It’s been interesting to watch the last few years of venture capital. The number of firms raising larger funds appears to be increasing. This sounds good until you consider the math of venture capital funds. Most early-stage funds consider an investment a winner if it returns the entire fund or more. If you raise a $500 million fund, you’re looking for an investment in a single company to return $500 million or more. The number of companies capable of such a return is small, so when you find one, you must capitalize on it. If you don’t, a fund is less likely to generate a meaningful return for its investors when the companies that will fail are factored in.

Instagram is a well-known acquisition. It was founded in 2010 and acquired in 2012 by Facebook (now known as Meta) for $1 billion. Andreessen Horowitz invested $250,000 in Instagram’s early seed round and realized $78 million at the time Instagram was sold. That’s a 312x return. The challenge is that Andreessen made the investment from a $1.5 billion fund. Instagram was the investment of a lifetime, but it didn’t return the fund. It returned less than 6% of the fund. That means Andreessen would need to make 19 investments like this one to return its fund. That’s not likely. Do note that Andreessen made decisions specific to this situation that reduced the firm’s return, but this nevertheless illustrates the challenge of large funds investing at the ground level of a company.

The larger the fund, the larger the check the fund needs to write (unless it increases the number of checks) for a single investment to return the fund. When VC firms raise larger funds, many choose to invest at a slightly later stage (think seed instead of pre-seed or series A instead of seed) because the larger check size makes sense given the number of checks they want to write out of that fund. I think this leaves a void to be filled. The question is, what’s the optimal way to fill that void AND still generate a meaningful return?