Caravans of Camels

Since Covid-19 hit the economy, a growing number of mainstream media sources have been warning investors of a looming unicorn bubble burst, with some predicting dire black swan events. Lately, economists and investment analysts have begun urging investors to stop chasing unicorns and start investing in camels to overcome the pandemic crisis.

But this abundance of advice is missing a key point nobody seems to be acknowledging: camels have always been a better prospect than unicorns.

 
Unicorns may look appealing, but they bite

Representing only 1% of VC deals, unicorns achieve ≥$1B valuations in just a few years, generate prodigious buzz, and tend to register over-subscribed IPOs. Over the past several years the VC petting zoo has added even more tantalizing species including dragons, decacorns, hectocorns, chimeras, and other fantastic beasts notably rarer than unicorns. Owing to a variety of factors including relentlessly breathless promotion in tech, finance, and popular press; FOMO; and record venture fund sizes; unicorns have seen a population explosion, multiplying 8.3X between 2013 and 2019.

Despite growing fear of another dot-com bubble, TechCrunch has reported a new unicorn came into being every two working days in 2018 vs. every two months in 2013. Even Covid-19 is expected to bring seven new unicorns next year, stemming from new market opportunities formed due to social distancing.

While the majority of observers continue to cheer the unicorn parade, a small but growing chorus has raised alarms. Of the various terms used to warn of an impending unicorn burst, perhaps the most universally repeated is Unicorn Apocalypse, dating back to at least 2015. My personal favorite is CNBC’s “Unicorpses” simply because I find the word amusing. Pithy phrases and bleak humor aside, these commentators are naming a serious concern.

The unicorn concept centers on a principle of valuation over profitability. In many instances, venture-backed companies driving overambitious valuations have postponed profitability for a prolonged duration of time, or indefinitely. For years many VCs and venture-backed founders have pursued a spend more faster approach, in a race to capture magic $1B brass rings. But the market may finally be losing its appetite for money-losing enterprises. There is a growing roster of notorious fallen unicorns, such as Groupon whose shareholders lost ~$15 billion within a year of IPO. More recently, the WeWork scandal epitomized many of the inherent hazards of the inflated valuation proposition.

Martin Pichinson has warned unicorn chasers of a forthcoming black swan event. “The Undertaker of Silicon Valley” is seeing dramatically increased demand for his services due to Covid-19, which he sees as a sign of more widespread danger. Layoffs.fyi reported that tech companies have been laying off tens of thousands of employees due to the pandemic. Dealogic revealed that tech companies (e.g., Rackspace Technology, McAfee, Root Inc) making their public debut this year are higher in number than in the last two years, however have traded below the offering price much quicker. Business and news media have been regularly publishing new evidence of how vulnerable unicorns have proven in the pandemic.

Is hindsight 20/20?

While tension builds over the fate of unicorns in 2020 and beyond, a vital question is often overlooked. Do unicorns truly yield the investment returns for which they are praised?

Writing in TechCrunch, John Backus and Hemant Bhardwaj from NAV.VC find that unicorns in a venture portfolio did not correlate with better return, and that only 7% of them returned their funds over 10 years to 2015. According to them, unicorns seemingly served as a branding “logo” that some VCs paid their entire fund return to acquire.

Digging further into the same unpublished Horsely Bridge analysis of 7,000 investments made by funds from 1985 to 2014, Zebediah Rice concluded that VCs must have at least one dragon — defined as an investment that returns the entire fund; 4X less common than unicorns — to meet the basic threshold of success for most VC firms. He notes that historical pattern produces an investing mentality of, “Base hits don’t do the job, so every pitch has to be a homer, or it isn’t worth swinging.”

If the success is measured by securing at least one dragon in a portfolio, virtually only 0.25% or less of venture deals are worth making.

But as the SEC requires advisors and fund managers to note, past performance is not an indication of future success. And as made famous by the book Moneyball (and even more popular film) about the Oakland A’s under manager Billy Beane, the conventional approach to choosing talent and swinging for the fences isn’t necessarily the best way to win the game. Adopting the approach Beane pioneered, the Red Sox went from 86 years of heartbreak to a string of championships.

Switching from Silicon Valley to the Silk Road

Under Covid-19, some industry commentators have started advocating for camels over unicorns. According to AllWorld Network, an organization co-founded by Michael Porter, camels have an increased survival rate, ability to time their growth, and balance it against costs and risks, all the while ingesting less capital. Less photogenic than unicorns or dragons, investing in camels is the venture equivalent of playing moneyball.

VCs tend to use the term moneyball disparagingly, even as camel proponents (e.g., Forbes,  Crunchbase, Inc, Entrepreneur, Harvard Business Review) have touted their allure for surviving the pandemic.

Both are missing the fundamental point.

The unicorn approach to escaping the “Valley of Death” is typically a steep growth curve and a highly inflated cash burn rate.

Contrary to unicorns, camels prioritize profitability over growth so they can effectively survive and thrive in harsh environments with limited resources. Low failure rates coupled with low cash burn and profitable growth translate into high performing investment returns.

According to Brian Largeler, the US Midwest is one of the best performing regions over the last decade, with startups generating an average multiple on invested capital (MOIC) of 5.6x last year, outperforming the Bay Area by 33%.

Thus camels are not a lesser option or a temporary alternative. They are the means to build highly successful portfolios with return profiles that are sustainable and replicable across funds. Far more reliable than unicorns on an individual basis (e.g., Grubhub, Zoom), a caravan of camels can significantly improve fund returns by accumulating success stories across the portfolio. 

Camel wranglers outperform unicorn hunters

Last year, Kapor Capital published an IRR of 29.02% for their portfolio spanning 2011-2017, materially outperforming the VC industry average. In his >20 years of prior experience as an impact VC, Reinventure Capital President Edward Dugger III built camel caravans by exclusively investing in profitable enterprises led by Black founders. The majority of his portfolio companies had successful exits, and the portfolio generated 32% IRR.

In the unicorn world, these two examples would be equivalent to top-performing VC funds with at least one dragon.

It is important to note that both Kapor Capital’s and Edward Dugger III’s investments were focused on diverse and inclusive companies. The role of diversity & inclusion in generating investment returns is often neglected in both worlds — mystical and earthly creatures alike. For example, there is evidence that suggests that unicorns founded by BIPOC founders generate a higher return than their peers, yet they receive the least capital from the VC community.

For our part, Reinventure invests exclusively in US-based companies led and controlled by BIPOC and/or womxn founders, at or about breakeven, and poised to grow profitably. We have a majority success portfolio model, based on propagating self-sustaining economic engines — a caravan of camels. And drawing on Ed’s track record, we know that profitable enterprises that hire, promote, and compensate equitably create economic and social value far beyond merely superior financial returns.

If you would like to join us in cultivating our next camel caravan, please contact us. We would love to welcome you along! And if you are already an accomplished camel wrangler, please introduce yourself and share your story!

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Image Credit: kellywilson.nz

While there’s no such thing as a guarantee in investing and no one can reliably predict the future, Ed’s prior track record delivering 32%IRR to investors provides direct evidence that it is indeed possible to consistently invest for both financial returns and social value creation. If you are an accredited investor and would like to learn more about investments that can advance social, racial, and gender equity by supporting high-value companies led by women and/or people of color, please contact us to start that conversation.

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