Paul Graham had a very interesting post up today on Black Swan Farming
Go read it here.
If you didn't read it - I'll summarize:
1. Venture investing is hard because the return distribution is so skewed toward outliers that it is almost impossible to tell which those will be.
2. Great ideas often lok like idiocy at the beginning
3. You don't know if you've won until after they've drawn the numbers.
For those of us who have been investing for years, much of this is a rehash, but a great one written by a very thoughtful investor.
It should come as no surprise that the return distribution in venture is far more fat tailed than one would typically expect. After all, what is seed stage investing across a ton of companies but the purchase of a lot of lottery tickets. While one can predict the outcome of a single company based on the founders, the idea, the marketplace, the opportunities for exit etc... - the ability to predict the next Google / Facebook simply does not exist - and more than the ability for me to pick the winning powerball ticket with certainty.
And yet, that Powerball distribution is what we seen in seed stage across a large portfolio. One winning ticket absolutely dwarfs all other outcomes. More people play Powerball than invest in seed - and despite the average persons desire to see Gaussian normal distributions, people participate in fat tails twice a week.
Of course, as the saying goes - You've Got To Be In It To Win It
It is very rare to make great returns betting with the crowd.
You need to be early, and you need to be willing to be alone and wrong.
Oh yeah, and you need to be right.
That pretty well describes point two.
Just betting against the crowd is not enough - because more often than not -the crowd has it right. It is only by looking at things in a different way than the crowd, and seeing the possibilities that you can get those big outcomes.
Graham goes into great detail about funding as a measure of success and how he doesn't do this with the YC classes.
Methinks he doth protest too much.
I don't know Paul, and by all rights he is doing a great job and is incredibly well respected - but as a complete outside to his world, and from the press coverage we are already seeing, it seems as if the purpose of YC (or any other incubator these days) is to be able to jack up the proce of your next round. Lots of posts on this - but the main point is this: you really don't know if you are winning until you have won - and winning is a long term game.
VC is a long tailed asset class with an enormous amount of volatility in it.
Go back and read the Black Swan and Taleb will suggest these sorts of investments paired with super safe bond portfolios.
Not a bad suggestion