The Power Law of Venture Returns
Venture capital returns follow a power law: a small number of investments generate the vast majority of returns. In a typical fund, 1–2 companies out of 20–30 will produce more than the entire fund's return. This has profound implications for how you construct your portfolio.
Diversification vs. Concentration
There are two schools of thought. Concentrated portfolios (10–15 investments) allow deeper involvement with each company and larger ownership stakes. Diversified portfolios (25–40 investments) increase your chances of catching a breakout winner. For first-time fund managers, diversification is usually the safer approach.
Reserve Ratio: The Hidden Key
Smart investors allocate 40–60% of their fund for follow-on investments in their best-performing companies. If you invest your entire fund in initial checks, you won't have capital to double down on your winners — which is where the real returns come from.
Sector and Stage Balance
Avoid putting all your eggs in one sector basket. Even if your thesis is focused, maintain some diversity across adjacent sectors. Similarly, spreading investments across vintage years (the year of initial investment) reduces your exposure to market timing risk.
Check Size Discipline
Define your initial check size range and stick to it. If your fund is $10M, initial checks of $200K–$500K with reserves for follow-on keep you disciplined. Oversized checks in any single deal create dangerous concentration risk.
Portfolio Management After Investment
Active portfolio management means knowing which companies need more support, which are ready for follow-on, and which are failing. Regular portfolio reviews (quarterly at minimum) help you allocate your most valuable resource — your time — to the companies where it matters most.