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Massive inequality exists

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This is a post about secret #2 about startups by Peter Thiel. To see all 4 of the secrets start here.

These views and thoughts are all Peter’s and notes are from Blake Master’s. If you find any of these ideas intriguing I suggest reading through the full notes here.

TLDR: Massive inequality exists. Tweet this.

This is the second secret. A power law distribution curve (or more generally called a power law) is one where a small sample produces the majority of the effect or put in easier way to grasp one in where 20% of the actions produce 80% of the results (Pareto’s principle).

In one sense it’s a secret about finance, Startup outcomes are not evenly distributed; they follow a power law distribution. But in another sense it’s a very human secret. People are uncomfortable talking about inequality, so they either ignore it or rationalize it away. It is psychologically difficult for investors to admit that their best investment is worth more than the rest of their portfolio companies combined. So they ignore or hide that fact, and it becomes a secret.

Here is how this secret manifests itself in venture capital investing.

How VC’s think
The most important concept to understand for technology investors is exponential power. As Einstein says the most powerful force in the universe is compound interest.

Because of the power law distribution, Venture Capital investor returns are incredibly skewed. In practice VC’s only make money if your best company investment ends up being worth more than your whole fund.

The two conclusions this brings up for investors are:
 

  • Every investment has to have the potential of being worth more than the whole fund.
  • It’s better to be very concentrated in a few investments as opposed to being diversified.

 
Real example of power law
The 100th employee at Google did much better than the average venture-backed CEO did in the last decade. The distribution is worth thinking hard about.

The power law distribution simply means you have to think hard about a given company is going to fall on the curve.

Power law applies to everything
Understanding exponents and power law distributions isn’t just about understanding VC. There are important personal applications too.

Many things, such as key life decisions or starting businesses, also result in similar distributions.

This secret plays a very important part for all of Peter Thiel’s other secrets and views as a whole.
 

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Written by Chris McCann

May 15, 2012 at 5:35 am

Posted in Uncategorized

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  1. […] The power law distribution curve […]


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