To better understand the chart, let’s explore a few points.
The red dashed line represents the chance an average VC has of having an outlier in their portfolio. This is calculated using a 2% chance of an outlier with every investment, which comes from reducing the Cambridge Associates industry average of 2.5% a bit to remove top tier investors.
Looking at a few key points (the vertical gold dashed lines), an average VC with a concentrated portfolio of 20 investments has a 33 percent chance of investing in at least one outlier and an average VC with a large portfolio of 70 investments has a 76% chance of investing in at least one outlier.
Given Ulu’s experience over more than a decade of seed stage investing, we believe the blue dashed line, representing a top-tier investor’s odds, is the better model for Ulu.
The right portfolio size is still a judgment call based on risk tolerance, opportunity set, support model, and deal flow access. At Ulu, we have built a team and process we believe can source and support four to five high quality deals per quarter. Using a 4-year investment period, typical of a venture fund investing horizon, this translates to approximately 70 investments.
Some VCs contend this analysis doesn’t apply to them, pointing to their concentrated portfolio and great performance as proof. However, funds can make bad portfolio decisions and still have a good outcome thanks to chance.
The average VC with a concentrated portfolio of 20 investments only has a 33 percent chance of investing in an outlier. If there are 100 such funds, however, odds suggest 33 of them will have an outlier success! However, the odds also indicate that only 4% of such concentrated funds will invest in an outlier in three funds in a row.
Using the same logic, Ulu has an 88% chance of finding an outlier in three consecutive funds. While the Managers can make no guarantees, they believe smart portfolio construction can dramatically improve the odds of finding an outlier and delivering consistent top tier performance.