If 90% of the holdings in your stock portfolio went to 0, you would probably be a really crappy investor. VC firms, however, commonly see 90% of their investments die off.
Even though term sheets say they’re purchasing company shares, venture investors are really buying long-dated call options on pro-rata rights. It’s acceptable for 90% of options to expire worthless (and that’s in line with CME option market averages).
Options are most valuable in times of uncertainty. Look at the Apple option chain (click for expanded chain):
AAPL call options that expire after Sep 12 command a much higher premium than options expiring the week before. Why? Because Apple’s iPhone 6 launch event is on Sep 09.
Will the iPhone 6 be totally lame? Who knows. Not a lot of uncertainty about company sentiment before the event, but a lot of uncertainty after, hence the premium.
Higher education is another form of optionality. College kids pay six-figure tuition fees for a Bachelor’s degree. They aren’t paying for the education, which is available for free on the internet; they’re paying for the career optionality that comes with a college degree.
People are willing to pay ridiculously high prices for optionality out of fear of missing out. Option prices are subject to irrationality just like any other market. If the option premium isn’t tiny, there are better options out there.