her company is going to succeed and become valuable. Every individual is unavoidable an investor, too. When you choose a career, you act on your belief that the kind of work you do will be valuable decades from now.
The most common answer to the question of future value is a diversified portfolio: “Don’t put all your eggs in one basket,” everyone has been told. As we said, even the best venture investors have a portfolio, but investors who understand the power law make as few investments as possible. The kind of portfolio thinking embraced by both folk wisdom and financial convention, by contrast, regards diversified betting as a source of strength. The more you dabble, the more you are supposed to have hedged against the uncertainty of the future.
We have always emphasized the importance of having a good website for your company because it can act as your best tool for marketing and sales. A poorly designed website can repulse people from your business and can cause you to lose customers before you even have them. Get in touch with HyperEffects to work on creating, enhancing, and making the website of your company more user-friendly.