Brian Nichols is the co-founder of Angel Squad, a community where you’ll learn how to angel invest and get a chance to invest as little as $1k into Hustle Fund's top performing early-stage startups

Have you ever wondered why some VCs seem perfectly comfortable with most of their investments failing?

Or why investors keep pouring money into startups when the odds of success seem absurdly low?

The answer is the power law. It is one of the most important concepts in startup investing, and most new investors get it wrong. Not because it is complicated, but because it goes against everything we have been taught about how investing works.

What the Power Law Actually Means

Power law in startup investing means that a tiny percentage of companies deliver massive returns, and most others return little or nothing. This is the fundamental economic model that makes venture capital work.

You could invest in 10 companies. Nine of them might return nothing or a small 1x or 2x. But if just one of those companies is a huge success, it more than makes up for all those losses combined.

Here is a real-world example. If you had invested $5,000 in Uber at the seed round and held until IPO, that investment would have been worth $25 million. A 5,000x return. That single investment would make your entire portfolio wildly profitable even if every other company you backed went to zero.

Why Traditional Thinking Fails Here

Most of us think in linear terms. You work 40 hours, you earn twice as much as someone working 20 hours. You save $100 a month, you have $1,200 after a year. Inputs match outputs in a predictable way.

Linear thinking in investing looks like this: if 2 of your 10 companies fail, you are down 20%. If the remaining 8 return 2x each, your portfolio returns 1.6x overall. To improve, you either reduce failures or increase the average return.

That logic makes perfect sense for stocks or real estate. But venture capital does not work this way.

In venture, returns follow a power law distribution where outliers dominate everything else. Adding more investments does not dilute your returns. It actually increases your chances of finding that one extraordinary company that returns 100x or more.

When most people see a portfolio with one massive winner and nine failures, they think "what a shame that the other nine did not succeed." Experienced VCs think "let's find more companies like that winner, even if it means having more failures too."

This is why accelerators like Y Combinator keep increasing their batch sizes. With strong deal flow, investing in more companies increases the chances of capturing those rare power law winners. Each massive success more than compensates for all the failures combined.

The Mistake New Investors Make

A question we hear constantly from new investors: "How can I get more of my portfolio companies to succeed?"

It sounds like the right question. It is not.

If you had 10 companies in your portfolio and 9 were "successful" but only returned small multiples, your portfolio would still likely underperform compared to having just one massive winner. Nine companies returning 5x will not hold a candle to one company that returns 100x.

What truly matters is not how many companies succeed, but how big the successes are.

Elizabeth Yin has talked about this in the context of how money is actually made in early-stage investing. You need to be shooting for 100x returns in your winners. A 2x or 3x win is not good enough, because those modest returns will not cover the losses from the rest of your portfolio.

Why You Cannot Just "Pick More Winners"

The natural follow-up question: "Why not just try to pick better? Why not aim for nine out of ten companies returning 4x?"

Because finding product-market fit is incredibly hard. And startups, by definition, have not found it yet. Even the best investors and founders only succeed 30 to 50 percent of the time. Finding product-market fit involves skill, yes, but also a whole lot of luck.

Even serial entrepreneurs struggle with this. They know how to run a business. They know how to hire and manage teams. But finding that specific combination of product and market that takes off? That is still unpredictable.

This is why the power law is not just a nice theory. It is the operating system for how startup investing actually works. You cannot control which companies will find product-market fit. What you can control is how many shots you take and how big the potential upside is on each one.

The math boils down to this: optimize for outlier exposure, not hit rate. If you want to learn how to build a power law portfolio alongside 2,500+ investors, Angel Squad gives you access to co-investment opportunities in Hustle Fund's deal flow starting at $1,000 per deal. More shots, more chances. Check it out at Angel Squad.

It is not about the number of wins. It is about how big the wins are.