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January 16, 2007

Home Runs vs. Singles: Long Tail in the VC World?

Being an avid WIRED reader (the print version now thanks to a subscription for Christmas the last two years running), I rushed out to buy Chris Anderson’s Long Tail and have been following the post-media hoopla ever since.

  Khao Sok: Longtail at Dawn 
  Originally uploaded by Nathan Moody.

While Anderson uses online video, music, and book sales/services for the main quantitative analysis in the book, it didn’t take long for the rest of the blogosphere and the MSM to jump on the Long Tail premise and begin applying the concept to other industries (e.g. newspapers).

From my various RSS feeds, came across VentureBeat’s article on whether entrepreneurs should always accept VC funding. I highlighted the following nugget (emphasis added):

“In addition, my partners and I won’t be too excited about a $50M acquisition. This type of exit is not sufficient to ensure superior returns to our limited partners across a broad portfolio of investments-our returns are determined by home runs, not singles.”

I’m not in the VC industry but can assume from what I read/listen to and from the article’s tone that the VC world has at least traditionally been won or lost on the home run successes that Charles writes about above. With that context, is there a connection between the changes we’re seeing in the VC industry and the Long Tail theory on the future being less dominated by the big hits?.

The VC industry is definitely changing as the required startup capital for entrepreneurs is now much lower (thanks in part to Web2.0) than it was during the Dot Com days so we can imagine that the required ROI for VCs is now lower as well—does that translate into lower risks or point simply, will the new world of venture capital be less dependent on having home runs to subsidize the singles (the Long Tail theory)?

Have the relative differences between homeruns and singles changed, with successes being slightly less pronounced and failures being slight less negative (overall spikiness is reduced) so that VCs will become less dependent on overcoming the majority of losses with the few and far between big successes?

Or would we expect the home runs to be even more important because the market is so crowded with the average single or double hits that making money in a more open, lower barrier to entry playing field actually requires even more success in order to stand out from the crowd of average entrepreneurs and startups?

My hunch is that the scales of the investment risks have changed but that the ratios of successes to failures is still roughly the same with entrepreneurs and startups so that we’re still balancing an acceptable level of risk (albeit smaller) with an anticipated exit reward (perhaps smaller) down the road. Even if the investments have become smaller, I don’t think that fundamentally changes the odds of being a successful entrepreneur. It’s still lots of hard work and a little luck too.

I’m not really into trading stocks but the reason that I’m interested in the VC world is that I’ve always been into business and technology and how to combine those interests to understand the future. And if I can be in the middle of those two worlds and be a part of the exciting changes we’re seeing now with the internet, and make a buck or two while doing it, than all the better.


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