Zero to One: Notes on Startups, or How to Build the Future

The biggest secret in venture capital is that the best investment in a
successful fund equals or outperforms the entire rest of the fund combined
.
This implies two very strange rules for VCs. First, only invest in companies that have
the potential to return the value of the entire fund. This is a scary rule, because it
eliminates the vast majority of possible investments. (Even quite successful companies
usually succeed on a more humble scale.) This leads to rule number two: because rule
number one is so restrictive, there can’t be any other rules.
Consider what happens when you break the first rule. Andreessen Horowitz invested
$250,000 in Instagram in 2010. When Facebook bought Instagram just two years later for
$1 billion, Andreessen netted $78 million—a 312x return in less than two years. That’s a
phenomenal return, befitting the firm’s reputation as one of the Valley’s best. But in a
weird way it’s not nearly enough, because Andreessen Horowitz has a $1.5 billion fund:
if they only wrote $250,000 checks, they would need to find 19 Instagrams just to break
even. This is why investors typically put a lot more money into any company worth
funding. (And to be fair, Andreessen would have invested more in Instagram’s later
rounds had it not been conflicted out by a previous investment.) VCs must find the
handful of companies that will successfully go from 0 to 1 and then back them with
every resource.
Of course, no one can know with certainty 
ex ante
which companies will succeed, so
even the best VC firms have a “portfolio.” However, 
every single company in a good

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venture portfolio must have the potential to succeed at vast scale
. At Founders Fund, we
focus on five to seven companies in a fund, each of which we think could become a
multibillion-dollar business based on its unique fundamentals. Whenever you shift from
the substance of a business to the financial question of whether or not it fits into a
diversified hedging strategy, venture investing starts to look a lot like buying lottery
tickets. And once you think that you’re playing the lottery, you’ve already
psychologically prepared yourself to lose.

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WHY PEOPLE DON’T SEE THE POWER LAW
Why would professional VCs, of all people, fail to see the power law? For one thing, it
only becomes clear over time, and even technology investors too often live in the
present. Imagine a firm invests in 10 companies with the potential to become
monopolies—already an unusually disciplined portfolio. Those companies will look very
similar in the early stages before exponential growth.
Over the next few years, some companies will fail while others begin to succeed;
valuations will diverge, but the difference between exponential growth and linear growth
will be unclear.

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After 10 years, however, the portfolio won’t be divided between winners and losers; it
will be split between one dominant investment and everything else.
But no matter how unambiguous the end result of the power law, it doesn’t reflect
daily experience. Since investors spend most of their time making new investments and
attending to companies in their early stages, most of the companies they work with are
by definition average. Most of the differences that investors and entrepreneurs perceive
every day are between relative levels of success, not between exponential dominance and
failure. And since nobody wants to give up on an investment, VCs usually spend even
more time on the most problematic companies than they do on the most obviously
successful.

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If even investors specializing in exponentially growing startups miss the power law,
it’s not surprising that most everyone else misses it, too. Power law distributions are so
big that they hide in plain sight. For example, when most people outside Silicon Valley
think of venture capital, they might picture a small and quirky coterie—like ABC’s