Luck’s Role In Venture Capital

By Dan Gray

How much of a startup investor’s success can be attributed to luck?

Pablo Ventura, general partner at K Fund, believes that luck has a significant influence. His personal retrospective provides a fascinating opportunity to look at the philosophy behind venture capital and early-stage startup investment. I applaud the humility, but would like to suggest a different outlook.

Defining luck

Winning a high-stakes poker tournament as a beginner requires luck. Making a comfortable living as a professional poker player requires ability.

Of those two scenarios, it’s the second we’re likely to identify with venture capital, given the shared focus on analytical thinking and consistency. The first is a better reflection of a founder’s journey.

We all know the stories about VCs taking risky bets on early-stage companies with big ideas. Surely that’s evidence of a major luck component?

The greatest hurdle to understanding venture capital is that VCs expect most of the companies they back to fail. That sounds unintuitive, but it’s the simple and natural trade-off against potential.

You might have heard this concept referred to as the “VC Power Law,” well-explained by Luke Mostert, head of investments at Future Africa, in his recent Twitter thread.

In essence, the nature of a startup’s category-leading ambition means a lot of small losses is worth it for a few massive wins for investors. VCs want to back founders who will blow their company up trying to break the stratosphere, rather than those seeking a modest exit.

The corollary is that if every company in a VC’s portfolio produces a return, that’s a bad signal. It’s a sign that the VC is playing a low-stakes game: Not thinking big enough, not taking enough risk, and likely not producing the scale of return people expect from that asset class.

If that ratio of failure to success is intrinsic, and priced into the VC model, can you really attribute success or failure to luck?

Professional poker players will talk about the curse of “variance” (the deviation from expectations based on chance), but ultimately agree that luck is not a factor on long-term results. How the cards get dealt, how you deal with those situations, and the times you just have to take a loss on the chin are all assumed and accounted for. Only bad players refer to luck as an excuse.

If you want to see luck at work in venture capital you can certainly give it the opportunity: Dump your whole fund into one company, invest exclusively in sectors you don’t understand, or throw a dart at a board of opportunities. Just be wary, because while you might cite luck when you’re being humble about success, LPs certainly won’t accept it as an excuse for failure.

The smart approach is always to eliminate your exposure to luck with the usual combination of careful long-term strategy, observation and calibration.

“Hilariously-early stage” VC firm Hustle Fund offers a useful example to illustrate this philosophy: as the descriptor implies, it focuses on founders at the riskiest end of the spectrum, with the most untested assumptions.

Writing a lot of small initial checks allows it to convert that uncertainty into a strategic advantage: it gets the inside track on a startup before others, saves its seat at the table, and makes better decisions about involvement in larger future raises. It is smart, systematic and works out well for everyone.

The bread and butter of investors is consistency and repetition.

Leave luck for the founders, they need it more.

Dan Gray is an adviser supporting impact entrepreneurs in emerging markets, and is the head of marketing at Equidam, a platform for startup valuation.

Illustration: Dom Guzman

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