The Mathematics of Venture Capital
The Venture Capital maths means that VCs need to invest in outliers. How do you become an outlier, or find one?
The first time someone tried to explain the math of venture capital to me, I nodded for forty-five minutes and understood almost none of it.
It was a video call. An investor with good lighting and a bookshelf arranged to be seen. I was in Chairmanbari, holding the laptop at an angle so the chalk-smeared wall stayed out of frame. He kept saying the word “returns” the way other people say “weather.” Casual. Assumed.
He asked what I thought Pathao could be worth one day. I gave the answer a sensible person from Dhaka gives: steady growth, improving margins, profitable and durable. He smiled the way you smile at a child showing you a drawing, then ended the call early.
It took me two more years to understand what had happened. He had been waiting for me to say the company could be enormous, and I had spent forty-five minutes promising him it would be fine. To him, “fine” was an insult. To me, fine was the dream. We had been speaking two different languages, both of us calling it business.
The man who needs you to be huge
The investor was not evaluating my business. He was evaluating it against a private mathematics that had nothing to do with whether Pathao was good or well run. His firm had taken money from big institutions, pension funds, university endowments, and those people did not hand it over to earn fifteen percent. They could get that from gold, from property in Gulshan, from boring stocks that had paid out for a hundred years. They gave it to a venture firm for one reason: the rare, ridiculous outcome that pays back the whole pile many times over. So the reason that man would wire millions into a company run by a few kids with rusty fans overhead was not that he wanted to grow his money twenty percent. He did not need Pathao to be profitable. He needed it big, very fast, because big is where his return comes from. Growth was the product. Profit was a distraction I kept trying to sell him.
Let me show you the math, because the math is the whole argument.
When VCs are raising their funds, the people who give them money, the LPs, want to know what sort of returns the VCs are targeting. Most VCs are targeting three to five times the money, and few hit that ambitious target. So how do they get to 3x or 5x? It is not by investing in a lot of businesses that each return 5x. Venture is a power-law business, which means it is a business of outliers.
The rule of thumb is that a third of a firm’s portfolio goes to zero, a third breaks even, and a third generates the returns. The real distribution is much starker than that. Six percent of venture investments generate sixty percent of all venture returns. That single fact drives everything a venture firm does, and everything that investor did to me.
Take a hundred-million-dollar fund targeting a 5x return to its LPs, so five hundred million dollars. First, the firm probably will not invest the full hundred. Fees and expenses for ten to fifteen years come off the top, so the firm might invest closer to eighty million. Hitting 5x therefore requires 6.25x of the capital actually invested.
Now consider the power law. If a third of the investments have to carry the whole portfolio, we are really talking about twenty-five million of invested capital (eighty million times a third) needing to generate five hundred million in returns, an 18.9x return. And it gets worse. If you break that top third down further, it is really the top six percent of the portfolio that carries the fund’s returns. So we are relying on five million of the original hundred to generate five hundred million for the LPs, a 100x return.
What does all this mean? It means that no matter what criteria a VC claims to look for, the firm has to rely on extreme outliers to carry the entire fund. And if you are a startup? You have to be that outlier. You have to be the company that can get to a 100x return. The investor on my call was not hoping Pathao would do well. He was hoping it would be the outlier, the one that made every dead company in his portfolio stop mattering.
### Why your healthy business is the wrong answer
Everything in our culture trained me to give exactly the wrong answer.
I grew up around a particular idea of a good business. The trader who bought well, sold steady, kept his books clean. The cloth shop in New Market that had stood for thirty years. A business that fed a family and grew a little every year was a life well spent.
So when I described Pathao, my instinct was to prove we were that. A responsible, real company. The numbers add up, sir. We will be profitable. Every word of it was poison in a venture meeting.
A business that grows a steady twenty percent a year and throws off healthy profit is a magnificent thing to own and a useless thing to a venture investor. It doubles your money in about four years, and the man on my call needed a hundred times his money. They have a phrase for this that sounds like an insult even though they do not mean it as one. They say the business is not venture-backable. What they mean is: this is a horse, and I am only allowed to buy horses that might turn out to be unicorns.
Be clear, because this is where founders get hurt. There is nothing wrong with a twenty-percent business. A company that pays its people, feeds your family, and lasts thirty years is a genuinely good life’s work, and most businesses on earth are exactly that. It is simply a different game, and venture investors are not playing it. Offering it to a venture fund is like bringing a healthy goat to a man who only buys racehorses. The goat is not the problem. He is just not buying goats.
There is a famous version of this in Silicon Valley. Andreessen Horowitz put a quarter of a million dollars into a photo app called Instagram, and two years later Facebook bought it. The check came back as seventy-eight million dollars. A 312-times return. A miracle. And here is the part that should reorder your thinking: it still was not enough to carry their fund. One miracle was close to a rounding error. That is the water these people swim in, and it is why “we will be profitable” lands so flat. When they look at you, they are not asking “will this work.” They are asking “if it works, can it return a hundred times, enough to carry the fund on its own.”
The flaw is the entry ticket
There is a second thing about outliers nobody warns you about, harder to swallow than the first. The companies that become the one almost always look broken when they start.
When we launched bike rides in Dhaka, we were operating in a country whose vehicle laws did not imagine a motorcycle carrying a paying passenger. Whoever wrote the Motor Vehicle Ordinance in 1987 pictured a man riding his own bike to his own office, not a stranger in a red helmet climbing on the back for a fare. By the letter of the law we sat in a grey zone, and the police knew it. They stopped our riders and fined them. By every traditional measure this was a fatal flaw. No bank, no cautious uncle with fifty lakh would touch a company sitting one government circular away from illegal.
And yet that grey zone was the whole reason Pathao could exist. If bike-hailing had been clean and legal and obvious in 2016, someone bigger and richer would already have been doing it. The flaw was the door. The mess that scared off every sensible investor was the exact gap that let a few kids with a borrowed office build something before the giants noticed.
I did not invent this pattern. The home-rental company let strangers sleep in your house, against hotel laws in half the cities it entered. The ride company put unlicensed drivers on the road and fought taxi authorities for years. Each looked like a lawsuit waiting to happen, and each produced the kind of return that pays back a whole fund, precisely because it claimed a market nobody else was brave enough to touch.
So stop apologizing for the thing about your business that makes investors nervous. If your strength is genuine and large, the mess around it is often the moat. It is the reason the opportunity is still sitting there, unclaimed.
What this means for you
First, know before you walk in whether you are building a venture business or a good business. A venture business needs a believable path to being that outlier, the 100x, not a path to growing ten or twenty percent a year. If you are building the steady kind, do not waste your months chasing venture money. You will get the polite, sad smile I got, and it will hollow you out. Raise from a bank, bootstrap, keep your equity, sleep well.
Second, if you are building the venture kind, your job in the room is to prove the ceiling is high and that you can reach it. The investor has already accepted that you might fail; failure is in his model. What he cannot accept is a company that succeeds small. So when he says your market is too narrow, he is not insulting you, he is checking whether the ceiling is real. Defend it with evidence. And when he raises the regulatory risk, do not promise to fix it before launch. Explain why that exact risk is the reason the market is still empty.
Third, the person across the table is not your friend, your judge, or your father. He is running his own brutal lottery, and he needs you to be the winning ticket as badly as you need his money. That is not cynicism. It is clarity.
Understanding all this did not make the meetings easy. I gave the big answer in plenty of rooms afterward and still got the polite smile, because understanding the rules of a lottery does not hand you the winning numbers. It only means you stop buying the wrong ticket. But I never again promised an investor “fine.”