Abstract: the press have been whining “there’s another bubble in tech!” for years but it hasn’t happened (yet)… meanwhile VC-funded startups continue to raise capital, drive innovation, and disrupt incumbents. While some claim the recent downturn in unicorn financings and valuations is proof they were right (finally!) they couldn’t be more wrong — valuations have calmed down, but tech entrepreneurs and investors aren’t going anywhere. In fact, that ugly little asset class called Venture Capital is poised for monstrous growth as thousands of startups aim to disrupt EVERY public company, and since VC fund returns have risen over the past decade they don’t completely suck as much as they used to.

No, the next bubble is NOT in tech where innovation and capital are never in short supply… rather, the REAL bubble is in far-too-generous P/E multiples and valuations of global public companies, whose business models are being obliterated by startups and improved by orders of magnitude. As more Fortune 500 CEOs recognize and admit their vulnerability to disruption, expect them to hedge their own public valuations by buying the very same unicorns that keep them awake at night… Welcome to the Unicorn Hedge.

Everybody in the press loves to write stories about the next “Tech Bubble”.

Of course, they all think they’ve seen this movie before — twice in fact, in 2000 and in 2008. They think they know the script. They think they know the actors. They love the rollercoaster ups and downs, and just like M. Night Shyamalan they love a big TWIST right at the end… except the twist that’s coming isn’t the one they’re expecting. The REAL twist will be in public markets, not private markets. And I’m not talking about tech IPOs, I’m talking about NON-tech public company dinosaurs that have been hanging around for decades. They’re about to get disrupted by a unicorn / comet.

The REAL twist won’t be tech founders or investors losing all their money on over-valued unicorns (though indeed, that will happen too) — the REAL twist will be watching a bunch of senile, senior-citizen Fortune 500 CEOs & out-of-touch Gordon Gekko private equity “Barbarians at the Gate” get beat like a drum by tech startups and VCs half their age and twice as greedy.

The REAL twist is Wall Street finance getting disrupted by Silicon Valley tech (and, by NYC and LA tech too). The REAL twist is the S&P 500 not realizing their avg P/E multiple should be ~5–10 instead of ~15–25. The REAL twist is big oil & gas and automotive companies not realizing their market caps aren’t just overvalued, but that in 10–20 years THEY WILL GO TO ZERO as electric power and autonomous vehicles become the norm. The REAL twist is thousands of public companies hemorrhaging billions in losses and value over the next ten years, like gigantic, collapsing Manhattan skyscrapers in slow motion… except that it might not be that slow.

Introducing The Unicorn Hedge

This is the reason Unilever bought Dollar Shave Club for $1B. This is why Walmart is buying Jet.com for $3B (although that may be a bit desperate). This is why GM bought Cruise for $1B, why they invested $500M in Lyft, and why they may even have considered buying Lyft for $5B. Of course, this might be risky, but it’s no more risky than not doing anything and expecting to keep your CEO job intact and the stock price rising. Hedging your public company stock by buying potentially disruptive unicorns for only 5–10% of your market cap may be one of the simplest ways to defuse the startup threat and keep on trucking... this is the Unicorn Hedge.

For those paying attention, unicorns and disruption aren’t news. You may have heard predictions of disruption for the first time in the mid-90’s, and you might have been skeptical after the 2000–01 dot-com crash. Except internet juggernauts like Amazon and Google were started in the 90’s. And you might have been skeptical again after 2008–09, except social platforms like Facebook and LinkedIn and Twitter and YouTube were started in mid-2000’s (and also the 2nd coming of Apple, Steve Jobs, & the iPhone).

No surprise, most of the now-public tech giants are investing in and buying OTHER tech startups and unicorns to stay on top of their game. Microsoft bought LinkedIn and Skype. Google bought YouTube and Android. Facebook bought WhatsApp and Instagram. In fact in the past five years ALL of the top 5 highest-value public companies are tech companies. So what do you think is more overvalued? The average unicorn or tech IPO? Or the average non-tech public company that hasn’t innovated in over a decade?

Even for those NOT paying attention, ever since Marc Andreessen wrote “Software is Eating the World” five years ago and “The Social Network” movie became a blockbuster hit for millennials, smart people everywhere know The Next Revolution Will Not Be Televised… it will be untethered, unplugged, and viewed on a mobile phone running iOS or Android or Miui, and shared on Facebook, SnapChat, or Instagram. Or maybe on some new multi-user immersive VR or AR platform like Oculus or HoloLens or Magic Leap or Minecraft. Or, perhaps something even newer out of Seoul or Shanghai instead of Silicon Valley, delivered via drone or autonomous vehicle or via Hyperloop. Innovation isn’t coming from NASA or Detroit anymore, it’s coming from Tesla and SpaceX, from Stanford and Berkeley, from 500 Startups and Y Combinator, a garage in Bucharest or Bangkok or Bangalore, or a startup accelerator in Mexico City, Istanbul or Lagos.

Now it’s true that tech bubbles do happen. However, it’s also true some of the most valuable companies on the planet were started at the same time. After Lehman blew up summer 2008, I got my first job in venture capital working for some PayPal Mafia colleagues at Founders Fund, running the FF Angel program and Facebook fbFund incubator. Between fall 2008 / spring 2010, I invested in 3 unicorns: Twilio, Credit Karma, and Lyft (then Zimride). When we invested all 3 companies were valued <=$5M. Seven years later, all three companies are now valued at >$3 Billion.

Now of course I didn’t just invest in 3 companies, I had to make lots of little bets in over 40 startups to get lucky enough to discover those outliers. Most of my investments failed, some had small exits between $5–25M, and a few like SendGrid, TaskRabbit, and Life360 are now valued at over $100M (we call those companies centaurs). Another one, Wildfire Interactive, was acquired by Google for $350M. And the most successful ones turned into the 3 unicorns I now brag about all day long (Twilio [NYSE: TWLO] just went public in June). Whether I was smart or lucky is up for debate, but regardless the $3M that I invested in those companies on behalf of Founders Fund is now worth ~$50-100M. Not bad for a rookie VC in the middle of a bubble, eh? I’ll take lucky over smart any day. (Peter & Sean: thanks for giving me a shot ;)

As it turns out, most unicorns and many tech IPOs are perhaps overvalued, but a few of them are actually UNDER-valued as well. Remember when Facebook went public at a valuation of over $100B? And then dropped like a rock to less than $50B in under 3 months? And THEN rose like a rocketship over the next four years to almost 7X its post-IPO bottom? Who would have guessed that could happen?

You’d be happy as punch to have bought FB at the IPO price, but you’d be even happier to have bought it when it was valued at between $5B–50B on the private market. Just ask Yuri Milner, founder of DST Global, arguably the godfather of the Unicorn investment. In 2009 Milner invested $200M in Facebook at a $10B valuation, and everyone thought he was crazy. Turns out he *was* crazy — LIKE A FOX! — and now Facebook is worth over $300B. Milner also famously invested in a bunch of other late-stage tech companies including AirBNB, Twitter, Spotify, Snapchat & WhatsApp. Most Russians will claim first-man-in-space Yuri Gagarin as their hero, but my favorite Yuri’s last name is Milner! (Mr. Milner, pleez to forgive meme joke, da?)

Of course sometimes tech does get ahead of itself, and it’s rare that even unicorns turn into Facebook, but many folks who got access to Uber or Airbnb shares at below $5B a few years ago might want to pat themselves on the back for making such a smart decision. Sure, there will be plenty of unicorns who go bust after receiving too much capital at too generous valuations, and many of those unicorns will have their horns cut off and get sent to the glue factory. But SOME unicorns are NOT overvalued and NOT over-funded — a few are the real deal, growing like crazy, and scaring the bejeezus out of CEOs at non-tech public companies they’re competing with. A few might be lucky enough to become the next Uber, Airbnb, or Twilio.

THIS is the reason private equity and mutual funds are scrambling to figure out how to get into tech startups earlier & earlier, rather than waiting until they go public later & later, long after they’re worth billions. They don’t want to miss out on the value created before those companies IPO, or even before they get to unicorn valuations of $1B+. As larger investors realize this — private equity, mutual funds, corporates, and sovereign wealth funds — they’re jockeying to get access to early-stage A/B/C rounds by investing in venture funds. Or, if they can get an allocation, by investing in unicorns directly when they get to later Series D/E/F rounds. The private market unicorn is the new IPO. Whether or not valuations make sense, demand for access to this new “stage” of capital is huge & growing.

Lastly, we should observe this is definitely a global story, not just Silicon Valley or US. This is why China is investing billions in their own unicorns, as well as those in Silicon Valley. This is why Tiger & Softbank & Sequoia are investing in India / SouthEast Asia and other emerging markets. This is why Saudi Arabia wants to take Aramco public at >$2T (Saudi Aramco is the world’s largest company by revenue), and convert all those oil & gas dollars into innovation & tech investments as fast as they possibly can. It’s also why the Kingdom’s Public Investment Fund invested $3.5B into Uber at over $62B valuation, and wants to do even more. Hello, global venture capital.

This is why every country on the planet is trying to duplicate the Silicon Valley ecosystem in their own backyard, rather than California or Beijing. There are now over 3 billion smartphones around the world, and many of those customers speak English — but many more speak Mandarin, Spanish, Arabic, Hindi, or Malay. You can expect many future unicorns to come from the US & China, but others will come from Nigeria, Pakistan, Brazil, & Indonesia. This is why 500 Startups invests in over 50 markets around the world. We might be early, but we sure as hell ain’t gonna be late.

Summary: expect more VCs, and expect more Unicorns. Expect more investment in Startups and Innovation, and expect more Disruption.

To avoid this, expect more public company CEOs to spend some of their market cap buying a Unicorn or two... Welcome to the Unicorn Hedge.

(next: learn why buying 10 Centaurs is a better strategy than 1 Unicorn)

Dave McClure, Troublemaker, 500 Startups

The Unicorn Hedge was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

Abstract: Startups are more likely to find product/market fit by narrowing their target demographic, understanding customer needs/benefit better, and building more focused & differentiated products along with more specific marketing messages that are better tuned to those audiences. Later, after getting initial traction with a small audience, startups can then grow their market and expand product offerings to go after bigger market segments.

Many investors give startup entrepreneurs this terrible piece of advice: “Your ideas are too small. You need to think bigger & go after a larger market. Otherwise you’re not worth my time or money. We only want to invest in entrepreneurs who are changing the world & doing something REALLY BIG.”

What a load of horse shit. That’s the WORST suggestion for a startup just getting started, when it hasn’t quite figured out product/market fit yet.

• Yahoo and Google both started out as simple interfaces with a directory or index of web pages that <1% of people on the planet cared about.
• Facebook started out with pictures of college students who Mark Zuckerberg wanted to try and get a date with.
• Twitter started out as a stupidly simple notification app that posted 140-char status updates to a very small audience of geeky people. Most of them didn’t know why or what to do with it.
• Uber started out with a crappy mobile app connecting a small number of San Francisco nerds with a few taxi drivers who weren’t total alcoholics.

Most startups build crappy initial products for a small audience of users or customers, and the product is usually so terrible at first that it *BARELY* solves the problem, and is hardly better than nothing at all.

In fact most startups can be incredibly mediocre & still be very successful.(sounds so inspirational, right? i know, but stick with me for a minute…)

But that’s exactly the point: If it’s crappy but still works and/or is useful, that’s a great sign… that means there could be a lot more potential ahead.

Most founders think they have to be AWESOME for EVERYONE to succeed. In reality, they only need to be BARELY FUNCTIONAL and BETTER THAN ALTERNATIVES for a SMALL AUDIENCE, long enough to survive until next sunrise. Then they can gradually iterate & improve.

The secret is to find your Niche — that initial <customer segmentation + product differentiation> combo that enables you to just barely beat your more established, mature competition with a much crappier product.

This strategy is called “Niche to Win”.

Most VCs (especially those with limited operational marketing experience, or with too much good fortune / a few big wins) have no understanding of this. They commonly & foolishly advise founders:

a) “You’re thinking way too small”, or

b) “Your market isn’t big enough for us”, or

(… sorry Vinod it may make sense at Series A/B, but not in the beginning…)

c) “We only fund Ambitious Entrepreneurs who want to Change The World”.

While this perspective isn’t completely irrational coming from VCs who manage larger funds ($250M to $1B+) who need big exits & returns to satisfy their investors, it’s incredibly unhelpful in the short-term for entrepreneurs just getting started, who may be a year or two from figuring out their eventual big market opportunity.

In fact it’s a bit counter-intuitive, but the crappier you are but can still find Minimum Viable Product success, the quicker and better you’ll be at identifying initial customer-problem opportunities that create the possibility your still-tiny startup can stay alive & iterate one more day.

Let me give you an example:

Suppose you’re a tiny, new startup working on products for women, and you’re competing against Proctor & Gamble, or Johnson & Johnson, or BabyCenter, or ShoeDazzle, or something huge & profitable & successful.

You feel like you can’t win right?

Like it’s impossible to beat those big incumbents.

But now consider: those companies focus broadly on a huge, largely undifferentiated market for women, with the only focus that they are between the ages of 18 and 65.

Now, consider if you NICHE TO WIN, you can focus on products for:
… women ages 25–40
… who have 2 or more kids age 3–7
… who live in urban areas
… who work for a living
… who make $50K-100K/yr
… who feel like they never have enough time in the day, and would pay good money for just a few more spare minutes.

Now, it’s actually quite easy to focus on a much more narrow demographic, research & discover their common problems, and build products & solutions that focus more specifically on these customers, rather than the broad market segment of all english-speaking women in north america.

Now, you can compete with a much less mature product but much more focused customers, more specific problems, more targeted marketing (that also probably costs less to acquire customers ready to purchase), and thus a more differentiated offering.

In fact, your product can be far inferior, far more expensive, far more profitable than a big competitor’s product designed for a much bigger, more un-differentiated audience, & crappy un-targeted marketing.

Also, because they’re a big company, they’ll move and innovate much slower than you, so you’ll always be ahead of them & they’ll never, ever catch you.

Ultimately, if you *do* want to become a bigger company, you’ll have to grow your market, change your product offering, & compete in multiple customer segments against those big incumbents — but in the first few months of existence, your job is simply to establish a foothold, to get an initial MVP out the door, and SURVIVE.

If that’s the goal, then focusing on a big, world-changing vision is EXACTLY the WRONG thing to do. Instead, narrow your field of view, find a very targeted demographic, and build a simple, crappy, focused solution that barely works, just well enough for that customer to pay for.

so in the slightly paraphrased words of Al Davis: “Just Niche to Win, Baby.”

(dmc note: this blog post in slightly different form was originally posted on svbtle.com about 3 yrs ago… i’ve updated a few things).

Niche to Win, Baby. was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

most of the time I think of myself as a failure.

when I’m optimistic, I think maybe I’m just a late bloomer.

I know a lot of folks won’t understand this perspective, but when I was growing up I was always the smartest kid around. it was expected that I would do great things, by my mom, by my teachers, and most importantly, by me. I don’t know whether that’s a good thing or bad thing, but high expectations were always around me, and for the first 10–15 years, the results would seem to indicate that was a likely thing.

but after lots of good grades and academic achievement (I skipped 8th grade and another in high school), that kind of stopped happening. I went to college early, and found out that performing well wasn’t always based on being smart. hard work and regular, consistent effort was also required… and I wasn’t really very good at those things. I also had a lot of trouble in college with too many fun things to do… many of which didn’t involve school. I got really good at playing foosball, pool, frisbee, and going to lots of parties and making friends, but I kind of barely made it to graduation. altho I did make dean’s list later in college, I was also on probation a few times, and I spent a lot of time doing “recreational activities” (ahem) which caused a lot of pain and hassle for me, and probably even more for my family. I got through those times, but I started to think about all the things I was supposed to be, and the reality was that I wasn’t quite getting to the goals that had been expected. I didn’t become an astronaut, or an astrophysicist, or a great singer or dancer or pianist, I didn’t end up in politics, I didn’t join the peace corps, I didnt get a Phd or even a masters degree. by my mid-twenties, I headed west to California in search of myself, barely managed to become a decent programmer who bounced around a few jobs, and wasn’t really sure where I was going next.

by my late twenties, I stumbled into running my own consulting firm, which sort of became my first startup. we had a lot of ups and downs, and altho we won a few awards and did some interesting and innovative work, after 5–6 years of trials & tribulations and serious questioning of my own ability as an entrepreneur and leader, I barely escaped bankruptcy multiple times and ended up with only a very small and desperate acquisition that was hardly anything to brag about. I didn’t take the job with Microsoft or Intel in the early 90’s, and I didn’t join Yahoo or Netscape in the late 90’s. i had applied to business school at Stanford, but didn’t get in. I was fortunate to get a job at PayPal in 2001 after the first dot-com blowup, but it wasn’t with any fanfare, and I was struggling to adjust to a new career in marketing, working with people ten years younger than me from Stanford and MIT who seemed to have their shit together a lot more than I did. after 3 years hard work at PayPal, I made some progress, but didn’t get any promotions and mostly got shuffled around working with 3 different bosses who really didn’t know what to do with me. in fact, I felt lucky I didn’t get fired during my time there, and as I walked out the door I was relieved no one had figured out I was a lame duck who didn’t know where the hell I was going.

don’t get me wrong: PayPal was a great place and I made some wonderful friendships and learned a hell of a lot. my own startup had been a comedy of errs, but i did learn a lot about running a business (mostly what not to do) and learned a lot about myself in the process. I also ran a lot of user groups and events, and realized I was pretty good at marketing, and I really loved technology and the silicon valley culture. but I still felt like an unfocused underachiever, and at 40 hadn’t accomplished much other than finding a good woman foolish enough to marry me, and somehow managed to father two wonderful children I was vastly unqualified to raise. I joined Simply Hired for a few years and did some work I was proud of there, but then continued bouncing around at consulting gigs with oDesk, Mint.com, O’Reilly Media and others where I still felt like I didn’t quite fit in, and wasn’t making the impact I had hoped. at Mint, I was again fortunate to work with some amazing people, but Aaron correctly assessed I wasn’t really the right guy for the job, and I felt lucky to just play a small part in a decent success story (Aaron did let me invest some money in the company, which worked out pretty well for me; thanks Aaron :)

so after twenty years in the valley, I had made only a little bit of money, had some modest accomplishments as a programmer, an entrepreneur, and a marketer. meanwhile my peers at PayPal had gone on to create incredible businesses like LinkedIn, YouTube, Yelp, and Yammer, and other kids half my age were seemingly even more ambitious. most folks thought I was a decent fellow, but over the hill with my best days behind me… and I guess I thought so too. I watched as other friends helped make companies like Google and Facebook and Twitter into juggernauts, but mostly I was on the sidelines, only peripherally involved in their big ideas. but I had started doing some angel investing when I left PayPal in 2004, and after finding Mint.com, SlideShare, & Mashery, I figured maybe I had some talent as an investor… since it seemed like I was only a half-assed entrepreneur.

so after some small notoriety in 2007 teaching a class on Facebook at Stanford (strangely, a school where I wasn’t good enough to get accepted as a student let me become a visiting lecturer), I decided I’d try to become a venture capitalist. my timing was of course impeccable, and as i was attempting to raise a small fund in summer 2008 the next huge financial crisis hit, and the bottom fell out of the market. again I was fortunate, and my plan B was to humbly say yes to a job offer by Sean Parker to help do some marketing and investing at Founders Fund. I was likely the only person hired in the entire venture industry in Q4 of 2008 (thanks Sean, I owe you one). I threw myself into the job, and after a year or so had made some decent picks investing in Twilio, Credit Karma, Lyft (then Zimride), Wildfire, and SendGrid. along the way, I also got the opportunity to run the Facebook fbFund for a short time, and made some friends at Accel and Redpoint and BlueRun. these folks, along with Founders Fund, Mitch Kapor, Michael Birch, Fred Wilson, Brad Feld, Marc Andreessen, Josh Kopelman, and several other generous souls helped me to finally & barely raise a small fund in 2010 that I brazenly named 500 Startups. Since then, we have had a little success finding good companies & making a lot of “little bets”. so far it looks like it’s working.

it would have been easy at any point in this journey to rationalize my limited success, and accept being a small cog in a bigger wheel, at likely much better pay and much less stress. but I was still hoping I had a little fire in the belly, and maybe some gas left in the tank to make something more of myself, before I ended up with just a broken spirit and a comfortable life.

and so here I am: still standing in the arena, in hand-to-hand combat with demons mostly of my own making, aiming to make a small dent in the universe. nowhere near a great success story, yet fighting the good fight and perhaps helping others to achieve greatness as I attempt a bit of my own. I’ll be 46 in a month, well past the age when most folks have already shown what they’re made of. but I’m still grasping for that brass ring.

I don’t mean to whine or bemoan my lot in life — I’ve been far more than lucky, and I’ve had a great time on this planet. I have nothing to complain about, nor will it be the end of the world if all I get to do in the next 30–40 years is to breathe in the air. all things said, it’s been a wonderful life.

but I’m not giving up yet.

I’m still betting my epitaph will read “late bloomer”, and not “failure”.

wish me luck :)

- dave mcclure, july 7, 2012

late bloomer, not a loser. was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

99 VC Problems But A Batch Ain’t One: Why Portfolio Size Matters For Returns

Abstract: Most VC funds are far too concentrated in a small number (<20–40) of companies. The industry would be better served by doubling or tripling the average # of investments in a portfolio, particularly for early-stage investors where startup attrition is even greater. If unicorns happen only 1–2% of the time, it logically follows that portfolio size should include a minimum of 50–100+ companies in order to have a reasonable shot at capturing these elusive and mythical creatures.

Like startups, most venture capital firms fail — at least in terms of returns.

Historically, 1/2 of all VC funds fail to return 1X initial capital. Another 1/4 fail to beat the (much more liquid) public market. Of the remaining “top-quartile” VCs that actually do perform, most can’t do it consistently across multiple funds. Yet we still view most VCs as pseudo-divine interpreters — powerful wizards who peer into their palantir to see the future, tell us what new companies or trends will disrupt existing incumbents, and write big checks to amazing founders who create the next Insanely Great startup.

Except most of the time this is just a big bunch of baloney, and they don’t.

For the few firms that by luck or skill get those predictions right, a strategy of very big bets on a very small # of companies can pay off handsomely. In fact, the more concentrated the portfolio, the better the returns will be for investors, assuming the portfolio still contains one or more big winners.

However in its most extreme form, this strategy devolves into betting all one’s money on a single turn of the roulette wheel, or buying a single ticket in a lottery. Surely winners of such games of chance should not be viewed as financial geniuses. Yet we still worship concentrated portfolio strategy as an industry best practice — when clearly, longitudinal performance of the venture capital asset class has yielded less than stellar results in the average case, and only consistent, frequent success for very few (~5–10%).

In the past five years of investing in over 1,000 companies at 500 Startups, we have found a few companies in our portfolios perform extremely well, but they occur very infrequently. Most of our investments (likely 50-80%) don’t ever get to any kind of exit, or return less than 1X invested capital. Perhaps 15–25% of portfolio companies succeed and result in a small exit of 2–5X. Another 5–10% might attain valuations of over $100M (which we call “centaurs”) and achieve exits of 10–20X. And if we’re lucky, 1–2% attain valuations of over $1B ( “unicorns”) and result in very large returns of 50X or more invested capital. In summary: most investments fail, a few work out ok, and a very tiny few succeed beyond our wildest dreams.

While these numbers might be unique to our own experience and process of investing at 500 Startups, most people in the industry would not disagree that large outcomes happen infrequently, or that a few big investments tend to dominate returns (re: Peter Thiel / power laws, etc). If this is true, then a more prudent VC investment strategy would be to construct portfolio size based on # of investments required to generate at least one big outcome (or ~3–5 large outcomes, to be on the statistical safe side).

Currently most larger VC funds ($200M+) doing Series A/B investments rarely invest in over 30–40 companies, and most micro-funds (<$100M) doing Seed & Series A investments rarely invest in over 50–75 companies.

We believe the current VC fund industry average portfolio construction is inherently & critically flawed, and undersized by a factor of 2–5X. We believe a more rational # of investments is ~50–100 companies for later-stage funds, and at least ~100–200 companies for early-stage funds.

Let’s presume that even for the average khaki-wearing VC — tall, smart, good-looking, went to all the right schools, and likely very white & male — that their portfolio distribution looks something like this

Looks pretty doable, right? With only 7% big wins, a VC fund could theoretically return almost 2.5X — hey, we should all become VCs!

But given the frequency of centaurs & unicorns (5% and 2% respectively in this model), let’s look at three portfolio sizes of 15, 30, and 100 companies.

What is excruciatingly clear from this model is that returns are dramatically based on the # and % of unicorns (& possibly also centaurs) that occur in a portfolio. If portfolio size is too small, you risk finding ZERO big wins.

In the model above, if we assume Unicorns occur only 2% of the time, then with portfolio size of less than 50, you might not find any. In fact, given the drama that occurs with many startups and VC funds, you might come to the conclusion that you really don’t feel statistically “safe” without constructing a portfolio that gives you a decent shot at 3–5 unicorns. So unless you think you’re going to pick unicorns at a rate of 5–10 % instead of the 1–2% industry norm, you are essentially GAMBLING with LP money by selecting a portfolio size of less than 50–100 companies.

Depending on how often the average VC is able to find & invest in unicorns, we believe a minimum safe # for most large funds is 50–100 companies, and for early-stage seed funds (where company attrition rates are even higher), we believe a “right-sized” portfolio requires at least 100-200 startups, and possibly up to 500 startups. (hmm, what an interesting number/name ;)

Note: we acknowledge this is a very simple example — management fees and other expenses are not included, nor have we modeled any follow-on capital typically reserved for 2nd/3rd check investments in winners (which might or might not improve overall performance), nor have we modeled the timing of deployment and return of capital, nor any recycling / re-investing of capital.

However, the basic argument remains: portfolios too highly-concentrated in small # of companies risk missing out on ANY unicorns whatsoever.

Ok, it’s a Saturday & since I’m overdue to take the kids to the pool, I’ll skip a more in-depth debate on why VC portfolios are so typically under-sized — my guess is it’s due to the mistaken belief by traditional VCs that they need to serve on boards directly, rather than simply securing the necessary voting rights and control they want that usually come with board seats.

Or maybe they think they’re just better than the rest of us who aren’t tall, white, male, or didn’t go to the right schools. Or who don’t wear khakis.

Or maybe it’s due to all those tee times, I’m not quite sure.

Regardless, we will be sure to discuss this in more detail at PreMoney.

Hope to see you there.

99 VC Problems But a Batch Ain’t 1 was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

Summary: pundits argue billion-dollar startups are overvalued, but few realize why public company valuations might also be too expensive. Traditional P/E ratios of 15–20+ are likely too optimistic, relative to how long the future cash flows and operating margins of big dumb companies can be sustained. Unless they innovate more rapidly (or acquire their internet peers), expect most S&P 500 Dinosaurs to be disrupted and destroyed by an endless march of VC-funded Unicorns that will bash their tiny little reptile brains in with software and internet marketing.

Lately it’s become fashionable to suggest that Unicorns are Overvalued.

For sure there’s a ton of billion-dollar valuation companies that seem to come out of nowhere recently. And while a few appear to be well on their way to becoming huge wins (Uber, Xiaomi, Airbnb), there are arguably as many losers ahead as winners. But it’s exactly due to these asymmetric outcomes that most unicorns become overvalued, and also why a lucky few Power Law outliers are always going to be severely UNDER-valued as well.

The nature of venture capital is such that for any given category, one big gorilla will run away with most all of the value, and the remaining chimps and monkeys will be worth little or nothing at all. But prior to the dust being settled, all the monkeys (and their investors) want to believe they are going to be the big damn gorilla… unfortunately almost all of them will be wrong.

Still, while it may be easy to predict the future demise of many unicorns and gorillas, we are probably overlooking the fact that many public companies (hereafter “Dinosaur Companies”) are substantially overvalued as well.

Why do I believe this to be true? There are three basic reasons:

1. Dinosaur Companies Don’t Innovate. This isn’t a new story; smarter & more eloquent folks than I have written about this topic (Schumpeter: Creative Destruction, Christensen: The Innovator’s Dilemma), so I won’t belabor the point. Dinosaur companies are easily addicted to mature lines of revenue & profit, and don’t take much risk going after possibly better alternatives. Over time, they slowly lose their edge to upstarts.
2. Dinosaur Companies have a tough time recruiting & retaining top technical talent. Dinosaurs may know that technology is important, and they might even realize that Software is Eating the World, but regardless most geeks dream of tomorrow’s million-dollar stock options over the more mundane reality of today’s fat paycheck (note: sometimes Wall Street does pay well enough to be an exception to this rule). As a result, Dinosaur Companies lose the competitive battle for tech talent, and thus also the larger war on innovation. Game over, man… game over.
3. Dinosaur Companies don’t get how critical internet marketing is becoming. They also don’t understand how important online platforms are to acquire & retain customers, and thus sustain operating margins and future profits. This third point is perhaps the most subtle, as it may not be obvious to most public companies how quickly their customers are shifting from offline to online. For the same reason as #2 above, acquiring and retaining top online marketing talent is extremely competitive. Yet most Dinosaur Companies don’t have any idea they should be racing as quickly as possible to hire growth-hacking nerds.

Fundamental to all of the above is the following observation: most public companies have not taken to heart how absolutely mission-critical software technology & internet marketing have become to business competitiveness. Thus, almost every Dinosaur Company is extremely vulnerable to a Startup Unicorn eating their lunch (stated so eloquently this past week by none other than JP Morgan Chase CEO Jamie Dimon).

Put simply: the average public company P/E ratio of 15–20 means Mr. Market assumes Dinosaur Company X will have 15–20 years of continued cash & profits from business as usual. HOWEVER THIS ASSUMPTION IS VERY WRONG — Dinosaur Company X will get its ass kicked by a venture-backed Unicorn in less than a decade.

By now, you’re probably saying to yourself: clearly this over-eager internet VC moron is clueless about how capitalism & economics work. Because if any of this were really true, the market would correct & gradually reduce the stock price & associated market cap of any such “overvalued” dinosaur company… right?

Since I’m such a well-behaved venture capitalist and armchair economist, I’d like to agree Mr. Market will usually find a balance. Except for one little problem: you can’t short the public market for an extended period of time, and certainly not for five to ten years. There isn’t really an appropriate short or hedging / derivative instrument that captures this Unicorn Disruption effect, and so the only practical alternative is to go long on the Unicorns themselves.

Which is exactly what Mr. Market is doing, and exactly why those pesky Unicorns seem to be so overvalued, and why All Dinosaurs Gonna Die.

Bubble, My Ass: Some Unicorns Might Be Overvalued, But All Dinosaurs Gonna Die. was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

aka: do you give a Shit + can you get others to give a Shit.

as a founder, it’s easy to lose focus on what job(s) we’re supposed to do.

sometimes it’s all rainbows & unicorns: designing and building product, marketing and selling, recruiting the team and raising money. other times, it’s a bowl full of crap: dealing with unhappy customers or employees, making payroll when you’re low on cash, handling rejection from a partner or investor, or maybe just cleaning up dishes after someone left them dirty. it really doesn’t matter — they’re all your job. Just #gitrdone.

it’s often hard to figure out which jobs are necessary and important, and which ones you can leave for others, or maybe even not worry about at all. this is the eternal founder dilemma — which hats do you wear, which ones do you give to others, which ones do you forget about? all in less time than you need, while your hair is on fire & your house is burning down. Choose.

but there’s one job you can’t hand off to anyone else: setting the vision and inspiring your team. that job is yours & yours alone. no one else can do it.

now here’s a question: are you doing that job? are you inspiring? to both yourself and others? are you doing it well, and enough? how can you tell?

my guess is most of you are not. to paraphrase Eric Ries and Steve Blank, you don’t have an MVI: Minimum Viable Inspiration. people just don’t give a shit, or what’s worse: YOU don’t give a shit. even if you do give a shit, it may be hard to get others inspired… either because you’re not a very inspiring communicator, or maybe because you’re tired or worn down.

now of course, most Vision and Mission efforts are a steaming pile of smelly turds. in most cases, you’re over-thinking how important bringing your startup is to the world, and you’re over-emphasizing how important YOU are to that mission. a lot of founders are FAR more in love with themselves than anyone else is (even their mom), but that doesn’t stop most of us from fantasizing for days about how amazing and wonderful we are, regardless whether we’re the next Steve Jobs or next Homer Simpson. (by the way, most of you fuckfaces are Homer Simpson, but you bet your ass *I* am the next Steve Jobs. < — see? that’s founder disease right there ;)

but for those of you who have a real business — that is, you’ve got shipping product or service, users or customers, maybe even some revenue — if you aren’t completely incompetent, you may find after some time you develop the opposite condition. as Ben Horowitz says, you might be in The Struggle.

you’ve probably been busting your ass for several months (years?) getting your Insanely Great Thingamajig off the ground… you’ve probably been grinding away so long you’ve forgotten what the hell was so inspiring in the first place… you probably get pissed off at your co-founder(s) and your team for not doing their job, or for whining about some crap that doesn’t really matter that much… you spend a hell of a lot of your time just trying to keep all the plates spinning, all the whiners happy, and make sure you just get the damn product out the door to customers, and make sure accounting gets vendors paid and gets payroll out on your time… Jesus H Christ will you ppl PLEASE shut the hell UP and just DO your *FUCKING* JOB?!? srsly, what is your damage? can’t you leave me the hell alone for a minute & SELL something?

yeah, that’s a telltale sign: “just shut up and do your job” — that’s when you know it’s bad. you don’t want to listen to the whining anymore; you just want to get shit done (#GSD) — like it’s their problem and not yours. you’re fucking grinding away, grinding away… like that’s all there is. grinding both you and them into microscopic little goddamn pieces of your former selves.

you don’t care about the why, and there is absolutely no fucking inspiration whatsoever in the mission anymore. yer dead, yer done, stick a fork in you.

so let me tell you what’s wrong… it’s not them — it’s *YOU*.

it’s *YOUR* job to make them care. it’s *YOUR* job to make YOU care.

and it’s *YOUR* job to Sell the Goddam Dream... Every. Fucking. Day.

when they start whining about all the little stuff — and believe me, they will — and you’re thinking why the FUCK aren’t they just getting shit DONE? — that’s when you’ve lost the plot my friend. time to stop grinding.

that’s when you know it’s time to re-inspire yourself, re-inspire the troops, & make sure they know why it’s important to wash those damn dirty dishes. why it’s critical for them to make that stupid little widget just so. why it’s ABSOLUTELY IMPERATIVE & EARTH-SHATTERING to get that customer.

‘cuz if you can’t inspire yourself and your team to get fired up about doing the job, then sure as hell you ain’t Steve Jobs… you’re just Homer Simpson.

so wake the fuck up, Homer.

time to write a little love poem to you & the people you brought along for the ride. why are we here? where are we going? what does it all mean?

good luck with that shit… you’ll probably need it.

Engineering Minimum Viable Inspiration. was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.

In fact, failure is a rather warm, safe blanket for most folks around these parts. Unlike most places in the world where public failure could ruin your career, destroy a family, or even bring risk of death from shame… in Silicon Valley, everyone is all too comfortable openly discussing their failure(s). While this is generally a good thing — most people won’t learn how to stretch themselves unless they push the boundaries of potential failure — a far greater fear for many entrepreneurs is that of unsustainable success.

Far worse than hitting the ground, most of us are scared shitless of flying high, staying aloft, and keeping arms extended as we climb into a big blue sky, reaching for ever higher heights… Icarus, beware.

Indeed, fear of flying is the most frightening thing ever for truly great entrepreneurs. Usually accompanied by a little voice inside your head saying “Crap. any minute now these fuckers are gonna realize i can’t keep this up very long, and then i won’t be a Golden God anymore.”

Exactly.

Of course it’s easy to fly high for a few days or weeks. Everyone gets lucky, hits their stride with gusto now & then, sinks a sweet 3-pointer once every 20 shots, writes some challenging routine that compiles the 1st time and works flawlessly, or closes a big deal they didn’t think was gonna happen. Sure, you can do that every once in awhile — but can you do it for a month? for a quarter? every day for a year? can you beat last month’s number consistently, and can you say with a straight face you’ll be able to beat that high-water mark again next month too?

Or are you afraid you might come crashing back down to earth? Are you afraid you’ll get tired, and your wings will fail you? Are you afraid you might only be a flightless chicken, with just a really big gust of wind behind you?

Cluck-cluck, motherfucker… we know who’s really behind that Mask of Zorro you’re wearing. Aren’t you scared of flying too?

Cuz I sure as hell am.

To all of us who strive for unlikely outcomes, it is this dual challenge of consistent and regular outperformance which is our real nightmare. In fact, it’s almost certifiably insane to sign up for such a goal — like agreeing to break a world record, and then keep breaking it over and over again, while maintaining perspective and focus, as well as the emotional stability necessary to lead and grow your team. Who the hell believes they can do that? Who the hell isn’t afraid they’ll falter, somewhere along the way?

Yet, it is exactly this fear of flying which sustains us, perhaps even exhilarates us, motivates us to find the passion, stamina, and renewed energy to stay aloft, to continue climbing higher, up and to the right.

And so: I wish you luck, junior birdmen and women. Your task is not an easy one, and many of you will come crashing back to earth, broken and crying. I cannot help you stay aloft, and i cannot help remove the fear — I can only remind you that you’re not alone.

Fly, little bird… spread your wings, and FLY!

We’re right behind you. Godspeed.

Fear of Flying. was originally published in 500 Hats on Medium, where people are continuing the conversation by highlighting and responding to this story.