If you miss the best-performing seed investment, you will eventually be outperformed by someone who blindly invests in every credible deal.
Conventional investing wisdom tells us that VCs should pass on most deals they see. But our research indicates otherwise: At the seed stage, investors would increase their expected return by broadly indexing into every credible deal.
That’s one of the results we found when we analyzed the thousands of deals syndicated by AngelList over the past seven years to test assumptions about the nature of venture capital returns. We’re presenting these findings in a first-of-its-kind report out today, Startup Growth and Venture Returns.
Theoretically Infinite Regret
According to our research, missing the best-performing seed deal can cause you a theoretically infinite amount of regret. What does that mean? Consider Mark Suster, who passed on the Uber seed round and was quoted in the Financial Times saying: “Aaaargh.”
How can you avoid missing the best seed deal? The simplest way is to put money into every credible deal. Maybe you have a crystal ball that gives you perfect foresight, in which case you can pick only the best winners. Even then, if your crystal ball is even a little cloudy eventually you will miss a winning deal—and that winning deal might have been the best-performing investment.
Simulations on 10-year investing windows for seed-stage deals suggest fewer than 10% of investors will beat the index, even if those investors have skill in picking deals. Like Vanguard has taught us in the public markets, individual investors could benefit from viewing the index as the default and then overlaying individual deals that they like.
How Startups Grow
Seed-stage returns tend to be more extreme than later rounds for two reasons: Startups tend to grow faster earlier, and seed investments have longer to compound these higher growth rates. By the time these companies go public, their growth rate has tailed off (consider Uber again, but this time at its IPO). We used AngelList data to compare the relative value of each year of a startup’s life on its compounded returns. We found that growth drops off in a startup’s second year of funding and continues to decrease from there:
Companies Staying Private Longer
Startups are staying private longer, meaning a powerful wealth-creating engine now exists entirely in the private markets. That’s why in our response to a recent SEC Concept Release we proposed steps to open broad-based early-stage venture capital indexing to the 90+% of retail investors who are unaccredited, while maintaining appropriate investor protections.
Disclosures
This post and the information contained herein is provided for informational and discussion purposes only and is not intended to be a recommendation for any investment, investment strategy, or other advice of any kind, and shall not constitute or imply any offer to purchase, sell or hold any security or to enter into or engage in any type of transaction. Any such offers will only be made pursuant to formal offering materials containing full details regarding risks, minimum investment, fees, and expenses of such transaction.
Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.
Download the Report here
Abe Othman is the Head of Data Science, AngelList
Charles Rapulu Udoh
Charles Rapulu Udoh is a Lagos-based Lawyer with special focus on Business Law, Intellectual Property Rights, Entertainment and Technology Law. He is also an award-winning writer. Working for notable organizations so far has exposed him to some of industry best practices in business, finance strategies, law, dispute resolution, and data analytics both in Nigeria and across the world