The tail that wags the dog.
By the end of the 1930’s, Walt Disney’s humble studio had sketched over 400 cartoons – most of them adored by their viewers, and most of them losing money. Disney had been bankrupted before, and with the incredibly high cost of cartoon production and onerous finance available at the time, a second and tectonic failure looked certain.
Snow White and the Seven Dwarfs changed everything. Disney earned $8 million in the year ending 1938 – a staggering amount at the time. Borrowings were repaid, bonuses were given, key staff retained, and a state-of-theart studio built (where the company remains today). Of the hundreds and hundreds of hours of film produced by Disney Inc., those 82 minutes and 32 seconds of Snow White were the ones that mattered.
And this is a proxy for life in general: business, investment, sports, politics, careers, everything – they are dominated by long tails. Outliers. Black Swans. Extreme departures from the mean. Most anything that is huge or profitable or famous or influential has its kernel in a long tail event.
Venture capital – for those that are part of it – is a tail-driven business. As the accepted wisdom goes: make 100 investments and almost all the return will come from five of them; and most of your return from one or two. For the empirically inclined, Correlation Ventures has crunched the numbers:
Of 21,000 venture financings from 2004 to 2014, 65% lost money. 2.5% of investments returned 10x-20x their capital invested; 1% made 20x; 0.5% (about 100 companies) earned 50x or more.
The last group is where the majority of the industry’s returns come from. There has been $482 billion of venture funding in the last ten years – the combined value of the ten largest VC backed companies is $213 billion – so ten venture-backed companies are valued at half the industry’s deployed capital.
But this is what puts the ‘venture’ in venture capital, right?
Not really. Warren Buffet once said he has owned 400 to 500 stocks during his life and made most of his money on ten of them. As his counter-part Charlie Munger put it: “if you remove just a few of Berkshire’s top investments, its long-term track record is pretty average”. For instance, the S&P 500 gained 22% in 2017 –a quarter of that return came from just five companies: Amazon, Apple, Facebook, Boeing and Microsoft. Ten companies made up 35% of the return. Twenty-three accounted for half. The Nasdaq 100 even more so: the index gained 32% last year. Five companies made up 51% of that return; and just twenty-five companies were responsible for 75% of the overall gains.
Even if you take the last thirty-five years of data (curtesy of a JP Morgan Asset Management report on the Russell 3000) it shows that 40% of all listed companies lost at least 70% of their value and never recovered; and that effectively all of the index’s overall returns came from just 7% of its constituents. That is pretty similar to venture capital.
A lot of of our attention goes to things that are huge, profitable, famous, or influential – and when you pay a lot of attention to something, you can underestimate how rare it really is. The comforting part is that no matter what you are doing, you can take solace in the fact that if things are not working right away – it’s normal. This is true for companies, for investors, for careers, for most everything. Jobs and even entire careers might take you a few attempts before you find a winning formula – that is just how these things work. And for perspective, remember that of the billion or so likely planets in our galaxy, and of the 9 million species on this planet – the very fact that you are part of the only group that can read this sentence makes you part of the longest of long tails.
Stay safe.
