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Welcome back to our series on diversification and portfolio size. In case you missed last week's primer, you can check it out here.
The TL;DR version:
Studies have shown that investing in several startups mitigates risk much more effectively than investing in just one or two.
Many of the world's top angel investors suggest a bare minimum of 10 portfolio companies while leading VC firms, like the one we'll discuss today, have hundreds.
As part of this series, we’re going to take you on a few deep dives into some of the world’s most prominent VC portfolios. We’ll also highlight some of the different ways these titans approach diversification as a strategy.
First up is Andreessen Horowitz, or a16z. Founded by tech entrepreneurs Marc Andreessen and Ben Horowitz in 2009, the firm has invested billions of dollars into hundreds of companies, including big winners like Lyft, Instagram, Slack, Github, and Airbnb.
A16z: Largest portfolio IPOs since 2011
Let’s get right into it.
Profile
Firm: Andreessen Horowitz
Founded: 2009
AUM: 28.2B (Jan. 2022)
Industry Focus: Tech
Sectors: Bio + Health | Crypto | Consumer | Enterprise
a16z’s investment style: backing big, crazy ideas
Co-founder Marc Andreessen believes investing in “non-consensus” companies is what helps his firm attain outsized returns. Non-consensus companies are those with bold ideas that most people doubt will work (hence the name).
The theory is that if everyone already agrees a startup’s idea has legs, it’s probably already been done before–or, at the very least, will be easy for competitors to mimic.
In his own words, he describes his risk-minded hypothesis:
“Most of the big breakthrough technologies/companies seem crazy at first: PCs, the internet, Bitcoin, Airbnb, Uber, 140 characters… It has to be a radical product. It has to be something where, when people look at it, at first they say, ‘I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual.”
Big ideas that raise eyebrows are risky… but a startup that does something completely new, and succeeds at it, can often leave a huge competitive moat in its wake, essentially creating a new market only they occupy.
Not that long ago, the idea that you could charge a complete stranger on the internet $50 to sleep on your couch, inside your home, with you in it, sounded completely insane.
In 2008, Airbnb co-founder and CEO Brian Chesky received rejection letters from five of the seven VC firms he initially pitched to. The other two never replied. They simply didn’t see the market potential for a home-sharing service.
At the time, Airbnb was seeking $150k for a 10% stake in the business. Just three years later, Andreessen Horowitz led the company’s Series B round, which valued the company at just over $1 billion.
Today, Airbnb has a market cap of over $108 billion–over 100X what it was worth when a16z got in.
Important to note: Airbnb is just one of Andreessen Horowitz’s portfolio companies. The firm has invested in hundreds of startups and counting, because of what Andreessen calls “power-law returns.”
Power laws and the importance of investing in 100+ startups
Many prominent entrepreneurs and venture capitalists assert that VC returns are distributed according to a power law. Translation: a very small number of firms capture the overwhelming majority of the returns.
The same goes for startups that get funding and ultimately succeed. As Andreessen puts it, each year, of the roughly 4,000 technology startups seeking VC funding, only 200 are fundable, with “15 of those generating 95% of all economic returns.”
Maintaining a diversified portfolio by spreading risk across as many investments as possible is one of the keys to a16z’s industry-leading track record. Not only does the firm invest in dozens to hundreds of startups annually… they also spread their capital among multiple different industries:
Their strategy has paid off so far; a16z had 43 exits via either M&A or IPO last year alone.
With a risk appetite bigger than most other firms, they rarely shy away from a chance to diversify into new, burgeoning markets that present potentially world-changing results–for example, blockchain and crypto.
In 2021, the firm made a tectonic shift into the category, increasing its blockchain & crypto-related investments by a staggering 7X YoY (year-over-year).
It’s moves like this that set a16z apart from the pack. While most other firms have only dipped a toe into the crypto waters, a16z dove in the deep end—investing the third-highest amount of capital into the industry behind Coinbase Ventures and AU21 Capital.
Part of the reason they’re able to take such big risks is exactly what we discussed earlier: a sky-high volume of overall investments. A firm that’s doing hundreds of deals a year–and cashing out with dozens of exits annually–can afford to take big leaps on “non-consensus” ideas.
From a diversification standpoint, their investments span multiple industries, from ride-hailing to cryptocurrency to healthcare and beyond. If the firm only invested in one or two categories, it may have been too vulnerable to weather market conditions.
Startup investors can learn a lot from a16z’s approach: investing capital into as many opportunities as possible, rather than just a few.
There’s no shortage of opportunities here on Republic.
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