The same applies to the value of venture portfolios as they have convex pay-off structures like call options, built to capture right-tail events.

Overall, participation in an early-stage company can be seen as a far out-the-money call option with:

1. The strike price (K) which is often based on the target of returning the fund , which is a multiple of the entry valuation and ratio of the check size to the fund size. It can also be based on reaching a certain magnitude of outcome ($1b+, $10b+, e

... See more

Far out-the-money options are where the security price is further away from the strike price (K), hence possessing a low likelihood of paying out anything. That makes them cheap but with an asymmetrically rich upside relative to their initial cost in case of a payout—in a way that’s quite similar to investing in early-stage startups.

On the other hand, when many market actors do so to catch a few companies, this deprives the investment of its optionality, creating regression to the mean. When it becomes systematic, overpaying is an effective way to kill the whole portfolio’s optionality. While one can only hypothetically argue that the chances of a better outcome tomorrow incre... See more

From this, it follows the popular idea of not fundraising at a spuriously high valuation2, as it turns the startup into an option with a higher strike price (K), that is probabilistically worth less as now the startup would far surpass that valuation in a lower number of potential futures. Funnily enough, investors end up paying more for such early... See more

Similar to the strike price (K) of a call option, for an early-stage company to be worth something, it is required to hit a minimum threshold of de-risking and size.

Similarly, most venture funds perform better in a market of steep ups and downs rather than steady growth. If you own something worth nothing, the dispersion of the potential outcome increases the likelihood that this will be worth something.

Venture capital has a pay-to-play nature, where not only bad investors, but many good investors often pay up as they mature to make sure they are part of the biggest success stories partly since they can afford it (and need it) with more capital and credibility, partly due to their more granular and selective pattern recognition, partly due to the ... See more

It also means that one cannot afford to create static strategies in a backward-looking way and expect venture-scale returns, rather bet on discontinuities and update the strategy and the resulting portfolio along with the market shifts.