VC Unicorn Hunting: What VCs Look For

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  Hello, I’m Mike Collins. I’m the founder and CEO of Alumni Ventures. Today we’re doing a masterclass called Unicorn Hunting. This is a very common question we get from our community and our customers, is that before a company really establishes product market fit, where you have a lot of numbers, et cetera, to look at metrics, what do you look for? What do you look for at the pre-seed seed deal stage? So I thought I’d share a few thoughts about that today. So next slide. Yeah, so the disclosure, this is for informational purposes only. It is not a solicitation to buy or sell securities. That has to be done through a formal offering document. We encourage you to read this if you’re interested in more of the disclosures. Okay.

  Mike Collins. As I mentioned, I’m the founder and CEO of Alumni Ventures. This is a company that we started about a decade ago, and we’ve built a nice business here servicing over almost 11,000 individual investors. We’ve raised approximately $1.4 billion. We have 1400 portfolio companies. Every year, we’re one of the most active, if not the most active, venture capital firm in the United States. We have about a hundred employees. About half of those are full-time professional investors located in Menlo Park, New York, Chicago, Boston, et cetera.

  One of our missions is to help educate. Our masterclass brand at Alumni Ventures is about providing a window into venture capital—what it is, how it works, how we work, how we think. We try to be very transparent about that, and this falls into that category. We take questions that a lot of people have on their mind or things they want to learn or understand better.

  People are at all different points on their journey. We have some of the most sophisticated VC investors in the world who are investors, and we have people who are just dipping their toe and are curious and want to understand a lot more. So we’re addressing the unicorn hunting issue today. What do you look for to find big winners that really drive portfolio returns? And having been in the space of innovation and entrepreneurship and venture capital for 40 years, these things are really obvious in hindsight, and they’re really often really hard to predict in the moment. So a lot of humility, a lot of pattern recognition. Okay, let’s dig in.

  
  Several kinds of rules of venture capital. In an ideal situation, you get in early, you put in more money as a company gets product market fit, you chase your winners. But if you’re waiting around for a pre-IPO company or to buy on the IPO, especially in today’s age, a lot of the value has been wrung out.

  So again, here are just three examples, and I’ll also give you the counter to this, which is: in a venture portfolio of 10 companies, five will just not make it—will disappear. On average, three or four of the 10 will do okay—somewhere between losing a little, making a little, getting your money back—and then one out of 10 really drives returns. This is a hit business. This is a power law business, and one of the reasons we’re big believers in seed investing, one of the reasons we believe in large, really diversified portfolios, and we believe in co-investing alongside really strong name-brand VCs, especially when you’re getting into the A and B rounds of financing.

  All of these amazing companies had their pick of venture capital firms, and so there is a strong correlation there. But again, just to give you kind of orders of magnitude of what is possible. Now, these are kind of career-level opportunities where you’re looking at making a thousand, 10,000 times your money. But again, at the time, these were not obvious. These were not no-brainers, and we’re going to look at some of the signals that we look for in trying to identify the next home run.

  But you make these incredible returns by being early. Next slide. Next slide.
  Okay, so what do we look for in seed deals and the questions we ask ourselves when we’re evaluating a pre-seed or seed deal? Next slide.

  So number one, you’re really betting on the jockey here. There’s probably a market, there’s probably a problem, there’s probably an opportunity, but is this somebody that has vision? Is this somebody that sees something different than everybody else?

  One of Peter Thiel’s favorite questions is, what does this person think the entire world has wrong? And that tends to come with baggage. The brilliant, maniacal entrepreneur is not normal in many senses of the word. Just like the most successful, extreme professional athletes, they have a vision, they have a drive, they have reality distortion around them.

  They can tell the story, which I think, is a really important characteristic. So it’s not just in their head, but they can have people gravitate to that vision. But they also tend to be incredibly focused, adaptable, and resilient. And these are rare cats, but you’re looking for them. And if you find one and they’re generally going after something big and audacious, that’s a really good bet to be making early.

  
  Somebody or a group of people taking on a really hard problem. I think our society today can be a little short-sighted, a little impatient, and unwilling to do really hard things that take a long time. And so we look for the opposite, frankly.

  We look for really smart people with deep, deep domain expertise taking on really hard problems. That’s how you create real value. And I think this is amplified in an era of robotics and AI. If what you’re doing is easy, it’s not going to be that valuable, that sustainable.

  So we’re not afraid to tackle tough problems. We look for people—clear statistic: MIT, one of the top engineering schools in the world—their graduates who take on really hard, tricky, thorny problems have created trillions of dollars and employed millions of people around the world.

  So usually we’re looking for really strong tech teams. Now, you have to be careful. You don’t want just science projects. You want to be sure that within the realm of reason that there’s more than just an academic paper here—there’s a business.

  Can we do it in a reasonable timeframe for a reasonable amount of money? Is there a chance to convert a really hard technical thing into a really great business? But the starting point is the tech team, hard problems, big pain points.

  
  You try to look through for really interesting business models. Now, sometimes this isn’t apparent at the beginning, at the very early stages, but you’re looking for something that creates an unfair advantage—and I mean that in a legal, compliant way.

  But great businesses have moats and lock-ins and network effects and flywheels. And I’m not going to go through all of those, but you know what I mean. These are things where you do something that has a lot of business leverage. A small team can add disproportionate value. You can create a network effect where it gives you a huge moat as you scale. And if you’re first to market, typically that just drives your customer acquisition costs way down, your retention rates way up.

  
  So those are the things you want to have an inkling that there might be opportunities with. And again, if you look at Microsoft, Apple, Amazon, those things weren’t totally obvious on day one, but you clearly had a leader who was thinking that way. And again, as I mentioned, get in early and chase your winners. If you are in early and they’re starting to show some of these characteristics, that’s when you want to really kind of push your chips in behind that company and behind that team. But these things are really important to creating that unicorn, that home run investment as opposed to just a nice investment. They’re going to have one of these things working as a tailwind to their business.

  
  Number four, yeah.

  
  Everybody’s heard of product market fit. That’s the case where the dogs are eating the food. There’s customers, they like the product, they like the product a lot, and it’s either land and expansion or there’s word of mouth, but the thing—the product—is really at the right place at the right time solving the problem.

  But at the very earliest stages, that’s oftentimes—you don’t have product market fit yet. But what you can look for is founder-market fit. Does this person know the problem? Does this person, either because they’ve been in the space, or they’ve built businesses before that are analogous to this, just the way they understand and talk about it with nuance and feeling and passion, leads one to believe that this is the right fisherman for this pond.

  A lot of times you’re looking for teams that are complementary. If you go back, sometimes it’s just the solo Elon Musk/Zuck model, but a lot of times there’ll be the Jobs/Woz, where people have their vertical area of expertise—maybe a technical, maybe a salesperson, maybe inside, maybe outside.

  They divide and conquer really well. But is the team—is the founder—really, really have deep domain knowledge and feels this problem and the solution in their bones?

  So I think one has to be very skeptical often of young MBAs—very smart, very talented, very accomplished—deciding they want to be entrepreneurs and going and looking for a problem to solve. I think more often it comes from being in a space and identifying a problem and living it and relating it to your own personal experience.

  I’m an entrepreneur. I founded Alumni Ventures at the age of 49 or 50—I can’t remember—but this was a problem that I knew and felt. That as an individual, even one with contacts and experience in the space, it was very, very difficult for me to get access to the quantity and quality of venture deals that I wanted.

  And so I felt it in my bones and went all in because I knew I could create a solution to that problem and was pretty uniquely qualified to do it. So is this the right fisherman for the pond?

  
  Number five, timing. Timing is everything.

  
  And you don’t know, but you’d rather be early than late. And again, over the course of a career, you’re going to be early. You’re going to have the right problem. You’re going to have the right person. You might even have the right product, but you might be five, ten years too early, right?

  I think you look at something like the Apple Newton—it was just too early. Technology infrastructure, which is often really, really important—a lot of innovation is built on prior innovation. That’s why you see things come to market at the same time.

  We’re seeing some of that in the space area now, where there’s infrastructure being built that is going to allow a huge world of innovation, but you couldn’t do that in 1975 because just the technology wasn’t there.

  So we’re looking to see if the tech, the infrastructure, the customers are ready. Sometimes the technology is ready, but the customers aren’t there yet. Humans don’t like change. They can really only take one step at a time.

  You’re looking for clues that this is not only the right team and the right problem coming together, but is the context right? And have they thought about how they’re going to crack this market? Usually it’s a huge problem that is best addressed by a very narrow initial execution.

  So I’d rather see a startup whose ambition is not the world, but to go after this kind of micro-market and just nail it and then build from there. Again, you can use a million examples, but just take Amazon. Amazon did not start out as the world’s retailer. Amazon started out doing books and said, we’re going to do that really, really well, and then et cetera.

  So it’s very important to think about timing. And again, really hard to do, but this should be part of the evaluation in the process. And if you are early, do you have the time and money to be patient?

  And if you’re a little late—and again, companies like Apple are not the first to market—but have they thought and have a credible story for why what they’re doing, because of technology, because of their orientation, because of something else, will allow them to be the winner in a market that is crowded?

  And clearly—again, Google, another example. Those of you that were around know that in the early days, there were a lot of different search tools and engines. And they had a better technology and ultimately a better business model. So they were the winners. All right, next.

  
  Everything is… Price and time. It matters. So it’s really the risk-adjusted return that you want to be thinking about. So tread lightly. If the seed round is at a billion dollars, given the rate of failure, you have to think about risk/reward—the quantity of deals that are in your portfolio that have a one-in-ten shot of becoming 20, 40, 50x deals.

  Are you designed to chase success? I was with a venture firm that was an investor in Federal Express—huge company, hugely successful, very capital intensive. And if you really go through the history, the people who made money were the people that had the capital to stick it out, and the money was made kind of late because you have to understand the time and the capital to get you there.

  And do you have the patience? Do you have the capital? Do you have the reserves to do it? Clearly, good things can happen, bad things can happen. There’s a lot of game theory that goes into here—a lot of great writing by poker players about how you should think about these things. A lot of behavioral economics is involved.

  But it’s a really important part of consideration. You can also go the other way, where if this thing works, whether I pay $15 million pre or $25 million pre isn’t really going to matter. So sometimes it’s worth the decision.

  I encourage people to go to Bessemer’s anti-portfolio—great firm, have friends there—but all of us… they’re really open about the companies they’ve missed. And some of the companies they missed, they just couldn’t handle the valuation, and so they passed. And 200x later, that in hindsight didn’t look like such a great decision.

  But again, hindsight’s really easy. But you have to take this kind of risk/reward—how high is up? What traction have they shown? How have they executed? Have they done this before? All of that kind of goes into this game theory analysis.

  
  Number seven, patience. Doing hard things takes…

  
  Time. These things—you have to be sure that people are committed for a long ride. That includes the team, that includes the capital.

  There’s a J-curve in venture capital. When you have a portfolio, typically the bad companies just never get out of the blocks or blow up early. And the ones that really are the difference makers take a while.

  So do you have the experience to stick with it? Again, one of the beauties of venture capital, I think, is it keeps humans from being human and selling low and buying high, which is kind of the natural human tendency in our world.

  So it’s just really important to understand context—and this comes with experience—how long these things take, understanding how the cap table evolves.

  You want to be sure you know what you’re doing in this kind of situation. But we’re talking median times of five to seven years.

  
  I actually think it’s probably more bifurcated than that, and I’m very interested to see what the next 10 years bring. I think there’s an argument that says smaller teams, more technology can accomplish more faster. I can also make the opposite argument—that unless what you’re doing is integrated, complicated, high-tech, high-touch, it’s not going to be a very good business. And building those things takes time. So I think it’ll be very interesting.

  It’ll also be very interesting to see how the public markets continue to innovate and evolve, and how the secondary markets continue to evolve. All that’ll be fascinating.

  
  Next slide. Yeah.

  
  I touched on this and actually it’s in our deck here, which is on the right here—so there’s no such thing as these things are obvious. Again, in hindsight, no such thing as a sure winner. You do your best, you do your work, you place your bets, you shoot on goal, and some of them go in and some of them don’t.

  And sometimes you get really surprised. You live with failure. This is like being a defensive back in the NFL—you’re going to get beat and you’re going to make mistakes, and you’re going to be pretty certain about X or Y and be proven wrong. So you better be prepared to live with that.

  It’s a power law business. It’s illiquid. But if you run a process and you grind and you stick with it, it’s lucrative. It’s impactful. It’s intellectually interesting, and it’s important.

  
  Next slide. If I were to give one… Tip, which is: get the right allocation for you and then stick with it. Have a plan. Don’t overthink it. Work with good people and treat it like you would other assets, which is a long-term, consistent commitment.

  People have that with their primary home, typically—that’s one of the reasons they tend to do pretty well there. I think increasingly, people are doing this with their public equities, which is: they try to do it consistently, they try not to time markets, they try to get kind of broad diversification.

  Those things apply to all asset classes. Don’t treat venture capital differently. Put the right amount for your portfolio in this asset class. Do it with good people. Do it consistently. Have a big enough portfolio and you’ll do well.

  Okay, next slide.

  Yeah, again, this is just me as if I was talking to my brother. It’s really hard, but you need to focus on process, not outcomes. And when you have a winner, you’re not the world’s genius, and when you miss it, you’re not the biggest idiot in the room.

  It’s just—do the work, do the right thing, and you’ll have a decent batting average.

  Humans are emotional. We have thinking fast, slow brains. We’re all different. So know yourself. Know your own strengths and weaknesses. Know what you’re susceptible to and try to create systems to complement that or prevent you from doing stuff you’re prone to do that is stupid.

  Don’t watch the pot. Focus on life, family, friends. Do the work. Be prudent. But don’t sit there and check on your portfolio every day. There are better uses of time, and it really doesn’t matter.

  People that do well as investors don’t watch the pot. They focus on the process and then work with good people. For us, we hire good people, we invest in great teams, we co-invest alongside proven, reputable, top-quality lead investors. Life is just too short to do anything else.

  And then just humility and luck—again, can be in short supply in the tech entrepreneurial ecosystem. But I grew up in the Midwest. My parents were teachers. I live in Southern New Hampshire. I think it’s really healthy. I think it’s one of the reasons Warren has been great—is he’s in the middle of the country. There’s a lot of luck, a lot of timing. Get up, do your job, work hard, do it with humility. I think it’s a better approach.

  
  Okay, that’s it. That’s my presentation.

  
  Okay, so we’ve had questions submitted and we’ve had some things go on in chat. So let me just answer a couple questions here at the end.

  The first one is really a question about: now—is now a good time? And as I’ve mentioned, it’s like—we don’t know what this particular vintage will be. I will say my instincts are that it’s a pretty darn positive time. I think there’s a couple of factors.

  I think pricing coming out of the pandemic has adjusted and capital has gotten way more discerning. These things go in decade-long cycles—typically eight years of just grinding, good entrepreneurs building companies. Then things can get a little hype-y, overpriced. Usually there’s a correction, and then it gets back to normal times.

  I think we’re kind of in normal, positive times as a buyer of assets. I think it’s been a quiet time on the IPO market and the M&A. I think that’s going to loosen in the next 12–24 months to some extent, as long as the underlying companies and assets are creating value and succeeding. That’s the most important thing.

  There’s plenty of capital available for good companies. I just don’t think there’s plenty of capital for bad companies right now. So that makes it a pretty good time.

  I would also just say—and this is more from perspective—I think it is a very, very exciting time with technologies. I think humans do not fully appreciate geometric phenomena. We’re kind of wired for linear. And there’s a bunch of technologies that are really on kind of geometric improvements, and it’s really broad.

  That’s again, very unique—from food to energy, healthcare, robotics, AI, space, transportation—sector after sector is seeing real innovation, real disruption, and I think the next five or 10 years are going to see a lot of change.

  And when there’s change in our space, there’s more good than bad, and there’s more opportunity than risk. So I think it’s a pretty darn interesting time to be in our space.

  
  Another… Things coming in—this is a very common one: Can I invest retirement money?

  The quick answer is yes. That’s evolved over the last five or ten years. It’s pretty straightforward. I’d encourage you just to reach out to our account management team—our IMs—and they can walk you through that.

  But it’s actually a very smart matching of capital and asset. Most people consider retirement money kind of do-not-touch, long-term, illiquid anyway. There’s some tax reasons this can be pretty interesting with appreciating assets.

  So yes, good thought, good question, good idea. Pretty straightforward.

  What does the IPO/exit market look like? Again, a really good question. It’s been really quiet. A couple of factors there.

  I think there’s been a lot of regulatory scrutiny. I think there’s a lot of anti-big-tech sentiment out there. So they’re being very cautious about trip wires.

  There’s been a lot of capital available if you’re private. And frankly, it’s kind of a pain in the ass to be a public company. So if you can raise it privately—and again, we’re seeing innovation in the secondary—so the ability to provide some liquidity to early shareholders, employees, that pressure to go public is really off right now.

  So again, one of the reasons one wants to get in early is there’s a lot of buyers now for your appreciated asset even before the company has a full exit. So again, another reason that I think having really good seed, pre-seed exposure is important.

  So good questions. I’ll wrap it up. I’ll do the little Steve Jobs: one more thing.

  Here, I just think are some of the kind of classic reads for people that want to understand our space a little bit better. These people all have perspectives on venture capital and building businesses, and these books, I think, are really compelling. So number four, definitely check that out. But yeah, all of these are kind of classics in our space. So I should read ’em all.

  
  Okay, appreciate your time today. Hopefully you gleaned a couple of things. We have a seed fund. If you’re interested in checking that out, please reach out. We’ll put you in touch with our team, our documents, or any of our funds—or just want to learn more about venture capital and our approach to it.

  It’s a really important asset class. We think most people should have an appropriate allocation. And we’re biased, but we think for many, many people, we’re the best alternative.

  So thanks for your time today, and we’ll see you again soon.