Success in Venture Capital comes down to getting an entrepreneur to pick you.
So much has been written about the jobs of venture capitalists. We invest in fast growth companies and help guide them through their journey as they (hopefully) grow in value. To do this, there are four key activities that venture capitalists engage in, Sourcing potential investments, Sorting the great from the merely good, getting Selected and Shepherding companies through their growth. But success in venture capital comes down to Getting Selected, and Getting Lucky.
Success in sourcing is about seeing a large number of potentially interesting companies. This is mostly about having high activity. Like sales, sourcing is a numbers game. And the harder you work, the more companies that you meet. The more companies you meet, the more likely you are to find great ones.
Additionally, if people like you, you’re more likely to get referred interesting companies.
Deal flow can also be bolstered by harvesting your existing networks. Having networks (e.g. from undergrad, grad school, past companies) that are full of future entrepreneurs can be a huge advantage. Matt Cohler mined his relationships from Facebook and it led to his investments in Quora, Asana and Path, among others.
But if you don’t currently have a strong network, you can build one over time through high activity.
So in the long run, being good at sourcing is mostly about work ethic and interpersonal skills. This is doable.
Differentiating good from great is about miles. You can’t tell if a company is one in ten, one in a hundred or one in a thousand until you’ve seen a thousand companies. And you want to invest in “one in a thousand” companies. You’ve got to put in the miles, and see enough companies to be able to judge greatness. This happens with time, and once again with work ethic. More miles per day builds your mileage faster.
Of course, you need a certain level of intellectual horsepower too. Judgement is involved to be able to recognize the patterns and characteristics that matter. But you don’t need to be Fields Medal smart. If you went to a well regarded university or got a job at a well regarded company, you’re smart enough. And many people who did neither are more than smart enough.
Seeing a lot of companies and being reasonable smart. These are both doable.
After you’ve invested in a company, you need to help it as it grows. Shepherding the portfolio is like teaching at college. Students learn a lot from professors, but they learn a lot from TAs as well. If you’re a TA, you only need to be one lesson ahead of the class to be able to help. The same is true if you’re a new investor. Being “one lesson ahead” comes naturally if you’ve got deep operational experience, or if you’ve been an investor a long time. But even if you haven’t, if you join a good firm you’ll have partners who are experienced board members and investors. They will have seen most movies before and be able to help you guide your founders. Over time, you graduate from TA to adjunct professor and eventually to full professor. You will be far more than one lesson ahead of the class.
With time and good partners, all this is doable.
Winning competitive deals is by far the hardest part of venture in the long term. Most great deals are competitive. These days, co-leads are uncommon, so there is typically only room for one new lead investor. If the founders don’t choose you to lead the round, there is no prize for second place. I came in second to Peter Fenton on Yelp in my first year of venture, and watched it go public from the sidelines six years later. That was a wake up call for me. Winners are grinners and everyone else goes empty handed.
Part of winning is making sure that the company knows how much you love what they do. Explicitly saying as much can help. Actions speak louder than words. Actions and words together are even better. Never let an entrepreneur have any doubt about your excitement. Being coy is not a winning strategy.
But it isn’t enough to show your excitement. You’ve also got to show the founder why you’re the best investor for her company. This is a matching process, not a sorting process. So to do that, you’ll need to figure out why you’ll win in a competitive situation against the best investors in the world, at least some of the time. There needs to be some kernel where you have a “home team” advantage. Find that and focus on it.
My partner Nicole Quinn spent ten years covering Luxury, CPG and internet companies at Morgan Stanley before joining Lightspeed. She brings a brand centric perspective to ecommerce that is quite different to the more metric driven approach that most VCs bring to the category. That is her “home team advantage”, her differentiator. As a result, she bonds with brand centric founders, and this has led to her investments in Goop, Brandable, Rothys and several other companies building great DNVBs.
If you don’t have a home team advantage somewhere, you need to build one over time. Some techniques that can help include:
— Building expertise in a domain that few others have,
— Investing earlier than others,
— Going to a geography that isn’t well covered by others, or
— Tapping a network that others do not.
You need to think hard about what that advantage will be. “Being smart”, “working hard”, “caring for my companies” or “being likable” are not differentiators in venture today. These are table stakes.
Once you have invested in a couple of good companies, you can expand that kernel to adjacent areas by parlaying the lessons you learn. But you need that “home team” advantage somewhere to start with.
Finding a “home team” advantage is the part that is not always doable
Luck is the final ingredient to being a good VC. It doesn’t get enough credit. Luck is always part of the game, whether as an investor or founder. Looking back we tend to tell stories about how it was all inevitable, and how this decision or that factor was what caused the success. But that is survivorship bias writ large.
But as Seneca said
“Luck = preparation + opportunity”.
To some extent you can make your own luck, or at least you can put yourself in the path of where luck may be more likely. Seeking upside volatility is a winning strategy. In any investment, there are always lots of reasons to say no. Good investors listen to all those reasons but also find the key reason to say yes.
The biggest mistakes I have made as an investor are when I ignored companies that were clearly working because I convinced myself that they wouldn’t keep working in the future. Uber, AirBnB and RobinHood are all examples where I foresaw a ceiling where there was none. In the instances where I did invest and it stopped working for reasons that were foreseeable, I lost 1x my money. In the instances where I didn’t invest and it kept working, I missed out on making 100x or more.
You’ve got to get lucky, but you’ve also got to give yourself the opportunity to get lucky.
Success in VC
Success in VC is path dependent. Once you have made good investments, sourcing, sorting, getting selected and shepherding all become easier. And luck comes your way more often as well.
You learn more from successful companies than those that do not work as well. Tolstoy said, “Happy families are all alike; every unhappy family is unhappy in its own way.” He could equally have said “Successful startups are all alike; every unsuccessful startup is unsuccessful in its own way”. There are many (many, many!) ways that startups can fail, but successful companies share commonalities. Internalizing those commonalities into your investment judgement is what makes all five activities easier over time and sets you on the path to success.
But the hardest part of getting onto this path is getting selected by the founders of your first great investment.