I’ve been thinking about this passage from an article about Sequoia’s Michael Moritz recently:
“Moritz waxed philosophical by comparing venture capital investing to bird spotting. “I rarely think about big themes. The business is like bird spotting. I don’t try to pick out the flock. Each one is different and I try to find an interestingly complected bird in a flock rather than try to make an observation about an entire flock.” For that reason, while other firms may avoid companies because they perceive a certain investment sector as being overplayed or already mature, Moritz said Sequoia is “careful not to redline neighborhoods”.
Continuing with the ornithological analogy, Moritz pointed to Cisco and said, “There’s a lot to be said for investing in the ugly duckling.” When Don Valentine led Sequoia Capital’s investment in Cisco, many others had passed on the husband and wife founding team of Len Bosack and Sandy Lerner.
At its core, venture investing is a job that can be broken down into people (execution) and markets.
The best people in an awful market will struggle to build a business and a mediocre team in an amazing market will squander the opportunity.
The idea is to find one that hits the upper right quadrant (with high marks on people and opportunity) with a deal opportunity that fits into your fund’s thesis. (ht to Chris Michel who uses a similar quadrant for hiring new talent)
Some investors solely index on people. If they know a great person or team – they were ready to back them – mainly under the belief they would figure it out.
I think the biggest learning from this type of investment is that even the best people can’t execute in a martket that won’t exist (harder to hire, harder to fundraise, etc)
An alternative is to focus solely on market trends. To choose a market to invest in based on where investors want to find returns and find the best team (or go create a team to fund)
This partially solves the market question, but at least in early stage venture, I question the type of top down analysis working to choose the best markets. (And a bad team in an amazing market won’t turn into an outsized outcome)
At the earliest stages of company creation, the best markets are weird and don’t really exist yet. But the best creators have amazing instinct about the emerging market opportunity and innate drive to create something that doesn’t exist (as well as the ability to evangelize and sell the dream)
The other issue with solely choosing markets first is market blindness – either implicitly by focusing on other areas (and not leaving time for things outside that focus) or explicitly by stating that you don’t invest in a market.
Two recent examples are consumer hardware and ad tech. For years, consumer hardware was out of favor with VCs – until a handful of investors took early bets behind special teams (and are starting to see outsized revenue growth and exist outcomes. ie Nest, Dropcam, GoPro) Ad:Tech is on the other end of the cycle – having been a darling of investors until the end of 2014 – and after a slow down in public company performance – many firms will not touch the category. The paradox being that when less capital flows into a category – the remaining investors should see outsized returns.
Back to the premise of this post, I think the best answer is a nuanced blend of both market and people. To be more specific:
1. Focus on Founder Market Fit
The best Founder is relative to the company he or she is starting. Back the individual who has an unfair advantage due to domain expertise and is able to lead a movement around what they’re building. (ie Bre Pettis at MakerBot; Luke Kanies at Puppet Labs)
2. Optimize for spending time in unpopular markets
Time is finite and an investor can only be present for a fixed number of meetings. Spend time with the most interesting people doing weird things to put yourself in a position to meet the next great companies.
3. Read, study, and discuss business history
Launching a consumer hardware business before 2007 was expensive (relative to the amount of initial risk.) Spending time talking to individuals who had tried before (ie Chumby, Bug Labs, LiveScribe) and reading about what went wrong puts you in the position to ask the right questions (and the opportunity to identify the right Founder when you meet him or her.) The corollary to this is to spending time with successful (scaling revenue; going to go public businesses) and reading S-1s to understand what it takes to make a business truly successful.
4. Have many strong beliefs weakly held
I think I stole this from someone else, but its really good. Outsized outcomes come from unpopular beliefs and the fastest way to learn is to form opinions and test them. Be wrong a lot on the path to being right.
5. Be helpful and present in parallel
While the rest of this post has focused on the identification piece of venture investing, you’re only able to win the opportunity if you’ve spent time building trust in the ecosystem (by helping people and being a good partner) and you’re out actively meeting people (VC is a contact sport)
This post is really a summary of my first 5 years of venture – and will continue to change everyday. But what won’t change is that having a fundamental understanding of business is essential – but is only made valuable by hustling and providing value to others beforehand.