Paul Graham wants to farm black swans. Dave McClure likes ugly ducklings, little ponies, and centaurs. Almost all large VC funds are looking for unicorns, while some people argue that investors should hunt dragons, and others talk about decacorns.

If you have no idea what I’m talking about, here’s a quick refresher. The term unicorn was coined by Aileen Lee about two years ago to describe those rare and magical tech startups that have reached a valuation of $1 billion or more. Since then, $1 billion valuations have become somewhat less rare and there are now several private tech companies valued at $10 billion or more, for which the industry has come up with another name: decacorns.

Before unicorns were called unicorns, people used to call these rare outlier companies, which create massive returns for their early investors, black swans (or homeruns – back then, it wasn’t mandatory to borrow terms from the animal kingdom). Duckling is Dave McClure’s name for companies that don’t become quite as as huge, and ponies and centaurs are his names for the ones that have reached valuations of $10 million and $100 million, respectively. Finally, a dragon is a company that returns an entire VC fund.

So – what I mean by the question in the title of this post is what kind of exits a micro VC like Point Nine is aiming for. It’s a question that every VC needs to think about: If you have, say, a $250 million fund and your goal is to return $1 billion before costs, should you aim for one huge outlier, e.g. a $10 billion exit in which you own 10 percent? Or are you better off shooting for 20 percent stakes in 50 companies that exit at $100 million each? Or something in between?

For large funds, the answer is pretty clear. Although the number of smaller exits is of course much bigger than the number of large exits, the exit value is highly concentrated in a small number of huge winners. This power law distribution of venture returns, which Peter Thiel has spoken about extensively, is what makes it almost impossible to return a large fund without hitting one or more outliers. Or, as Jason M. Lemkin put it: VCs need multiple unicorns just to survive.

But what about a small (~$60 million) early-stage fund like ours? We spent a lot of time thinking about this question in the last years, and our conclusion – or, let’s say working assumption, because it’s still early days for us – is that (sticking to the terminology described above) we’re hunting for dragons, hoping for unicorns.

In spite of the growing number of unicorns in the last years, it’s still exceedingly rare for a startup to reach a valuation of $1 billion or more. According to Aileen Lee’s research, only 0.14 percent of venture-backed tech startups become unicorns. We can make around 30-40 investments with our fund, so statistically the chances of hitting a unicorn are very low. That doesn’t mean we’re not trying hard to beat the odds – and if you don’t believe that you can beat the odds you should never become a founder or a VC in the first place – but it means that our business model is not dependent on having a unicorn in every fund we raise.

We’re small enough for not being dependent on unicorns, but – and that’s the big difference from angel investing – we’re too big to generate a great performance by piling up a larger number of small exits. If we tried to get to, say, $240 million in exit proceeds in chunks of $10 million (corresponding to e.g. 20 percent of a $50 million exit), we’d need 24 of these exits. It’s not realistic that 60-80 percent of the companies in which we invest at a stage when there’s often just a handful of people and a few thousand dollars in revenues, will go on to become $50 million exits though. That’s why we need a few dragons, which we internally just call “fund-makers”: Investments that return an entire fund, which in our case means, for example, 20 percent of a $300 million exit or 15 percent of a $400 million exit.

The final question is, does all of this have any practical implications at all. Isn’t it impossible to look at a seed-stage startup and predict how large it can become anyway? That’s a very hard prediction to make indeed, but still, knowing what kinds of exits we need informs several important decisions that we have to make – how many companies we want to invest in, what ownership stakes we’re aiming for, how much capital we reserve for follow-on financings, and so on. It also makes it clear that we shouldn’t invest in companies that, for some reason, we feel don’t have enough potential to move the needle for our fund.

The very last thing I want to say, just to be sure I’m not misunderstood, is that I have absolutely nothing against unicorns. In fact, we love them. We’ve found two so far, Zendesk and Delivery Hero, so we’ve seen the beautiful side of the power law distribution first-hand. So: Hunting for dragons, hoping for unicorns.
Christoph Janz was the first investor in Zendesk back in 2008. Since then he has helped many of his portfolio companies raise tens of millions in follow-on rounds from the likes of Acton Capital Partners, Charles River Ventures, Bessemer Venture Partners, Benchmark Capital, Index Ventures, and others. He is Founding Partner at Point Nine Capital, a Berlin-based early-stage VC with a deep focus on SaaS and digital marketplaces.