How We Evaluate Opportunities
Brett Munster & Selina Troesch
In our last post we discussed that while demonstrated sales or user growth is important when considering an early stage investment, it by no means is a guarantee for future success. Often the decision is better made when considering what the company can become in the future rather than what it is today. To better understand what early stage investors look at when trying to predict a company’s future, we wanted to provide more detail on how we think about it.
A quick aside before we get into the meat of our criteria: companies live and die by their teams. Without a stellar team the company is unlikely to succeed. Many investors (including us) pay a lot of attention to the quality of the team. However, others in the industry have extensively covered the topic (a great example is this post from Mark Suster). We would rather spend time explaining some other things we think about: timing, ability to create a monopoly in a niche market, and defensibility.
Even good businesses can fall victim to poor timing. When we look at investments, we think a lot about why this business is positioned to displace incumbents and become a market leader now. Too early and the entrepreneur must go create the market. Often that means precious time and money are spent educating customers on a product category rather than building the best product or getting customers to love what you offer. Webvan was a victim of premature arrival in a market. Customers simply were not comfortable shopping for everyday staples online. On the flip side, arrive in a market too late and you are left fighting companies who have a head start winning the hearts and wallets of their customers. When a company takes advantage of one or more emerging trends magic happens. Uber capitalized on the wide adoption of smartphones and a broken piece of the transportation industry. Amazon used advances in electronic payment technology to help make people comfortable shopping online. These companies and many others found the right moment to exploit technological advances and provide products and services their customers were ready for.
A company with good timing and the wrong or no market focus, however, will also have trouble succeeding. An early stage company cannot be everything to everyone. Focus on a niche market with a cohesive strategy to expand to adjacent markets is much more valuable than a company going after the “enormous” market opportunity available. Attacking a very large market from the beginning is a recipe for failure for an early stage company. Not only does it take resources a small company does not have, it attracts the attention of much larger competitors. Incumbents have the resources to quickly crush a young startup, which is why we prefer to see companies dominate a very specific market. Some of the most successful and highly valued companies today followed exactly this strategy. Facebook started with college students. Amazon started with books. Uber started with black car service in San Francisco. Once they became the market leader, these companies had a well thought out strategy for expanding to additional markets. The key when we are evaluating new opportunities is determining whether the team can execute on the initial strategy and the team’s commitment to a focused expansion.
Finally, we want to be sure our investments have the ability to sustain their competitive position. Part of that defensibility is an incredible focus on dominating your initial market. There are numerous other ways to build a defensible product including establishing brand equity, solving a really difficult technological problem or setting up your business model in such a way that you achieve lower operating costs than your competitors. Regardless of the form defensibility takes, it is important to us that entrepreneurs pitching us are cognizant of the need to protect themselves against competitors and realistic about how they will do so.
Obviously the investment decision-making process is complex. Our hope is by sharing how we think about the companies we see we are able to help entrepreneurs build better businesses and pitch themselves more effectively.
