Do Not Let Early Traction Mislead You
Brett Munster & Selina Troesch
Everyone who is paying attention to the space knows success in VC depends on the ability to pick winners out of a set of really good-looking opportunities. However, there is a great deal of subtlety in assessing the traditional growth, market size, team, and product categories that leads investors to their final decisions. In particular, when considering growth, investors often throw money at companies with impressive early traction on the premise that past performance will accurately predict future results. In contrast, we believe, as with many things in this industry, this traction metric oversimplifies a complex evaluation.
After over a year of evaluating deals, we have both encountered our fair share of companies poised for success. The greatest challenge, of course, is figuring out which ones have the tools in place to build themselves into huge returners for our funds. Simply demonstrating a year or two of 2x or 3x revenue growth is insufficient in our minds. A year of stagnant revenue growth is also not a deal breaker. Rather, we realized in order to evaluate the potential growth of a company, investors must be able to peer into the future and determine what a company can become, not just what it is today. Many investors passed on Facebook because there already were other social networking websites. AirBnB got a lot of early no’s because it was hard to imagine how it could transform the lodging industry.
A company with limited recent revenue growth could still be a homerun investment because of the founders’ vision for the future. AITV is conducting due diligence on a company early to an emerging market. The sales team had to educate customers on the transformative potential in their technology, which led to low double digit revenue growth, hardly enough to get a VC excited. However, the company has an experienced management team, developed an impressive technology in an emerging space, and is in talks with many Fortune 500 companies. All of these factors position the company to be a market leader if that market takes off in the next couple years. While there is real risk that the market never materializes, this opportunity excites us because we believe the market will develop and we believe this company will be a leader.
On the flip side, companies with early rapid growth can fizzle out just as quickly. Meerkat, which exemplified this with user growth rather than revenue, failed to effectively communicate its long-term value proposition in a sea of video based social networks. Meerkat’s fall from prominence shows how misleading early traction can be. One contract or a little good press can give an early stage company an artificial pop. However, press coverage does not build lasting businesses. Companies that do not have distinct competitive advantages or focused go-to-market plans often cannot sustain initial success.
All this boils down to a quest for companies at an inflection point. We want to back teams that have a proven ability to execute their sales strategy and are poised to catapult their companies into rapid growth. So how do we determine if a company is capable of achieving that rocket ship growth? As we learn more and gain experience, we will likely refine our answer. But from where we stand today, one key criterion is the company’s path to its grander future self, not what it is at the moment we invest. Obviously, there are other considerations when making an investment decision, and we will explore some of those in depth in our next post.
