EP06 - How Venture Capital Math Works

How venture capital works. Learn about VC funding, power law returns, startup valuations, and why most VC investments fail while a few generate massive returns.

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WE JUST CLOSED 8M SEED AT40M PRE!! I still own 75 %!!

If we 100×, that’s… that’s $3 billion dollars for me! I’m gonna be a billionaire!

Congratulations. Now come sit. Let me show you the math on your new paper.

Returns here do not follow a bell curve. They follow a power law.

One rocket. Ninety-nine that never leave the pad. The fund only needs the rocket.

My $100B fund charges 2-and-20.

After fees, to return 3× net to LPs, one portfolio company needs to return the entire fund — 80–100×.

Wait… so for you to win, my company has to be worth $8–10 billion?!

Correct. Out of the 400 founders I back this vintage, 390 will probably become very expensive memories.

But we have traction! 300 % MoM growth! Users love us!

Every single one of these had ‘insane traction’ too. Right up until they didn’t.

In normal markets, Kelly Criterion says risk 1–10 % of your capital per bet on a coin flip.

In venture capital (VC), the edge is so low that under most mathematical models, the right move is to not bet.

Yet, weird things start happening when its possible for a single bet to payoff 100x-1000x.

Suddenly, it is mathematically OK to bet 0.1% of our fund for every chance that yields 100x, even if the success rate is <1%

That’s nuts! You are more degen than a WSB trader!

So we had to diversify across 40 companies knowing 39 will die. It’s the only rational way to play an irrational game.

And because VC loses so much money in many different places, we usually want liquidation preference.

Even if exit is $500M, VCs get paid first → common shareholders get roughly ‘thoughts and prayers’.

we have many other companies we want to fund

So… all my future employees, early friends & family… they get crushed first?

That’s why it’s called venture capital, darling, not venture charity.

How do I actually make money then?!

Quit and angel invest. Or index funds and touch grass.

Or stay, and try to be the one percent.

I’m going to build the next unicorn myself!

Statistically, you’re going to be one of the 99 corpses that funds the winner.

But 1 % chance I become the winner!

That delusional 1 % optimism is exactly why I wrote you the check.