The Long Tail of Venture Deals

  back to the future 
  Originally uploaded by jpjd.

Tom Evslin makes an interesting observation in his post about The Long Tail.

Tom says:

The power law also explains why it is bad idea to be the twentieth social networking site or VoIP phone company even if #1 was just purchased for a gazillion dollars.  Let’s assume that a gazillion means a $24 million just to make the math easy.  Power law says that #2 is worth  $12,000,000 (still not bad), #3 is worth $8,000,000 (you’d get by even after your VCs’ cut).  But #20 is worth only $1.2 million.  When you check the liquidation preference (see Brad Feld on this) in your financing, you’ll find that you don’t get any of that – it all goes to the investors and they won’t even be happy.

The lengthening tail affects copy-cat entrepreneurs as well as authors.  The ever lower cost of starting and running an Internet business means that #20 will always have to contend with #21 through #50 if it looks like any money is going to made in the category.  Tough to get the investors’ money back.  Actually, since so much of the value is at the head of the curve when talking about network businesses, it is impossible for any but a handful of network business to succeed within a category.

I’ve always felt this way about venture deals, long before Chris Anderson coined the term Long Tail. I dislike copycat deals because for one, they are not likely to produce big gains for anyone, but also because, as Clay Shirkey explained in 2003:

“We also know that as the number of options rise, the curve becomes more extreme. This is a counter-intuitive finding – most of us would expect a rising number of choices to flatten the curve, but in fact, increasing the size of the system increases the gap between the #1 spot and the median spot."

So the more copycat deals there are out there, the harder it is for the second and third players in a market to make it. Competition is good for sure, but too much copycat competition is problematic.