I’ve spent the last 10 years in the venture capital ecosystem as an investor, founder, and now as an educator.
In that time, no concept has better helped entrepreneurs understand what they need to fundraise successfully than the idea of “alpha.”
So what is “alpha” for startups?
You might be familiar with the concept of “alpha” from the hardcore finance world but its application in startups is slightly different.
To bridge our understanding…
It’s truly an amazing time to be a media consumer, even one with a set of tastes as weird as mine. Because of services like Netflix, HBO, Instagram, and Tiktok, my super-specific interests in foreign language food shows, sports documentaries, cute pitbull videos, montages of mediocre longboard surfers, and short dance clips are perfectly met with endless options.
I can't stop watching these videos
The same is true for me as a consumer of products and services in general. With innovations like cloud computing, no-code tools, FBA drop shipping, remote work, etc… launching products has never been easier.
It feels like there is a product to address every need, no matter how small, in my personal and professional life.
When I launched my podcast Funded in the middle of the 2020 pandemic, I struggled through a piecemeal solution of Zoom, Garageband, Dropbox, and a few other tools in order to record and produce episodes in a remote world. A few months later, Riverside.fm launched and greatly simplified the way I conducted remote podcast interviews.
When I onboarded my first virtual assistant and began offloading tasks to her earlier this year, I would manually create SOPs to outline the most mundane jobs. That meant taking screenshots, drawing arrows to highlight steps, adding the images in a document, and adding text instructions. It was the worst time suck that I ever suffered through...until I found Tango, a chrome plugin that automatically captures your actions and creates an incredible SOP with screenshots for you. Absolute. Game. Changer.
Even my IRL frustrations are not long for this world. When I got my dog Lola last year, I complained about holding her leash while struggling to post selfies on Instagram at the same time. Enter the startup Zee Dog and their hands-free leash. Lifesaver!
The point is we live in a world where demand is met with supply almost immediately. If someone THINKS it, IT can almost certainly be built (see Neuralink 🤯).
To reference the world of finance again, the market for content, products, services, and software has become an efficient market. In other words, all solutions are transmitted perfectly, completely, instantly, and for no extra cost to the consumer.
When people reference “efficient market” they’re usually referring to how information is transmitted completely, instantly and for no extra cost, in the public markets. In the efficient public market, the prices you see are meant to perfectly represent the long-term value of the company inclusive of plans for future growth. Theoretically, that means there is no predictable way to make excess return, or “alpha,” while investing in the public markets.
Of course, that doesn’t stop professional traders from confidently pursuing strategies that they believe will (and sometimes do) produce alpha.
If the concept of generating alpha in an efficient market doesn’t make sense right away, consider this analogy.
Think about efficient markets as a special F1 car race. It might be a stretch, but I’m counting on the popularity of Drive to Survive on Netflix for this to land. In this particular race, no one has an advantage because everyone is driving the exact same car and all the drivers have gone through the exact same training. It’s impossible to guess who will win.
In this case, alpha is generated when a driver somehow develops an edge. Maybe they think they know something about the road conditions that other drivers don’t. Maybe they thought of a new driving tactic on their own. Or maybe they have a screw loose and will drive more aggressively. When a driver can differentiate from the pack to gain an advantage, that is when there is an opportunity to predictably win the race (i.e. generate excess returns or alpha)
There is an analogous dynamic in startup investing and fundraising. In this efficient market driven by the low cost of infrastructure, building block services, and access to remote talent across the globe, everything that is needed should have already been built theoretically. And similar to the traders in the public investing markets and the drivers in that special F1 race, entrepreneurs need to believe they have an edge to produce alpha.
I define alpha in startups as the value awarded for being a category creator, disrupting an industry, or emerging as a market leader. Without alpha, your startup is at best an “also-ran” or more likely a failure. It’s not enough to launch a startup and become a lightly used 3rd alternative in a mature market... especially if your goal is to attract venture capital.
To generate alpha in startups, you have to be able to beat the market so to speak. The market has produced all that it thinks it needs, but you disagree. You believe there is an opportunity to produce something outside of what’s expected. And, when you’re correct you’ll be rewarded.
Fundraising is all about convincing investors you can produce alpha. What is your differentiated angle, your special ability, or your unique insight that allows you to do something the market hasn’t produced yet?
A good business idea is not enough. An investor has to believe your description of why you can make this product/service and have it accepted by the market at scale. They have to believe you can generate Alpha.
I once heard Ryan Hoover, the founder of ProductHunt and General Partner at the Weekend Fund, describe his outlook on founder pitches. He said for a company he’d consider investing in, he doesn't think he should ever fully understand the business on his own. He essentially said the core essence of a company or the unique insights they possess should be something the founder needs to teach him.
In so many words, this difference between what the efficient market (Ryan) knows and what a backable founder possesses is what produces alpha in startups. Everything Ryan easily understands, even as a hyper-intelligent operator / investor, is already baked into the current market and doesn’t represent a true opportunity for venture returns.
I fully agree with this. Whether you're just starting out with an idea on the back of a napkin or you’re a later-stage Series B company that is scaling, as you tell your fundraising story you need to be able to share some unique insight. In the case of a later-stage company, that insight may be illustrated and backed up by significant amounts of data and traction. For the founder who has an idea on a napkin, your unique insight / edge will come from expertise, ability, or passion.
My best friend is a successful serial entrepreneur who has spent his career building in niche industries that few understand. When we were in business school, he warned me about some of the consumer startup ideas I was working on. While he thought they were interesting, he also believed Whatgoesthere.com, Groupary.com, and Invitesy (all actual sites I started building) were going to be incredibly challenging to make successful.
The consumer space, he argued, was so hard to win in because the bar for understanding any problem is so low that almost anyone can work on them. Because of this, tons of smart people have been iterating, testing, failing, and competing in almost any consumer opportunity you can think of. He was essentially describing the dynamics of an especially efficient startup market.
When I talk to founders launching consumer startups, I often reference this concept to coach them on what will be necessary for them to raise. Founders in the consumer space must meet a much higher bar of uniqueness because every investor will likely consider themselves an expert since they are a possible user themselves.
If you are working on a consumer startup, be prepared to show some sort of insight beyond what is predictable by a normal user. Remember what Ryan Hoover referenced and find the thing that investors need YOU to explain to them. While more is always better, at the earliest stages your edge can be shown in amounts of data, a few customer interviews, or even an anecdotal experience. Whatever those unique insights might be, they should be a big part of the story of why you are the founder, why this business exists. In other words, why you’ll be able to produce alpha with this startup.
Whether you’re building the next great consumer social network, a b2b SaaS solution for a legacy industry, or a new web3 play, unique insights will be the key to getting funded. Especially early on, focus on pursuing that insight and know that it will require developing an expertise, an obsession with your customer, and a willingness to adapt.
If you can highlight your unique insight AND how you achieved it. You may demonstrate your ability to achieve alpha and convince a VC to invest.