The ingredients of an outlier – Build the start-up that every VC dreams of

🎶🎶 VC dreams are made of these, who are we to disagree?

They search the globe for schemes like these, every VC’s ultimate dream.

Some of them want to fund you, all want to return their fund with you.

Some of them want to build anew, every other startup wants to be like youuu 🎶🎶

Almost every VC fund is looking to back “outlier” start-ups. You’ve probably seen it on their websites, press releases, and investment theses. Though it might sound like just another industry buzzword, often linked with terms like “innovative” or “disruptive,” the reality is that VCs really are out there looking for outliers. Why? Because their life…ahem…fund depends on it. 

The problem with outliers is that most are not obvious in the early stages. This uncertainty transforms venture capital into a game of calculated assumptions. But VCs don’t just rely on gut feelings; they base their assumptions on a set of robust facts. We’re going to delve into these facts to give you a clearer picture of what VCs are looking for. 

Outliers are the fundmakers 

First, a little overview of the math behind a VC fund.  

This will explain why VCs are dreaming of huge markets (1B+) even though a start-up can thrive well enough in a smaller market as well. It also explains why VCs analyze every start-up from a unicorn-potential perspective, even though they are perfectly aware that most will not reach that level, and some won’t even get close to it.  

Let’s say they invest in 20 companies. The reality is that a good number of them, around 12, will fail. Another 5-6 might do okay, bringing back a 2x-5x return. But that’s not enough to return a fund. 

If you’re wondering where these numbers come from, it’s the Power Law in action, a principle where one single investment can yield returns larger than all other investments combined, very often by orders of magnitude. This law also applies to natural phenomena. For example, the few most destructive earthquakes, are many times more powerful than all smaller earthquakes, combined. 

This is why VCs look for fundmakers. A fundmaker is usually one or two of the portfolio companies that bring around 50-100x returns, or even more. They need to cover the losses from the failed companies and the modest returns from the rest.  

How can VCs predict the outliers?

Well, again, with many assumptions. But a few things have proved to be essential ingredients for outliers, throughout the time. Investors place their bets on these things, to ensure that the 100x return is realistic. 

1. Big markets – at least 1B+ 

You might roll your eyes when you hear VCs talking about 1B+ markets. But here’s the math behind it: 

Let’s think of a 50M fund. This means that a VC’s shares in a company need to bring in at least 50M. Those shares usually mean 5%-10% ownership, after dilution. For such a start-up to be a fundmaker, it needs to have at least a 1B valuation at exit. 

For a valuation of 1B+, it needs at least 100M in revenue (at a multiple of 10x). Realistically, such a company would have around 10% market share and this is why VCs are looking for 1B+ markets. 

But it’s not just the numbers per se. Pulling out statistics from some reports won’t cut it. VCs have seen it before. 

2. Strategic vision 

This is not just the “Vision statement” slide on your pitch deck or website. It’s the strategic vision that: 

1. Allows you to dream big – not everyone can do it. If you and you’re team are brave enough to embark on such a journey, well, you already have a head start.  

But, most importantly: 

2. Helps you turn those dreams into reality through strategic thinking. The key differentiator here is thorough commercial domain understanding. VCs look at it as “founder-market fit” – What makes you or someone on your team, the right person to solve the most burning problems in your industry? What traits will help you stay on track when things become difficult? (As they always do) – This is what investors want to see.  

And, this ultimately leads to the most important ingredient of outliers: 

3. Rockstar team 

VCs will not invest in a good product and a big market if the team is not right. But they will invest in a great team, even if the product or market is not there yet. Why? Because a great team is open to feedback, is adaptable, and is ready to pivot, if the business (or investors) require it. 

So, what does a great team look like?  First of all, it needs a great leader. That doesn’t mean that he or she needs to know everything about running and growing a business. No, a great leader knows what they’re capable of and, most importantly, knows what they are not capable of and can hire the right people to cover those areas.  If they are good at selling, they need to find the right CTO. If they are super technical, they need to find someone to sell. As they scale, they need to be able to focus on what matters and spend their time and resources right. When resources are limited, the right allocation is essential – whether it’s energy, money, or people.  

Another “fit” that investors are looking for is the “founder-fund” fit. Especially in the past years, VCs have started to invest more strategically – that is to provide more than capital to founders to help them succeed. Especially when it comes to outliers. They are willing to provide their expertise, network, and other capabilities so both sides can win.  

Bottom line

The rationale behind identifying outliers is a reverse thought process starting from the power law: 

1. The power law is universal – fundmakers are mandatory 
2. Fundmakers are made by outliers 
3. Outliers are made in big markets 
4. For this, they need a vision  
5. The vision comes from strategy  
6. Only the right team can turn a big vision into reality, by approaching it strategically. 

Now, reverse this and you’re on your path to becoming an outlier – the “fundmaker” that any VC needs in their portfolio. 

At Fortech Investments, we work with start-up founders as strategic partners, meaning that we offer added support beyond the capital that we invest. We provide founders with our own entrepreneurial networking, allowing them to connect with other founders, investors key players in their industries, potential clients, and experts. If you’re an early-stage start-up in Healthcare, Manufacturing, Automotive, Fintech and Energy reach out to us here or at contact@fortechinvestments.ro