Type II VC Error

Quiz question time: Making some reasonable assumptions about deals per year, success rates, etc., what is the likelihood that a first-time venture capitalist who is actually good at the stuff flops at his/her first four deals?

In other words, what is the likelihood of Type II errors in venture capital funding, where LPs deem someone to be unskilled who actually happens to be skillful?

It is an important question, so answer and discussion in a subsequent post.

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  5. Mary Meeker Watch

Comments

  1. Peter from Amsterdam says:

    I’m not sure we’re meant to try answer this in a comment but I couldn’t resist. Assume that a good VC makes does have a flop in 50% of the deals which is reasonable if you assume 1 out of 10 is a killer and 4 out of 10 or ok but not big hits), then the chance of having four flops in a row is 0,5 x 0,5 x 0,5 x 0,5 = 6,25%

  2. dj says:

    I think in order to assess the probability of a VC Type II error, you have to identify what the successful VC is made of.
    The 6.25% empirical prob is accurate, but is it real world accurate?
    My gut tells me that the probability of four consecutive flops is practically nil for a “good” VC by normative standards (less IRR of course) and therefore a type II error is practically nil as well.
    Historically, the only thing that most VCs shared was the ability to apply their vision where others couldn’t.
    As Benjamin Rosen once said, “The way to break into venture capital is to have a success.”

  3. proales says:

    …hence the pressure to increase the number of investments in the first fund portfolio and so make tiny investments.

  4. MPH says:

    Paul,
    Your question is phrased: “In other words, what is the likelihood of Type II errors in venture capital funding, where LPs deem someone to be unskilled who actually happens to be skillful?”
    Some people seem to have answered almost an opposite question – “what is the likelihood that (potentially) skilled first-time VC will fail in all 4 out of 4 investments.
    You may recall some discussions I had with you privately via email 4-5 years ago about venture fundraising; at that time, at least, there were an ironic set of challenges in play for first-time funds. Even with skilled teams with strong management and entrepreneurial track records (but by definition no venture track record), LPs were on the one hand saying that they were hungry for new investment opportunities, and on the other that they wanted hungry, successful, small, early-stage funds with large capitalizations so that they could take chunks of LP money, etc. They were looking for the proverbial “tall, thin, fat, bald man with curly hair”. One very large public venture LP told us “you’re a rock star team” and “come back to us when you’re on fund II”, and “we’re having a very hard time figuring out where to invest our venture money now that our allocation for venture just doubled from about $1.5 billion to about $3.00 billion”
    So, my answer to your question, based on my experience in that timeframe, is “very high”