The potentially unlimited upside of venture capital

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This week we’ll break down the concept of asymmetric returns and how they apply to venture capital. First, let’s try to better understand what asymmetric returns actually are.

Well, asymmetric returns are defined as an investment outcome where the potential gains significantly outweigh the potential losses, creating a disproportionate risk to reward profile. The concept of asymmetric returns is particularly relevant in high-risk, high-reward asset classes, such as venture capital, where a small number of successful investments can result in exponential returns, far exceeding the initial capital invested. We actually wrote about this Power Law phenomenon a couple weeks ago.

These high-risk, high-reward returns are considered asymmetric because the potential loss is typically capped at the amount invested, while the upside potential is theoretically unlimited.

When we think about public market stocks, they typically follow a symmetric pattern that can be somewhat accurately predicted. This predictability is due to the vast amounts of financial data publicly available, as well as regular updates about the general operations of companies and their management teams.

Let’s take a look at Microsoft’s performance between 2009 and 2014:

The stock traded at ~$20 per share at the start of the period and closed the period at $37.16. This would represent an 85% return on investment. Not bad, right? If you had invested $1,000 in 2009 and sold in 2014, you would have earned yourself $850.

Now let’s compare that to WhatsApp’s performance over the same time period:

We don’t know the exact valuation WhatsApp raised their $250,000 seed round at but let’s assume it was $5 million for 5% of the company (I’m being generous here). 5 years later they sold to Facebook for $19 billion. In this scenario, your $1,000 investment would have yielded $3.8 million (or $2.58 million after accounting for dilution in each subsequent funding round).

Of course, this is an outlier example of what can happen when all the stars align, but it’s a perfect example of the asymmetric returns that can be found in venture capital. Now, as we said before, all the potential reward comes with a great deal of risk. It’s critical to diversify your investments across a number of companies. This does two very important things

1. It increases your odds of hitting a homerun outlier; and 

2. It decreases your risk of losing money.

Just have a look at this data shared by AngelList:

The data above shows that as the size of a portfolio grows, the odds of achieving a 3x return increase while the odds of losing money significantly decrease. In fact, in a portfolio of 50 investments, your odds of losing money are only around 2.5%.

So there you have it, asymmetric returns in venture can offer theoretically unlimited upside, but this reward comes with a high degree of risk. However, this risk can be mitigated with a sufficiently diversified portfolio. It’s crucial not only to diversify across multiple private companies but also across various asset classes such as public stocks, real estate, cash, and possibly more (crypto, art, private credit etc.). Balance is key, and having a good strategy in place is essential to offset potential losses and achieve long-term financial stability.

What we’ve been working on at PitchedIt

• Some top secret brand updates 🎨

• Improving the customer notification systems 🔔

• Added logic for deal owner payouts via admin dashboard 💰

• Had all our terms reviewed by our corporate solicitors ✅

The Unsophisticated Investor is brought to you by Scott & Rob, the founders of PitchedIt. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. PitchedIt’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

Scott & Rob
PitchedIt Co-Founders