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Insurance policy and lottery ticket
The insurance policy
The insurance policy comes from indexing innovation against inflation. At that scale, coming in this early at these valuations, Monte Carlo simulations produce a 3 to 5x return because of the diversification. Access to follow-on investing then lets the fund rebalance and concentrate into the winners.
The lottery ticket
The lottery ticket is the chance at a 10, 20, or 100 billion dollar company, and with this many bets the portfolio will almost certainly capture at least a few of them.
Why seed is mispriced
Inception-stage companies are mispriced: a firm can get in at a valuation far below where it should be, because there is so little to underwrite. The 2 and 20 model most funds run on doesn't leave room for the infrastructure that underwriting requires at that stage, meaning an office, a large team, and something in person to see whether a founder is an outlier. Many funds wait for accelerators and inception funds to do that work and then bring the deals to market. Antler is capitalized in a way that pays for it.
How does diversification help early-stage portfolios?
Venture returns are heavily skewed, so a small minority of investments produce most of the gains, according to analyses of fund data such as those published by Horsley Bridge. A fund with only a handful of bets can miss every big winner. Spreading across hundreds of companies raises the odds of owning at least one outlier. Follow-on investing then lets the fund add money to the companies that pull ahead.
Why do funds keep small teams at seed?
The standard venture structure charges a management fee of 2 percent of committed capital each year and takes 20 percent of profits as carried interest. The fee covers salaries, offices, and operating costs, so a fund's staff is sized to that budget. Evaluating hundreds of unformed companies in person takes far more staff than a typical seed fund has. That gap is part of why some firms wait for others to do the early work.
How did accelerators create early-stage investing?
Y Combinator launched in 2005 and Techstars in 2006 in Boulder, Colorado, offering small investments to very young companies. Cloud computing, led by Amazon Web Services in 2006, cut the cost of starting a software company because founders no longer had to buy servers. Cheaper starts meant smaller checks were enough. A new class of seed funds grew up around that change.
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