Introducing the Unicorn Ratio
In a recent interview with the My First Million Podcast, Garry Tan revealed the incredible returns for investors at YC Demo Day. Here's the clip:
For investors who consistently backed at least three YC startups per batch (over a two-year period):
- Top 10%: 16x MOIC
- Top 25%: 8x MOIC
- Median: 5x MOIC
In comparison, Garry noted that the best performing quarter of traditional VC funds typically see just 3x returns. This isn't just beating the benchmark—it's shattering it.
This also challenges the conventional VC wisdom of making a few, highly concentrated bets as the only winning strategy. Instead, the data suggests a broader, more systematic approach to YC investing could also be a viable strategy to generating outsized returns.
But this raises the question: What's the optimal number of YC companies to back per batch? And how should investors structure their portfolios to maximize returns while managing risk?
The Unicorn Ratio
To answer these questions, we've built the Unicorn Ratio—an interactive tool based on two powerful mathematical frameworks:
- Kelly Criterion: A mathematical model (shared with us by YC) that optimizes portfolio construction
- Binomial Distribution: A probability model that predicts your chances of backing a unicorn based on portfolio size and historical success rates
We're grateful to YC for sharing these insights with the YC investor community.
In the spirit of openness and collaboration, we've decided to open-source the code here.
Let's dive into how these models work and how you can use the Unicorn Ratio to inform your investment strategy.
Disclaimer: The Unicorn Ratio is a framework that provides probabilistic estimates for portfolio construction based on historical data. It should not be considered investment advice.
The Math
1. Kelly Criterion
The Kelly Criterion determines the optimal check size for each investment based on probability of success and potential return.
Formula:
where:
- f = fraction of capital to allocate per startup
- p = historical unicorn rate
- b = return multiple if unicorn
2. Binomial Distribution
Formula:
where:
- P = probability of finding at least one unicorn
- n = number of investments
- p = historical unicorn rate
Key Assumptions
- Binary Outcomes: Each investment either becomes a unicorn or doesn’t.
- Historical Data-Driven: Both models use historical unicorn rates to set success probabilities.
- Independent Investments: Assumes each investment’s outcome is independent.
- Skill-Based Adjustments: Allows for customization based on investor experience and skill, effectively ruling out a portion of a batch.
These assumptions simplify the real-world complexity, so while these models are informative, they are not definitive investment advice.
Using the Unicorn Ratio
1. Set Your Investment Parameters
- Total batch size
- Available capital for deployment
- Your investing skill, i.e. filtering level (0% by default, up to 90% for high conviction)
- Historical YC unicorn rate (default: 5%)
- Target multiple (default: 50x based on typical $20M demo day valuations)
2. Choose Your Model
Kelly Criterion: Optimizes your check sizes and number of investments
- Perfect for determining exact allocation amounts
- Accounts for both success probability and potential returns
- Automatically adjusts recommendations based on your filtering ability
Binomial Distribution: Maps your probability of backing a unicorn
- Visualizes how portfolio size affects success probability
- Identifies the optimal investment count using the "knee" of the curve
- Shows diminishing returns beyond certain portfolio sizes
3. Interpret Results & Adjust Strategy
- Review recommended portfolio size and check amounts
- Compare scenarios across different filtering levels
- Adjust inputs to match your investment thesis
- Use the interactive visualizations to understand probability curves
The Unicorn Ratio adapts to various investment strategies—whether you're taking a broad index approach with minimal filtering (suggesting ~32 companies) or a highly selective strategy focusing on just a few companies based on strong conviction.
Final Thoughts
The Unicorn Ratio brings a structured, data-driven perspective to YC demo day investing. By combining probability theory with portfolio optimization, it helps investors find a middle ground between diversification and focused investment.
We built this tool to empower investors to make more informed decisions, and we hope it serves as a practical resource for the YC investment community. After all, as Garry's data shows, the opportunity is too significant to leave to intuition or conventional wisdom alone.
Disclaimer: This tool is for research and educational purposes only. Always conduct your own due diligence.
Learn More:
Play around with the Unicorn Ratio and view the GitHub project, we'd love to hear what you think.