How Do VCs Think About Concentration Risk in Early Portfolios?
VCs balance portfolio size, ownership targets, and reserves to manage concentration risk. Learn how portfolio construction affects your fundraise.
VCs manage concentration risk through portfolio construction strategies that balance ownership depth against diversification, typically targeting 20–30 investments per fund with 15–25% ownership stakes in core positions.
Concentration risk, having too much capital in too few companies, threatens fund returns if key investments fail. However, excessive diversification dilutes winners' impact. Early-stage VCs accept higher concentration than later-stage investors because individual company outcomes are less predictable.
The optimal balance depends on fund size, stage focus, and investment thesis. Founders should understand that VCs evaluate each investment not in isolation but as part of portfolio-level risk management.
Why Concentration Risk Matters to VCs
VC returns follow power law distributions, a small number of investments generate most returns. Portfolio construction directly impacts fund performance.
The concentration dilemma:
Too concentrated: One or two failures devastate returns
Too diversified: Winners don't move the needle
Optimal balance: Enough bets to find winners, enough ownership to benefit
What drives concentration decisions:
Fund size and deployment targets
Stage focus (earlier = more uncertainty)
Sector concentration vs. diversification
Follow-on reserve strategy
Target ownership percentages
Understanding how VCs approach ownership targets helps founders negotiate effectively.
Portfolio Construction by Fund Size
How fund size shapes concentration strategy:
Fund Size | Typical Portfolio Size | Initial Check Size | Target Ownership | Concentration Level |
|---|---|---|---|---|
$25–50M (Micro VC) | 25–40 companies | $250K–$1M | 5–10% | Lower |
$50–150M (Seed) | 20–35 companies | $500K–$3M | 10–15% | Moderate |
$150–300M (Early Stage) | 15–25 companies | $3M–$10M | 15–20% | Higher |
$300M+ (Multi-stage) | 20–30 companies | $5M–$20M | 15–25% | Variable |
Larger funds require larger outcomes, driving either higher ownership or larger initial checks.
The Five Concentration Risk Factors
1. Stage-Based Risk Tolerance
Earlier stages require more diversification:
Pre-seed/Seed: Higher failure rates (60–70%) demand more portfolio companies to find winners. Funds typically make 25–40 investments.
Series A: Lower failure rates (40–50%) allow moderate concentration. Funds make 15–25 investments with larger checks.
Growth: Lower risk profiles enable higher concentration. Funds make 10–20 investments with significant ownership.
Earlier-stage funds accept lower ownership for diversification benefits.
2. Sector Concentration Considerations
Beyond company count, VCs manage sector exposure:
Diversified approach: Spread across sectors to avoid correlated failures.
Concentrated thesis: Deep expertise justifies concentration with informational edge.
Balanced strategy: Core sector focus (60–70%) with opportunistic diversification (30–40%).
Sector concentration amplifies both upside and downside.
3. Follow-On Reserve Strategy
How reserves affect initial concentration:
Typical reserve ratios: 40–60% of fund reserved for follow-ons into winning companies.
Impact on initial deployment: If 50% reserved, initial checks come from remaining 50%, limiting either company count or check sizes.
Pro-rata rights: Maintaining ownership requires follow-on capital, affecting portfolio construction math.
Founders benefit when VCs have reserves, it signals capacity for continued support.
4. Ownership Threshold Requirements
Minimum ownership drives concentration:
Fund economics reality: 15–20% ownership often required for investments to meaningfully impact fund returns.
Check size implications: Achieving target ownership requires specific check sizes relative to round size.
Portfolio math: If targeting 20% in $5M rounds ($1M checks), a $50M fund can only make 50 initial investments maximum, often fewer given reserves.
Learn how startup valuation affects ownership and concentration dynamics.
5. Loss Ratio Assumptions
Expected failure rates drive diversification needs:
Early-stage assumptions: 50–70% of investments return <1x (losses or minimal returns).
Power law expectations: Top 10–20% of investments generate 80–90% of returns.
Portfolio math: Need enough investments that statistical likelihood of finding outliers is reasonable.
Concentration risk is managed by ensuring enough shots on goal despite high failure rates.
How This Affects Founders
Round size implications: VCs may push for larger rounds to achieve ownership, affecting your dilution.
Syndicate dynamics: Concentrated investors want to lead; diversified investors comfortable following.
Follow-on expectations: Concentrated positions get more attention and support.
Check SheetVenture's resources for frameworks on navigating VC portfolio dynamics.
Questions to Ask Investors
About portfolio approach:
"How many investments per fund?"
"What's your target ownership?"
"What percentage reserved for follow-ons?"
About your fit:
"Where would we fit in your portfolio?"
"Do you have capacity for this size?"
Explore SheetVenture's coverage to research investor portfolio patterns.
The Bottom Line
VCs manage concentration risk by balancing portfolio size (20–30 companies typical), ownership targets (15–25%), and follow-on reserves (40–60%). Earlier stages require more diversification due to higher failure rates. Fund size determines check sizes and ownership math. Founders benefit from understanding these dynamics, it explains round sizing preferences, syndicate behavior, and follow-on support patterns.
Your investment is one piece of a portfolio puzzle. Understand how you fit.
SheetVenture helps founders understand VC portfolio dynamics, so you negotiate from an informed position.