Venture Capital Portfolio Construction and the Main Factors Impacting the Optimal Strategy

Paper: arXiv 2303.11013

Authors: Francesco Farina, Mike Arpaia, Harpal Khing, Jonas Vetterle

Abstract

The optimal portfolio size for a venture capital (VC) fund is a topic often debated, but there is no consensus on the best strategy. This is because it is a function of many factors. It is not easy to find a general formula that can be applied to all situations, and it largely depends on the goal of the fund. In this report, we will go through the different factors step by step, studying how they affect fund returns and the optimal portfolio size, starting with some basic assumptions and then increasing the complexity of the model.

Complexity vs Empirical Score

• Math Complexity: 4.5/10
• Empirical Rigor: 5.0/10
• Quadrant: Street Traders — practical and empirical, lighter on theory

Why this score: The paper provides a structured step-by-step framework to evaluate venture capital portfolio construction through modeling key variables. While the mathematical formulations are accessible rather than deeply theoretical, it offers practical insights into how deal flow, follow-on strategies, and power-law return distributions impact optimal fund sizing.

Research Flowchart

  flowchart TD
    A[Goal: Determine Optimal VC Portfolio Size & Strategy] --> B[Data Inputs: Power-law Returns, Loss Rates, Fund Size Constraints]
    B --> C[Step 1: Base Analytical Model with Simplified Assumptions]
    C --> D[Step 2: Advanced Simulations Increasing Model Complexity]
    D --> E[Analyze Impact of Key Factors on Fund Returns]
    E --> F[Findings: Optimal Size Depends on Specific Strategy & Fund Goals]