The power law, which describes the phenomenon whereby a small amount of inputs generate a disproportionately large number of outputs, is just as relevant in explaining venture capital success as it is in explaining numerous phenomena in the real world – like earthquakes, professional athlete success, and drug discovery. Applied to venture, if you’re building a portfolio of – say – twenty companies, the power law says you should expect most of them to fail, some to have moderate success, and one or two to have such fantastic success that they’ll make up for your losses (and more, ideally).
Power law is often used as a justification for a “spray and pray” investing methodology, where investors haphazardly commit capital to dozens of potential breakout companies with the hope that one will be a home run. While the spray and pray method has been somewhat successful historically, we at SineWave believe that spray and pray will be an untenable strategy for venture firms moving forward. Instead, we believe that a concentrated, thesis-driven investing approach will win the day in venture capital.
There are three core reasons we believe a concentrated portfolio is the right approach for the future of venture investing:
- Capital has become a commodity. According to Preqin, the aggregate amount of dry powder available to global private equity and venture capital funds is $2.62 trillion. And between 2008 to 2022, the number of venture capital firms increased from roughly 1,000 to over 4,000, a 300% increase. There is an overwhelming amount of capital in the VC ecosystem. As savvy entrepreneurs seek competent funding partners from the pool of 4,000+, they value firms that have a significant level of expertise in the area(s) where they’re building. Building a concentrated portfolio – and spending significant amounts of time in a few core, critically important areas – enables investors to build expertise and differentiate themselves amongst founders.
- The investable universe has exploded. According to Pitchbook, as of Q1 2024, there were over 55,000 startups operating in the US. And, as Pitchbook describes in the same report, there’s over twice as much demand for venture capital than supply. So, not only is there too much capital in the venture ecosystem, there are too many startups, too. And with continuously challenging liquidity markets, sussing out which companies have a real opportunity to become category-defining businesses is increasingly difficult. Again, a high level of expertise and market coverage – virtuous benefits of building a concentrated portfolio – can help investors spot differentiation and choose winners in increasingly murky waters.
- Concentration and value-add go hand in hand. At SineWave, we help commercial-first technology companies scale GTM with high assurance customer bases, including the F1000 and the public sector. Because our portfolio is concentrated, and we have a manageable number of portfolio companies relative to our team composition, we can provide true value-add to all of our CEOs without needing to make significant sacrifices.
At SineWave, we’re committed to generating market-leading outcomes for our LPs, portfolio companies, and corporate partners. Building a concentrated portfolio – enabled by our vast expertise – has been core to our historic success, and we’re confident it will play a large role in our future success, too.
