The Power Law in Venture Capital

Maybe you have heard that returns from venture capital are governed by a "power law". But what exactly is that? When I first read about this I was confused. I have now figured out the technical steps need to convert the general idea of the power law you may see in popular articles into something actually useable. I'll skip those steps and show you what I think is a useable version of this idea. First we need to distinguish between investments that lose money and those that deliver a multiple of one or more times the capital invested. My version of the power law is just for profitable investments with a multiple of one or greater. The equation is:

This says that the probability P that the multiple M is greater or equal to m is equal to the formula on the right, where alpha is the power of the power law. To take an example, if alpha = 1.75 and m is 10, the probability is 0.178 or a 17.8% chance that you get more than a 10x multiple. Conversely, the probability that the multiple is between 1 and 10 is 1-0.178 or 0.822. Remember, that isn't the probability that your investment makes this much money, rather, that if it makes money how likely will it make more than m.

The interesting thing is that for 1 < alpha < 2, the probability of getting a given payoff decreases slower than the payoff is increasing. This means that more and more of the expected value of your portfolio is derived from higher and higher multiples (again for alpha = 1.75):

Expected value is just the product of average payoff and probability. This is why people say that you need to make a lot of investments in venture capital to get good results. If half your investments go to zero, you need to get an average multiple of more than two on the other half to make any money. If you only make ten investments, a 128-256x outcome, which has only a 1.1% probability of happening among your successful investments, probably won't be in your portfolio. 

 

 

Things I Don't Invest In

For every investment I do make, there are a lot that I look at and decide against. A recent example that I blogged about is the Pabrai Funds. 

I'm sent more and more invitations to invest in start-ups. One I saw today was Venice AI. Some complicated story about a privacy oriented LLM (but uses resources from other LLMs maybe?) plus two different crypto tokens. I couldn't understand the pitch and deleted it. In general, I like to see some attention to the "economics" - what is the route to profitability. If it is not discussed at all, I tend to pass on the opportunity.

And then there are more mature opportunities including two upcoming IPOs. One is the IPO of SpaceX. CommSec has provided an Australian version of the prospectus. I already have exposure via Pengana Private Equity (PE1.AX) and if I wanted more I could buy more shares in that fund, which are trading at a discount to what the NAV would be with the SpaceX IPO price. SpaceX is their largest holding by far. S&P have decided not to change their index rules to allow unprofitable and new companies to join their indices. NASDAQ on the other hand will be including it in the NASDAQ 100 index very quickly. I am sceptical of the idea that there will be a pop in price at the IPO beyond the already crazy price–the price is near 100 times 2025 sales. With USD 75 billion of shares being issued in the IPO, most people who want them will probably get them? Most IPOs do not perform well in the short term if you buy at the IPO price.

The other IPO I looked at was a new fund from Pengana focusing on 20 private AI related companies–AIX. Bytedance and Handshake are the two seed assets. They will also be investing in "picks and shovels" and applications companies not just LLM providers. But most closed end funds definitely don't trade well following their IPO. My preference is to be invested in related resources (e.g. via Tribeca Global Resources, TGF.AX) and in earlier stage firms that have routes to profitability (see above).

USVC

AngelList have announced a new mutual fund investing in venture capital called USVC. You can invest as little as USD 500. I have been thinking about investing in this via our SMSF. Previously, I wanted to invest in Unpopular Ventures on the AngelList platform using the SMSF but SuperGuardian, our administrator, said it wasn't allowed because of the partnership structure. Instead, we invested in Moominmama's name. This isn't a partnership, so it should be OK. It seems to be open to non-US investors despite the mutual fund structure. On the other hand, I feel I am too contrarian to be happy investing in all these US AI companies at this stage. At least 80% of the fund will be in US venture. That is why I like Unpopular Ventures because it is truly global. In retrospect I would have done much better with my investments if I had been less contrarian. But it is just this fundamental character trait. So, I try to work with it rather than against it. I feel uncomfortable going with the majority.

More Good Venture Capital News

I recently reported that my investment in the Aura VF2 fund was now in profit. Now, our Angellist investments through Unpopular Ventures have swung into profitability too:

 

There is a 3 month lag in reporting values. We invest in their Rolling Fund as well as individual firms. One of those firms is now reporting that it is worth 9.5x the value I invested at. On the other hand, two companies I invested in have effectively gone to zero. While I am excited to not be losing money any more, our overall IRR on our Angellist investments is only 2.76% so far. 

But this is an AUD 60k bump in value that makes a substantive change to our numbers for 2025. It pushes up our 2025 rate of return to 9.68% in AUD terms or 18.14% in USD terms. That puts us just ahead of the S&P 500 for the year:

The "retirement number" rises to AUD 7.011 million. Total net worth at the end of the year Was AUD 8.252 million, which is comfortably ahead of the base case net worth projection of AUD 8.2 million. Also, the private equity return for the year roses to 9.3% from 4.7%! The annual contribution to total return from private equity was 1.8% instead of 0.9%. Unpopular Ventures returned AUD 40,118 for the year, making it our 8th best investment.

Aura VF2 Reports

The Aura VF2 venture capital fund has reported for the final quarter of calendar year 2025 and it has jumped sharply into profit.

 

I now have an IRR of 10.6%. It increased the rate of return for December to 2.5% in AUD terms or 4.5% in USD terms, which crushed all benchmarks.

FOMO-ing In

I have been saying no to investing in Aura's new venture capital fund when I have been asked. My reason was that I am retiring and don't want to lock capital up. With lower taxes going forward, the negative tax status of Australian venture capital investments isn't so important any more. Also, I am an investor in both their previous funds and the parent company, so that feels risky. Also, I didn't have a current wholesale investor certificate.

But then I saw an email that now is the "last call" before the "first close" and I sent them an email asking if I could invest AUD 100k instead of the usual AUD 250k minimum. They approved right away and I just completed the application form. This is an investment of about 1.5% of net worth, which will be called over several years, so with this lower number it doesn't seem as risky or impose as large cash flow requirements. The fund plans to invest in 25 companies if the target amount is raised. So, this would only be AUD 4k per start-up. At Aura VF 2 I have around AUD 25k exposure to each start-up. And I now have a wholesale certificate again. Also, I have been thinking recently that we can cover our current cash flow requirements with just AUD 1.5 million (8% yield) to AUD 3 million (4% yield) income-oriented investments and invest the other half or more of our net worth in long term growth investments to compensate for inflation and maybe actually grow our net worth. 

But in the end, it's really FOMO.

Wholesale Investor Certification

As part of participating in the Aura Group capital raise, I had to get a new wholesale investor certificate. You have to do this every 2 years to remain current. There are two main ways to qualify: Show you have more than AUD 250k in income per year in the last two years or show you have more than AUD 2.5 million in net worth. You need an accountant to certify this. The test is on an individual not household basis. I am using the net worth approach.

I was certified in 2020, but when I tried to renew in 2022, the accountant I used said I didn't qualify, as she wouldn't count my superannuation including my SMSF towards the amount as I was under 60. This didn't stop me from continuing to meet capital calls for my existing Australian venture capital investments. 

Now I meet the required level with or without superannuation. I also argued that I am receiving a TTR pension from each of my superannuation accounts and am over 60 and about to retire. Anyway, I qualified. It cost AUD 550. 

It is much easier to qualify as an accredited investor in the US. You only need USD 1 million net worth and you don't need an accountant to prove it, so it is free. A couple can qualify with just USD 1 million between them. However, primary residences are excluded, which is not the case in Australia. Moominmama qualifies as an accredited investor for our investments via Angellist and the Unpopular Ventures syndicate. 

Kyte

 

I invested in this startup via Anglelist. Turns out that I invested more in this one (USD 15k) than any other, Now they are shutting down. That is something you should expect often with startups. I already knew they were closing, but now it's public I can let you know too.

Investments Review 8: Developing Alternative Investments

The last installment of the Investments Review, though, actually, there will be an action plan coming up!

Bitcoin Portfolio share: 11.9% IRR: 40%. We hold Bitcoin across the SMSF and our individual Interactive Brokers accounts. I first got into Bitcoin in 2019 when CME futures were introduced, thinking it would be good to trade it. I made some money and gave some back. Then last year, when the spot ETFs were launched I decided to do longer term trading. I got in a bit late and made things worse for myself by buying more when the price had already risen into the $70k range. Then the late 2024 surge generated some profit, which has been partially given back at this stage. The current game plan is to sell the ETFs sometime this year, based on market indicators. I am beginning to think of switching then to shorter term trading again, we will see.

Winton Global Alpha Portfolio share: 3.3% IRR: 4%. This is my larger managed futures investment. We hold it in the SMSF as it is not tax efficient. It didn't do well when interest rates were low and especially going into the pandemic. Then there was a big surge, as interest rates increased. These investments do well in high interest rate/high inflation environments. Recently, I redeemed some of the investment. Possibly, I should set distributions to be paid out rather than re-invested.

Masterworks Portfolio share: 2.6% IRR: 3%. I started investing through this fractional art investing platform in 2018. I have had a three profitable "exits" but the remainder of the portfolio is mostly down and I haven't added more. The IRR is pretty low. I will wait for this to gradually wind down I think.

Aspect Diversified Futures Portfolio share: 1.9% IRR: 12%. I invested in this (through Colonial First State) to diversify my managed futures holdings. We hold this in the SMSF too. The period of rising interest rates was good, but it is not doing so well since interest rates started to decline. Possibly, I should set the distributions to be paid out rather than be re-invested.

CD3 Portfolio share: 1.6% IRR: 13%. This ASX listed fund mostly invests in US private equity. It is also in the SMSF. It is trading at a large discount to NAV and has a good IRR. The portfolio is quite mature and exits are occurring. So, I think this is a good investment that I will continue to hold and maybe add more to.

Metrics

Count Financial told clients to sell private credit funds managed by Metrics Credit Partners. This crashed the share price of MOT.AX, one of their funds that I have owned before. So, I bought some on Wednesday for a trade as I think the sell-off is exaggerated even if the true NAV of the fund is less than the stated $2.14. The share price rebounded a bit. Wondering whether to close the trade?

P.S. 22Mar25

I did sell the shares, booking about AUD 1,400 in profit.

1997

I feel that 1997 might be a good analogy to 2025. After an aborted recession in 1994 (2022) the stock market went up strongly in both 1995 (2023) and 1996 (2024). But when I left the US in 1996 for Australia the mood was that the economy was struggling and maybe another recession was coming. There was also a feeling that the stockmarket was overvalued. Alan Greenspan first mentioned "irrational exuberance" in December 1996. But the stockmarket, or at least tech stocks, went up for three more years to crazy heights in 1999 (2027) before the tech wreck. Then the boom was mainly internet related stocks, now AI and maybe quantum computing. Oscar Carboni, who is very slightly older than me, often says: "This boom is just getting started." 

So, does that mean we should go all-in on tech stocks? There are no guarantees, and so I always diversify. My largest exposures to tech are through my venture capital exposures. If I am right, venture capital should do well for a while and maybe we can get some exits. And then I have WCM Global (WCMQ.AX), Generation Global, and Hearts and Minds (HM1.AX). Pershing Square Holdings (PSH.L) has investments in Google and Uber. Unisuper has some exposure through the Sustainable Balanced Option I am mainly invested in. But overall it would only add up to around 15% of net worth (and less of gross assets). On the other hand I have 18% of net worth in crypto-related assets that tend to move with tech stocks. Given that, perhaps my exposure is big enough?

Investments Review 4: Mature Private Equity Investments

3i (III.L) is one of our more successful and larger investments with an IRR of 24% and a net worth share of 4.4%. Note that the scale on the graph is in Pounds Sterling. They are a UK based private equity manager. Most of the capital they manage now is proprietary capital and so you are investing in the combo of fund manager and fund. I first invested in 3i in 2008 but the position was very small until we started ramping up our investment in 2018 peaking at 5,000 shares in 2022. Since then, I sold off 1,500 shares because I was concerned that the majority of their portfolio was in a single company - Action, a European chain of discount stores. This took our net investment down to zero. A classic mature investment.😀 Obviously in retrospect we would have done better by just sticking with 3i.

 

Pengana Private Equity (PE1.AX) did well for a while but then went sideways since early 2023. Overall it has achieved an IRR of 19%. With good timing, I reduced my investment dramatically at the start of the sideways period. The money was redeployed in another undervalued PE fund - CD3.AX. Since then I have added some back when it seemed a lot undervalued relative to NAV. It's now at 1.6% of net worth, which isn't that big. Hopefully, it will close more of the undervaluation gap and private equity will again do better.

Aura VF1 is a conventional Australian venture capital fund that preceded Aura VF2. Net worth share is 2.8% and IRR is 15%. Both the ramp up and now down in invested capital is dictated by the fund manager. The fund has one big success story - Shippit - and a mix of smaller successes and failures. Management fees will erode the value gradually if there are no mark ups... So we just need to wait for an exit from Shippit to get our money back. Unfortunately, exits from venture capital are still relatively few and far between.

Investments Review 3: Mature Alternative Investments

We start with our best investment ever in dollar terms: gold. 

I first invested in gold back in 2006. Then there was a long period where there was no gold investment or trading till 2018 when I inherited a gold sovereign. Maybe this sparked my interest in investing in gold again starting in 2019. We invest via gold ETFs. We gradually ramped up our investment as cash became available to the end of 2021. Since then we have maintained the gold allocation at around 10% of gross assets and withdrawn cash of around AUD 350k in total. This has gone primarily to funding venture capital investments. Total AUD profit has been almost $500k and it now constitutes 9.9% of net worth with an IRR of 16.9%. At this point this beats our venture capital investments hands down. So, on a short-term basis we should have stuck with gold. In the long term, who knows? On the other hand, this remains a large investment.

Next is our investment in Regal Investment Fund (RF1.AX). It now includes hedge funds, venture investments, real assets, and private credit. We bought at the IPO and then doubled our investment a little while later. We cashed out around the post-pandemic peak and then bought back in. However, the fund has not replicated its amazing performance of 2020-21 but on the other hand has not done badly and so we have been content to let our net investment drift down with dividends and occasional trades. More recently we have added to our position again including through a share placement:

At this point, I am happy to wait and see, as it has gained 26% over the last year. Lifetime IRR is 26.5% and net worth share is 3.6%. 

Wilson Alternative Assets (WMA.AX) is another diversified alternatives fund. Unlike RF1 it continues to trade at a large discount to NAV. We ramped up our investment into 2021 and then let it drift down with distributions paid out. As a result the value of the investment has been constant for a few years but profit has slowly increased. Here I am waiting for some more closing of the gap to NAV, as when Wilson took it on they promised to close the gap or put the future of the fund to a vote.

IRR has been 10.7% and currently it makes up 3.0% of net worth.

Updated Annual Performance

I said that I would update the annual performance numbers after receiving all private investment returns for the year. The final number for 2024 in AUD terms was 23.30% up from 23.18%. Aura Venture Fund II made a nice gain in the final quarter but Aura Venture Fund I was marked down a little due to ongoing management costs probably.

Integrated Portfolio Solutions Acquired

Back in 2021, I co-invested alongside Aura AUD 100k in Integrated Portfolio Solutions, a private company. At the time, I thought there wasn't a lot of downside risk as an acquirer would be willing to pay to obtain the client accounts they were advising. The company didn't manage to execute on the expansion plans that they touted at the time. In the wealth management/advisory/platform business there are economies of scale needed to achieve profitability. Today it was announced that the company is being acquired for roughly the value at the point when we invested. Various closing costs are going to result in about an 8% loss. Part of the consideration for the acquisition is going to be in terms of equity of the acquirer, DASH Technology Group, but now my position will be a much more reasonable amount for an investment in a non-profitable private company. I feel lucky I didn't lose more!

Sold 500 Shares of 3i

I sold another 500 shares of UK private equity firm 3i. At the peak I had 5,000 shares and a net investment of around £41k. Now I have 3,500 shares and a net investment of £2k. So, I have taken out almost all my original investments. The holding is worth £103k, which, therefore, is almost all profit. The firm has a very oversize position in Action, a chain of European discount stores and so I am reducing my exposure to this single firm risk. Of course, I also have ideas about what to do with the money instead...

3i has been an excellent investment to date, so I plan on holding the remaining shares till something fundamental changes. The IRR has been 21.8% and has been a 23-bagger. I haven't multiplied my investment 23 times though, as for the longest period I had only 600 shares. My original investment in 2008 was a purchase of 200 shares and at the low point I had only 100 shares. I reached 5,000 shares only in 2022. Still it is the highest notional multiple on any of my investments ever. The second best of those I currently hold is Platinum Capital at about 10x.

Regal Partners Acquires Merricks Capital

Regal Partners announced that it is acquiring Merricks Capital, a private credit manager. The performance of their main fund is quite remarkable:

The rate of return is high and there was only one down month. It reminds me of Bernie Madoff's fund. I am not saying there is anything wrong here, but this kind of performance shouldn't be possible according to efficient market theory! The fund is way outside the envelope of the other assets on this risk-reward graph:

We are investors in Regal Partners (13k shares).

New Investment: Putnam BDC Income ETF

I just bought 1,000 shares of the Putnam BDC Income ETF. This is an actively managed ETF that invests in US business development companies. These are basically private credit lenders. The dividend yield is 9.19%, which is high, but lower than many BDCs. I am thinking of this as an enhanced cash investment (though formally I am listing it under US stocks) and so I wanted to avoid the idiosyncratic risks of individual BDCs. I learnt about this investment from Armchair Income. I did think of investing in the KKR BDC, FSK.

This is what I did with much of the cash from selling The China Fund. As it is in our SMSF, only 15% tax applies to the income. I also have Australian Dollar cash in the fund. I didn't want to convert to US Dollars at this low exchange rate and so will research bank hybrids to invest in.

Capital Calls

So, as soon as I had increased the cash buffer in our offset account, I got AUD 40k of capital calls, so back to square one again. The capital call from Unpopular Ventures was expected. We have completed our first 2 year subscription period and are renewing for another two years. We need to make quarterly contributions of USD 10k. This is an act of faith that our investments will eventually be as good as their earlier investments. Ten years of fees come out of the investments up front, so we are underwater on our investment so far.

The other call is from Aura Venture Fund II for AUD 25k. These don't come on any schedule. When they need more money they make a call with about two weeks of notice. We have now contributed 55% of the total capital we pledged. There is no choice about this one. It's also losing at the moment.

One of Our Venture Investments Goes Bust

Expected that some or even many companies will go bust in this space. This is the first individual venture investment of ours that went bust. Luckily I only invested USD 2,500 so it is about a 0.1% loss to our portfolio. One of my main criteria for making an individual investment rather than through a fund is that there is a clear pathway to profitability or breakeven laid out. So, surprising this went under relatively quickly. I was going to mention the company involved but see that the email is marked confidential so can't give you more details. I think it should be OK to mention the company when they are no longer going to be in business but I'm paranoid about getting removed from AngelList so won't do so...