Keep the Unicorns, Give me the Camels
Silicon Valley and the rest of the VC is space is obsessed with finding the next Facebook, Google, Snapchat, or AirBNB….
In other words, finding the next Unicorn.
But why is this?
The reasoning for this boils down to a very simple concept.
Statistically most of the companies within their portfolio will not produce a significant return on their investment. Because of this, firms need to make a lot of bets. These bets are very well researched and vetted yet they are, indeed, bets. Thus they need a few winners to make up for all the losers.
So let’s say its an 80 million dollar early stage fund that wants to invest in 40 companies. To make things simple the firm basically accounts for 10 of those companies to completely fail and for that deployed capital to be lost. Then about 20 of those companies will fair a little better and basically produce zero to marginal returns. Then of those final 10 companies 3–5 will 2x. 2-3 of the companies will 5x and 1–2 will 10x.
Hopefully.
So let’s do the math. We will assume for simplicities sake that all capital was deployed evenly at 2 million per company.
This would mean of the 80 million dollars invested.
10 companies = $0 return (on $20 mil invested)
20 companies = $40 mil return (on $40 mil invested)
5 companies = $20 mil return (on $10 mil invested)
3 companies = $30 mil return (on $6 mil invested)
2 companies = $40 mil return (on $4 mil invested)
So this would mean that this fund returned $130 Million on 80 million dollars in capital deployed.
So that means our make believe fund realized 62.50%
This seems pretty good but when you realize the LP’s that make up this fund may not see these returns until 10 years down the line and realize the fact that most early stage funds don’t make money you may be able to see why 62.5% actually isn’t good enough.
So thats where unicorns come in.
Unicorns are the belle of the ball, one of these bad boys can make up for an entire portfolio i.e years of failed investment.
Also, keep in mind that the poor and struggling companies are actually way more work for the firm than the winners. Basically you don’t just let your loser kids die even if you should.
So let’s go back to our previous fund example.
A unicorn would return something like 100x on the capital deployed so even if 39 of the 40 companies you backed completely failed that one golden goose would make it all worth it and in our hypothetical return 200M for your 80M fund. Brilliant.
And the best part is since it is a unicorn the company almost every time has a rockstar team combined with their fabulous product so often your work load is less and your reward is much higher.
VC really is Pareto’s principle in reality.
So now that we established why unicorns are so desired what the heck are they.
Every one knows what a unicorn is, they just don’t realize it.
A unicorn is defined simply as “something that is highly desirable but difficult to find or obtain.”
Kristaps Porzingis, the Latvian PF/C for the Dallas Mavericks is a “unicorn” because at 7'3" he can shoot like a wing and dribble like a guard.
John Mayer is a unicorn because he is one of the greatest guitarists of all time, is a prolific songwriter and can sing in perfect pitch.
Jessica that you went to college with is a unicorn because she had a 3.9 and went to med school despite railing tequila shots 3 nights a week for 4 years.
I digress.
We all have seen unicorns in our lives but in this racket a unicorn is simply a private company valued at 1 billion dollars.
But like the definition states, these companies are very rare.
A venture backed company has about a 0.006% chance of ever becoming valued at over a billion dollars in its lifecycle.
10,430 companies received venture capital dollars in 2019, while 73 became newly minted unicorns.
So, all things considered bagging one of ‘em is hard but not impossible.
But as things go, the big players out in SF get a huge portion of the high growth potential unicorns leaving just a small number of them for everyone else. So there are around 1000 active vc firms all going for the same few girls at the bar. However this isn’t necessarily a problem.
The problem with unicorns.
Today’s unicorn frenzy would not of been possible 25 years ago. In 1997 Amazon went public after only raising 10 million dollars. Now thanks to smartphones, cloud computing, and social media startups can grow at breakneck speeds. The key to the tech elite like Google, Facebook, and Amazon cementing themselves is not the millions of users they attract but the unregulated monopolies that they have have been able to create. The next swath of these companies like in a much more competitive world with platform agnostic customers. The ride hailing and food delivery spaces are here to stay, however the companies that make them up serve promiscuous customers which requires them to wage a war of attrition to win them over with cheaper prices and more marketing. The concept of blitzscaling and buying customers to win equity in a highly competitive yet massive market requires the deployment of billions of dollars of capital. But what happens when it throttles down. The last year has shown us anything can happen and the LP’s pumping money into the firms which prop up these projects may start looking at other asset classes may start to want their investment to produce more reliable returns.
The solution lies in the Camel.
Camels are my favorite animal. Sturdy. Reliable. Yet Majestic. Camels aren’t trying to impress anyone they just go out and get the job done.
Did you know that camels can go for seven months without water?
The next generation of startups, the ones that will be around a decade froim now should and will be the camels.
Just like camels these companies will be able to not just survive, but thrive on limited resources. This decades will hopefully be defined by companies that have strong and defensible moats created by a loyal paying customer base that is fostered by a distinctive product and great team. These “camels” will use capital not to survive but to grow. They will dominate a niche and then grow that niche.
Consider this a manifesto.
Have a great week,
Trevor
