A big chunk of our time as VC is spent on internal discussions about companies we are looking at. We believe strongly that when making investment decisions, it’s important to score opportunities quantitatively but make decisions based on conviction. What this means is that we take quite a few votes and measurements from each team member when we evaluate a potential investment. We take two formal votes about the overall opportunity, and also score prospective companies on a few different qualitative dimensions. However, the final decision is not based on an algorithm, but by the conviction of the team member that is advocating for the investment.
Given this, why do we bother with tracking and analyzing this data? There are three reasons. First, it allows us to be explicit and clear with each other about how we see an opportunity. Second, it allows us to spot our tendencies and biases over time to improve our decision-making. Third, it allows us to center our conversations on the criteria that we collectively think matter most when we talk about companies.
It occurred to me that I’ve never blogged about some of these criteria, so I thought I’d share three of them. In addition to discussions around the team, these three areas are the most frequent things we talk about when we talk about potential investments. The lingo itself has evolved, and some of it has been borrowed from founders that we know or have worked with.
The first criteria is “Jaw Dropping Value”. The idea here is that we need to invest in companies that have value propositions that absolutely blow customers away. Typically, the value is based on being better, cheaper, or faster/more convenient. I’ve blogged about these before and why the hardest thing to do is to be jaw droppingly better. This is similar to the idea that startups need to be 10X better than incumbents to get traction. In consumer businesses, this is because of the breadth of choice available to consumers and the challenges of getting attention. For B2B companies, it’s because incumbents are often quite entrenched and there is resistance against trying new software unless the benefits are jaw droppingly obvious. The kiss of death for many companies is that they offer a customer value proposition that is pretty good, but not good enough to achieve escape velocity.
The second criteria is “Competition Crushing Business Models.” This idea here is that in order to capture the immense value you create by creating jaw dropping value, you need to have a business model that has strong increasing returns to scale. The question becomes, if a company is able to get off to a great start, are there multiple things about the business model that will make it harder and harder for competitors to keep pace?. This includes traditional network effects where a service gets more and more valuable the more customers or users participate. This also includes economies of data scale where your ability to deliver on your value proposition gets stronger and stronger the more data you accumulate and incorporate into your service.
The third thing we often talk about is “Distribution Advantage.” The idea here is that we tend to really like companies that have some built-in edge in distribution. This might mean a free viral product that we believe can quickly get scale and grease the wheels for a paid enterprise service, similar to what we see in our portfolio company Code Climate or our former portfolio GrabCAD which was successfully acquired a few years ago. Or, it might be that the team has particularly important relationships or a superpower in the most relevant go-to-market approach for the company. Not every company we invest in necessarily has this, but it’s something that definitely makes us take notice, because it helps address one of the biggest risks of any early stage company.
Obviously, there is a lot more that we discuss, and it differs quite a bit from company to company. We usually spend most of our time talking about the team, as I discussed in a prior blog post here. But these three come up over and over again. And when one or two are particularly strong, that is usually the main reason why one or all of us have built the conviction to get engaged with a company when things are so early and still largely unproven.