An intangible and qualitative judgement process is the core of a VC firm’s decision to invest in one startup vs another. My partner Rob Go has tried to deconstruct and demystify this effort and has even created a VC decision tree outlining our thought-process at NextView Ventures for making seed stage investments.
Fundamentally, all early stage venture firms look at team, market, product, and traction. Internally here at NextView we always talk about those four categories ourselves – and those four categories in that order of importance – when exploring a new investment idea. There isn’t magic or “secret sauce.” It feels almost “of course” when you describe it… after all, those are four inputs into what makes a company great.
However, recently in watching our own investment decisions and those co-investors, and I’ve observed different VCs deliberately employ different lenses for investment selection beyond the categories above. Although we could jokingly debate if most VCs are smart and analytically-driven, in my experience that’s just the ante to being in this business. How, then, do different investors arrive at vastly differing decisions if we’re all looking at the same thing? Great team! Big markets! Traction! Does the “‘pick’ create well over 80% of the [VC’s] return”? Are some VCs actually “better” at decision-making or is an investment decision merely eye of the beholder without rhyme or reason which yields to amount of luck?
Various investors have different styles, and often dramatically different styles, beyond some of those above core components to decision marketing. For example, I’ve come to learn my partner Rob has a unique recognition for exceptional product-driven founders. He saw that special something in Pierre Valade and Jeremy Le Van at Sunrise, which was later successfully acquired by Microsoft, which admittedly I didn’t fully appreciate initially.
My own personal investing lens is often tuned what I call an “unfair distribution advantage.” Given my marketing operational background, I have gravitated towards startups that possess a unique and defensible route towards gaining sales & marketing scale once there is product-market fit. This advantage can manifest itself in many ways. Sometimes there is a founder which a particular charisma to strike step-function business deals. Sometimes there is a structural advantage like exceptional SEO built directly into the product itself. Sometimes there is the presence of an analytically-trained marketing-oriented founder who knows the paid acquisition playbook cold. Or a true growth hacker marketer. Or a service which is truly inherently viral (not just high word of mouth & referral rates).
As an alternative approach, I’ve seen other VC firms sharpen their lens towards specific business models. SaaS investors who brand themselves that way can deeply look at the metrics of business to recognize patterns – say around cohort analysis – that a generalist would not. Similarly, I’ve watched investors with extensive marketplace experience move quickly to invest in a startup with the right components for the demand and supply balance but perhaps not yet the scale that a typical investor would require at that stage of financing. Beyond business models, some VC firms make a practice of “road-mapping” an industry to develop a core thesis around a market prior to making an investment commitment to a specific company.
Most of the above investor orientations are horizontal… they’re not specific to one domain. Of course if a VC knows one vertical through a series of investments, anything from media to enterprise storage, she will have an expertise to rely on for future investments in a category. These domain signals provide entrepreneurs with the most salient guidepost on who to approach when fundraising. But even though they’re the most visible, they’re not always the strongest. And sometimes it’s the opposite case – investors with deep domain expertise can recognize the warts and shortcomings more effectively, which can cloud seeing the upside potential.
Since fundraising is about finding true believers, not convincing the skeptics, it’s advantageous for entrepreneurs to look beyond the superficial domain signals of potential VC investors to try to learn more about the lens they use to filter their new potential investments. That effort can be challenging since the lens is more opaque and often undefined. But I think that’s where the public social media presence of VCs can be hugely helpful to entrepreneurs – it helps give insight into what these VCs see and express. Beyond that, leveraging existing investors who are plugged into the fundraising ecosystem is a great resource to gather than tacit knowledge. (This specific type of information sharing is something we at NextView do as part of our portfolio-focused Platform Initiatives.)
From the outside, an investment decision at the seed stage can seem somewhat arbitrary. But the finer-tuned the lens, the more clearly recognizable are the unique qualities that make a startup potentially exceptional. Only time will tell if that’s the right pick.