I have 15 minutes free and have been thinking about 2 topics that I can’t get out of my head. These will probably be blog posts at some point, but right now, thought I’d throw them out there.
1. Product / Distribution Fit
My friend Brian Balfour wrote a blog post yesterday about emerging distribution channels and how they impact innovation. It’s a great post – read the entire thing.
One point he makes is that in even established vertical, new companies tend to rise on the back of new distribution channels. One reason he points to is “product/distribution fit”. I think this is a really insightful comment, and a really great lens to think through the early stages of building a company and a product. Many times, I’ve seen a product to heard an entrepreneur talk about their business, and I thought to myself “this just doesn’t seem right for the times”, but what I really meant was “this product doesn’t fit the distribution options that are most likely / most accessible to get early traction”. I’m sure I’m going to be thinking about this all week and use this lens more and more when I evaluate companies and teams.
2. Seed stage founder heuristics
I had another conversation with my friend Nick Ducoff (incidentally, both Nick and Brian are involved in our portfolio company Boundless – I continue to learn so much from the entrepreneurs we work with). He pointed me to this cool article by Nicholas Taleb on the “Skin in the game Heuristic”. The gist here is that it is really really important to see a lot of skin in the game for leaders engaged in activities with long-tail but very high impact potential outcomes. We talked about this in the context of founders risk, equity splits, and opportunity cost.
This reminded me also of a question a really successful angel investor I know has found to be the single most important determinant of success or failure. Basically – how “all in” in the founder CEO. Has this person put in a significant amount of their net worth and sacrificed insanely high opportunity cost to pursue their new company?
I’ve been thinking about other sorts of founder “heuristics” that can be identified and I need to do an analysis of all the companies I’ve seen up close to try to develop something more data driven. But these resonate with me for sure, and I guess ultimately, they sound pretty obvious.
Gotta run. Would love thoughts on both of these memes!
A popular meme in startup investing right now is on the increasingly data-driven nature of the industry. More and more firms are employing developers and data-scientists internally to mine the trove of publicly available data to provide signals for companies that are exhibiting attractive momentum. Here are a couple recent articles, and we are also seeing companies like Mattermark popping up specifically to assist both VCs and angels in this endeavor.
Call me old school, but I think the impact of quantitative approaches on early-stage investing is pretty over-rated and misunderstood. Data is important and helpful (more on that later) but will not be core to what makes VCs successful, especially when it comes to identifying and sourcing the best early stage investment opportunities.
Here’s part of what informs my thinking. My prior firm, Spark Capital, has had a number of pretty terrific exits recently (congrats guys!). Namely:
- Tumblr: Acquired by Yahoo for $1B
- Adap.TV: Acquired by AOL for $400M
- Admeld: Acquired by Google for $400M
- OMGPOP: Acquired by Zynga for $180M
I often ask myself “how obvious was it at the time that these companies would be successful? How attractive would these companies have been at the series A (and in some cases, the series B) stage based on trackable measures of rapid growth or momentum?”
Honestly, I think the answer is that while these companies had a lot of good things going for them, many data-miners would have been relatively unimpressed early on. These companies did have some solid metrics, but they did not see hockey-stick like momentum and there were still a hundred reasons why they could fail.
At the time, we also saw a number of other companies that seemed to have surprisingly remarkable surges in growth and usage. These are the companies that quants would have identified as high-momentum opportunities. We didn’t invest in any of them. I don’t think many of them are still in business today.
I think ultimately, this is because early-stage investing is so much more about people, markets, and judgement than cold, hard, data. These great investments were much more a bet on a team, a vision of the future, and an early product that seemed right, even if the quantitative evidence was still pretty slim. Maybe at the later stages, one can take a more quantitative approach to picking the best companies, but I wonder if that will really be true, especially since pricing at the later stages has been so astronomical in recent years.
Now, I don’t think quantitative approaches to VC are useless. It’s an ever-changing ball game, and we at NextView employ data mining software for our purposes as well. But I think quantitative analysis and data mining is much less about finding the best companies or identifying hidden gems, and much more about understanding trends and market shifts. I think VCs that use data well are much less likely to “source” their next hot company directly from a data signal, but are much more likely to make smarter decisions about investments and better help their portfolio companies because of the data they are tracking and analyzing across thousands of companies.
This past Monday was a bit of a whirlwind. In addition to our typical (but contracted) partner meeting, we also said goodbye to our office at 186 South Street and moved in to our new space at 179 Lincoln Street.
For those of you who know the area, we just moved a couple blocks away. It was a little bittersweet to say goodbye to our old very first space, but it was fun to dig through our things and reminisce a little bit. We had been in our old space for a couple years, from the very first close on our first fund. Here’s a picture of the office the day before we moved:
In planning our next space, there were a couple things we really loved about 186 South that we very much wanted to maintain in our new office.
First and foremost, we loved the location. I’ve blogged a bit about this before, but we specifically searched for our first space knowing that we had very similar requirements to the types of companies we would fund. This led us quite obviously to downtown Boston, in the outskirts of the “Innovation District” closer to the Leather District and South Station.
When we first moved here a couple years ago, a number of people were pretty puzzled. But I think now, it’s pretty obvious that for the kind of investing we do, this is the perfect spot. The good folks at Kinvey put together an excellent infographic of all the companies that have moved into our area in recent years. Within our own portfolio, we have 4 companies within a stone’s throw of our office, and probably another 4 or 5 also within walking distance. More than once, I’ve crashed at a portfolio company’s offices because I forgot my keys, or was just too lazy to walk the extra couple blocks to NextView.
We’ve also seen downtown Boston become an emerging center of gravity for later stage companies in our sector as well, including Ebay/Paypal/StubHub, Brightcove, and TripAdvisor which is moving into down in the North Station area. I’m a big believer in the positive side-effects of density and serendipitous collissions, and we are finding only more and more of these as time goes on.
The other thing we wanted to maintain was the “feel” and “personality of the office”. Specifically, we loved that our old office was by nature, very familiar to entrepreneurs. More than once, founders have walked into our old office and commented that this was just like the kind of space they were planning to get after they raise their seed round. We specifically wanted to be in a space that was not at all intimidating to founders and communicated frugality and simplicity (although still maintaining good design). Hopefully when we finish decorating our new space, this will continue to be the case.
In our move, we did want to make a couple changes through our space, and I think we were lucky to achieve this. First, we wanted an office that had a bit more multi-purpose space. This would be handy to house a portfolio company for short periods of time, or comfortably host friends, entrepreneurs, and coinvestors stopping by Boston for a day or two. We also have some ideas cooking for more regular ways to get small, high quality groups within the tech ecosystem together on a regular basis. A larger space would allow us to be more creative in the kinds of community events we can host.
Second, we wanted to move into a building with a stronger sense of permanence. We are here to stay in the tech community and want to be partnering with entrepreneurs to build meaningful companies for a long long time. Dave, Lee, and I are all in the prime of our careers, and want to build a firm that will endure and keep refining itself to offer a better and better product for entrepreneurs. Honestly, our old building didn’t reflect this sense of permanence in quite the same way as our new home does, which was a major factor in our move.
We’re really excited for our new location, and really excited to share it with you when it’s ready. Stay tuned over the next few months, and we’ll provide a number of opportunities to stop by either through housewarmings, or other community oriented events for the startup ecosystem. Until then, here’s a little preview
Explicitly or not, I’ve found the tide has shifted away from PMF as a major goal. Instead, the focus has been on growth and distribution. Tons of stuff have been written about this too, but my favorite is from Paul Graham.
Traditionally, focusing on PMF means not really worrying too much about growth early on. The reason being that any improvements/refinements to marketing you achieve will have a bigger impact the better your PMF. Similarly, it doesn’t make sense to spend money and resources on growth if the thing you are growing fundamentally isn’t something that people want.
The counter-argument is that growth is a by-product of PMF. The is no great way to know if you have PMF, but if you can grow quickly and effectively, then that must be a signal (both internally and externally) that you have it.
The counter-counter argument to this is that this can lead to a death spiral because it’s very hard to know in a short period of time whether your product really is great, and thus, your growth is really durable. What will retention look like (and thus, LTV) for a SaaS or recurring revenue business? How does this degrade over time as you go outside your first set of users? Or, as in the case of social services that amplified their growth through another network, how durable is your user base and will they still be around in a few months?
What to focus on then? Well, like with all false choices, the answer is that both really do matter. But the key is in Sean Ellis’ blog post in PMF, specifically this sentence:
“Of course progressing beyond “early traction” requires that these users represent a large enough target market to build an interesting business.”
Getting to PMF is the most important thing for early stage companies, because without that, there is no hope for your business. But, growth informs product market fit. This is especially true for consumer or end-user focused businesses. You might have great PMF with a small set of users, who all say they would be “very disappointed” if they could no longer user your product. But that universe of users may end up being really small, and it might be too difficult/expensive to get anyone else to use your product. You won’t really know that unless you are constantly fighting to grow, even through unscalable means, to see if you run out of users that really fit your target market, or not.
This is why I find that companies with small-scale economics still often have a hard time finding investors. There seems to be product market fit, but the unknown question is “are there really that many people out there that want what you’ve got?” It’s a good question, and a pretty tough one to answer without growth.
I was asked recently how NextView evaluates such early stage companies for investment. The reality is that pretty much all investors looks for the same core things. It’s some combination of great teams, attractive markets, and promising products. As a seed fund, we tend to layer in “capital efficient beginnings” to the mix given our investing model and belief about the best way to build internet and software businesses.
But this time, I gave a different answer. We tend to favor companies that have a “distribution advantage”. This isn’t true for every single one of our portfolio companies, but in at least half, we had a thesis about why this company had some sort of unfair advantage or head-start when it comes to getting their product out into the market.
This is increasingly true in both consumer and business facing companies. The web and the app store is littered with terrific products that have a hard time getting scale, even though the teams behind them are strong and the product and market seem pretty attractive.
So what are some examples of distribution advantages? Here are a couple examples from our portfolio:
- Vertical Communities: One of the exciting attributes of GrabCAD in the early days was its rapidly growing, engaged community of mechanical engineers. As a vertical community, the business of GrabCAD was never going to look like that of a social network or social media company. However, as a software company enabling collaboration, the fact that GrabCAD has significant mindshare among engineers and hundreds of thousands of individuals discussing models they have uploaded to the cloud is a great head start. We invested in the company had only a few thousand engineers, but even then, you could see the beginnings of a vibrant vertical community that could provide an amazing distribution advantage once a paid product was released.
- Legacy Distribution Power: Quite a few successful companies got a nice head start because of legacy traffic. Sometimes, this comes from a prior business with an existing user-base or customer list (eg: Fab). In the B2B world, this could take the form of founders who have such strong market relationships that they can get things done on the sales and partnership side that create huge credibility for the company well in advance of what others could accomplish in the same time period. In our portfolio, Custommade had an early distribution advantage because Seth and Mike had worked hard to recruit large numbers of makers to list their portfolios on the site and build significant organic search traffic to custommade.com. When it was time for the company to shift the business model to a marketplace, the biggest challenges to early liquidity was largely addressed, which made this a very attractive investment opportunity even though the company was planning a business model pivot.
Sometimes, a business doesn’t necessarily have an inherent advantage in distribution apart from the strategy of the team and design of the product. This is often much harder to appreciate or identify early on, but can still lead to real go-to-market advantages. Typically, I tend to notice two approaches to delivering product-oriented distribution wins.
1. Design a product that by its very nature, touches a lot of non-users repeatedly. This tends to be pretty hit-or-miss, I find. Some products have what look like great viral loops, but aren’t very successful. Others have spectacular growth because they were clever about piggy-backing on another platform, but crash and burn pretty quickly (Remember Viddy and Socialcam?). As an investor, I tend to look for products that I think have several, extremely natural touchpoints between users and non-users and a team that is scrappy, analytical, and hyper-focused on driving growth.
2. Produce a “wow” moment for a narrow audience that cares. Also hit-or miss. But I think there are quite a few examples of companies that have taken this approach. These companies are often dismissed as being “small” or too “narrow’ by some investors. But strategically, the focus of the team is not to be applicable to lots of people (initially) but to go way over-the-top in delivering a uniquely great experience for a narrow segment. A couple companies come to mind here. On the B2B side, Crashlytics (which was acquired by Twitter) went over-the-top in delivering a premium, consumer experience to developers for crash reporting. This wasn’t just lip service either – this ethos was ingrained into every part of the company, even their office lobby which features an artistic flowering tree with hand folded origami petals to symbolize the attention to detail that was taken with every customer interaction. On the consumer side, I remember when many people wondered “how many people really want to book a hotel on the day of travel?”. But for those that were willing to do this, HotelTonight created an unparalleled mobile booking experience. All of a sudden, lots of people who thought they would never wait to book a room until noon on the day of travel decided that it was perfectly acceptable.
The last type of distribution advantage I’ve noticed is probably pretty controversial. But it’s the ability to access capital. There are few magic bullets out there for distribution, and many of the lead bullets cost money (to hire great people, buy media, maintain low prices and great service, survive long enough to establish a brand, etc). My friend Steve Kane pointed out that this has been a huge advantage for Square, for example. I think this can be an advantage, to a point. However, there are also many examples of companies with founders that had super-human access to capital that failed to get widespread, sustained distribution over time.
For more on growth and distribution, I always recommend Paul Graham’s “Startups=Growth” essay last year, Adam Nash’s three part series on “User Acquisition for Product Leaders” and David Skok’s presentation on “The Science Behind Viral Marketing”. If there are others that you recommend, please share them in the comments – I’m always looking to learn more.
Thanks to my friend Wayne Chang for helping me with my thinking here.