Conventional investing wisdom tells us that VCs should pass on most deals they see. But our research indicates otherwise: At the seed stage, investors would increase their expected return by broadly indexing into every credible deal.
That’s one of the results we found when we analyzed the thousands of deals syndicated by AngelList over the past seven years to test assumptions about the nature of venture capital returns. We’re presenting these findings in a first-of-its-kind report out today, Startup Growth and Venture Returns.
Theoretically infinite regret
According to our research, missing the best-performing seed deal can cause you a theoretically infinite amount of regret. What does that mean? Consider Mark Suster, who passed on the Uber seed round and was quoted in the Financial Times saying: “Aaaargh.”
How can you avoid missing the best seed deal? The simplest way is to put money into every credible deal. Maybe you have a crystal ball that gives you perfect foresight, in which case you can pick only the best winners. Even then, if your crystal ball is even a little cloudy eventually you will miss a winning deal—and that winning deal might have been the best-performing investment.
Simulations on 10-year investing windows for seed-stage deals suggest fewer than 10% of investors will beat the index, even if those investors have skill in picking deals. Like Vanguard has taught us in the public markets, individual investors could benefit from viewing the index as the default and then overlaying individual deals that they like.
How startups grow
Seed-stage returns tend to be more extreme than later rounds for two reasons: Startups tend to grow faster earlier, and seed investments have longer to compound these higher growth rates. By the time these companies go public, their growth rate has tailed off (consider Uber again, but this time at its IPO). We used AngelList data to compare the relative value of each year of a startup's life on its compounded returns. We found that growth drops off in a startup's second year of funding and continues to decrease from there:
Companies stay private longer
Startups are staying private longer, meaning a powerful wealth-creating engine now exists entirely in the private markets. That’s why in our response to a recent SEC Concept Release we proposed steps to open broad-based early-stage venture capital indexing to the 90+% of retail investors who are unaccredited, while maintaining appropriate investor protections.