The Case Against Pattern Recognition
The one most damaging myth that most VCs believe in.
Stop investing in people just because they’re young, have graduated from a brand-name school, and wear a hoodie.
Number one, it’s boring. Number two, it doesn’t work.
“If you look at the hugely successful startups of the last decade, the founders have many similarities that are easy to observe. When they started, many were male, young, unmarried, computer programmers, dropouts of elite universities, etc. As a result, a lot of investors look for founders with these characteristics. But, without an understanding of the deeper reasons these founders succeeded…pattern recognition can lead to bad investments and missed opportunities.”
Here’s the problem I see with pattern recognition: even when there’s an actual pattern, there are diminishing returns: if a, then a1, a2, a3… with every item in the pattern, the magnitude of impact drops. Soon we are at incremental changes that don’t move the needle. But, of course, that’s not why we are in this, neither the entrepreneurs or the investors.
In other words, every pattern in innovation exists for a reason — until it’s broken. And that’s why any investor who says they’re looking for something that matches a pre-existing blueprint is in trouble. You can be unwilling to take a chance on something new as long as you like — until it knocks you off your feet.
I’m proud to be part of a team that takes a contrarian approach. We are proud of taking chances on the wacky, the unheard of, the weirdly obsessive, the market and society changing ideas that defy every single pattern in the VC playbook. We were early investors in companies like MakerBot, Buzzfeed, and Uber. We took chances while other investors scratched their heads and passed on investing because they wanted “more data.” While we do have our fair share of passes that turned out to be big misses, we will still put ourselves out there with what we hope are courageous investments. (Because, damn it, being a founder is courageous and great founders deserve a vote of confidence from us.)
So, how do we exactly choose who to invest in? If there’s one takeaway, it’s this: the exceptions are the rules. Companies that we have seen become successful do not follow a set of prescribed rules. But it’s not just random either, and you need to go one level deeper to understand why. Here are some ideas of what doesn’t work — and what does:
First, what doesn’t work.
- Hoodie check: Any stereotype about the types of founders who succeed is almost always wrong (gender, age, how many times founding).
- First mover in a market: You don’t have to be the first mover to be successful. In fact, arguably four out of the frightful five were second, third, fourth movers. Sometimes a market needs time to ripen, so that barriers to adoption lower sufficiently, and it’s possible to overcome the inertia of the “good enough” solution.
- Second mover in a market: Conversely, attacking a market because X giant company succeeded there is dangerous logic. At the very least, it’s not enough by itself.
- Copying an idea in a similar/adjacent/completely different market: Think “Uber for x,” “Airbnb for y,” or “Mint.com for z.” Sometimes, this does work, but market-challenging ideas don’t typically follow a mold.
- Existing market size or competition: Targeting a market simply because it’s huge is far less important than having a compelling use case. I would define the latter as “someone specific has this problem and that design pattern applies to this giant market of people willing to pay for it to be fixed.” Or, perhaps, “If I can build a delightful experience that captures and keeps users’ attention, I can later monetize it.”
- How “hot” a space is: As my colleague David Frankel writes, today’s “hot” trends are poor predictors of tomorrow’s hot startups. How much more interesting (and rewarding) is it to invest before it gets trendy? This means looking at “boring” industries or for opportunities that are “weird and wonderful” or otherwise off the beaten path.
- Technical founders who build great products: Well, it’s not an either/or thing. It takes both technical and non-technical mindsets to build an incredible business.
- Structural impediments in the market: The sales cycle is too long, or there are no easily targeted buyers, so that it’s hard to get market feedback quickly enough.
And, what does work.
- Level of commitment: Are the founders full-time? Do they have a year of savings so that they can go heads down for 12 to 24 months? In other words, are they careful planners and have they demonstrated having skin in the game? Increasingly, we see more founders, especially repeat entrepreneurs, walk in our door after they’ve built a prototype on their own dime. On top of showing off their scrappiness, they likely already have some interesting data points on product-market fit, how to acquire customers, and maybe even a hypothesis on how they’ll hack market entry. If you’re a first-time founder, you can hold your own here too, but ask yourself this one question: how committed and knowledgeable are you showing yourself to be on the basis of a pitch deck alone?
- Market & economics: The startup’s market should be big enough to meet venture sizing requirements. To do that, we run through some simple top-down sizing exercises, nothing more complicated than what you need for a management consulting interview. Essentially, fund size will tell you everything you need to know.
- Execution & planning orientation: Teams who are great at execution win out every time. In our experience, they can even win despite tough economics, with a possible exception for especially challenging markets. (As Rachlett’s Rule dictates: “When a great team meets a lousy market, market wins.” Credit to Marc Andreessen for highlighting this.)
- Customer validation: Is there a buyer? Is there a sufficient pain point that they will take action? Is the team oriented towards product-market fit? And beyond that to sales execution?
- Founder mindset: Are the founders growth-oriented? Are they playing to win? Are they team builders? Are they passionate and even mildly obsessive? One of our highest compliments is to a team we think is “all over it.” (i.e. they own every single aspect of executing their idea) Again and again, we see entrepreneurs who execute and win have these characteristics.
- Team: Does the team have the right complementary skillsets? Have they worked together before successfully? Can they disagree with respect? Are they all in? Even with a great market and an attractive idea, so much of success comes down to execution, and a strong team is indispensable to this. From sales execution to building a product, the required skillsets for success do not often coalesce in a single individual which is partly why successful founding teams far outnumber the examples of solo founders.
For savvy investors, applying pattern recognition can be unhelpful. (I hope that’s clear from reading this article!) Instead, I hope these questions suggest a path to more fundamental questions around creating value in new sectors.
If you are a technology founder, consider reflecting on why previously useful patterns are no longer so. There was a time and place where going after large markets with a “Get Big Fast” mindset made sense because technology was filled with legacy companies that didn’t understand software and could be disrupted by a nimble, well-funded competitor. But most of the low-hanging fruit has been plucked leaving much of the white space in hugely capital inefficient markets, e.g. cars, or those mired by regulation/politics, e.g. education or healthcare. In 2018, where code is increasingly commodified and you can’t get by on the strength of your product alone, sales savvy and a strategic go-to-market which take account of your competitors matter more and more.
For every savvy founder, take heart that opportunities abound in overlooked places. And, if you can master the fundamentals of idea execution, customer validation, and team leadership, you can make the most out of the right opportunity.
PS — Are you a fellow entrepreneur who breaks the mold? Reach out to me directly at @parulia. We always love to meet compelling, ambitious teams who are tackling exciting markets. The more weird, wacky, wonderful — or even ‘boring’ — you are, the better.