Reflections on early-stage investing as a new(ish) venture capitalist
Since entering the world of unicorns and entrepreneurship 2.5 years ago, I’ve met with more than 700 companies, led a handful of investments (some | of which | are public), and attempted to invest in many more (spoiler alert: VCs compete). Venture capital is one of those fields where feedback cycles are long since it takes up to 5 years to find out if your investment was a good one. Despite the long feedback cycles, this job offers continuous learning for the curious mind. Having circled the sun a couple of times as an investor, I thought I’d reflect on some of these learnings about choosing founders to partner with.
Why distribution strategy should be part of product design
There is a symbiotic relationship between what you sell and how you sell it. Too often, founders treat their go-to-market strategy as an afterthought to product-market fit. If you haven’t identified a way to curate demand and enable the market to realize the value of your product, then you don’t really have product-market fit but rather a research project. Peter Thiel perfectly summarizes this idea in his book Zero to One:
It is better to think of distribution as something essential to the design of your product. If you have invented something new but you haven’t invented an effective way to sell it, you have a bad business. Superior sales and distribution by itself can create a monopoly, even with no product differentiation. The converse is not true — no matter how good the product, you have a bad business if you have no effective way to sell it.
For many startups, distribution strategies are what underlie their uniqueness. For example, dbt won the hearts and minds of data practitioners globally not because it was the first tool to embrace the ELT paradigm (it wasn’t), but because the company behind dbt invested heavily in building a robust online community. The central fixture of this community is its public Slack group, which has over 20,000 members and is the gathering point for data professionals who embrace the modern data stack. The wide adoption of dbt is the result of its well-crafted distribution strategy alongside a well-crafted product.
Don’t overstate the uniqueness
The belief that one is uniquely suited to tackle a problem for which existing solutions seem deficient is ubiquitous among founders. What matters is the degree to which they’re right. To borrow a quote from Mike Maples, “Startups are bets about how the future will unfold.” The future is solely a product of the past and the catalysts of the present. Founders should demonstrate an acute understanding of what led to the current market structure and which variables might impact how it will unfold in the future.
That market structure describes the market share among current players, how buyers discover and choose solutions, pricing dynamics, pending and current technological advancements, buyer characteristics, competitive state, and the degree of product-market fit among incumbents and substitutes, among others. The variables that impact the future depend on changes along any of these dimensions. Founders who overstate their uniqueness tend to underestimate the influence of external factors on their success. You can’t win a game if you don’t fully understand the mechanics of the sport you’re playing. My job as an investor is to qualify the assumptions that founders are making about the future and assess whether they truly understand the current market structure.
Incremental improvements aren’t sufficient
The two primary ways in which startups innovate within an industry are product and business model, the latter which includes go-to-market strategy and all aspects of distribution. Incremental changes to either of these ensure that incumbents — which are typically better capitalized and have broader distribution — will promptly follow suit if those changes prove successful.
A market advantage that results from a product that is 5% faster or a pricing model that is 5% cheaper than those of incumbents will quickly dissipate as better capitalized and distributed incumbents flex their resources to catch up. Conversely, fundamental changes in how products are consumed and/or adopted are harder for incumbents to replicate. The adjustments required to copy non-incremental innovations are much harder to copy. Let’s look at a few examples:
- Snyk launched a security product designed for developers instead of security professionals. The result was a fundamentally different product experience and buyer persona. Incumbent players like Qualys and Rapid7 would have had to fully reinvent how they sell and to whom in order to reposition themselves against Snyk.
- Twilio reinvented how companies embed telecommunications into their products. Instead of spending 12-plus months working with a telco like AT&T or Verizon to install an SIP trunking service and learn how to manually provision phone numbers, manage infrastructure capacity, and navigate archaic management portals, developers could simply embed telecommunications into their products with a few lines of code. For telcos to replicate this functionality, they’d have to reprice their offerings as commodities, restructure existing customer contracts, launch new product organizations, and replace or retrain their entire sales organizations. Not happening.
Product mindset = 🏆
Building a startup is an iterative process. Good product management means understanding what problem you’re solving before determining how best to solve it. Understanding what requires ongoing customer and problem discovery. The how will emerge through iteration. Beyond the product itself, how also includes how best to curate demand and enable customers to acquire the solution.
Founders who prioritize how over what struggle to find product market fit. The only idea that is sacred when building a startup is that there is a problem worth solving. Everything else — including the understanding of the problem and its optimal solution — should remain open to debate and subject to iteration along the way. A solid product mindset depends on characteristics like empathy, learning aptitude, and curiosity. Founders with this mindset also tend to demonstrate low ego: They’re willing to abandon previous convictions as they discover new information.
More than anything else: The team matters most
The most recurring piece of advice I received upon becoming a VC was that the team matters most. I’d nod in agreement with this advice, but my actions suggested otherwise. Upon receiving a pitch deck, I’d skim through the team slide and focus on the product, market, distribution, and so on. I’d hear about a newly formed company and then immediately study the landscape in search of an understanding of how this company might fit within it. I’d meet with a founder and scurry through introductions in favor of a discussion about — you guessed it — everything except their motivations for starting the company, who they’re bringing along on the journey, how they think about building a team, their bench of candidates they’ll attempt to hire after the financing, etc.
Fortunately, it didn’t take long before I started to realize that the most common feature among companies that succeed is undeniably the presence of a strong team. In fact, it’s harder to point to examples of companies where exceptional teams struggled to find success. (General Magic is the only one that comes to mind.) There is a reason that the most successful startups regularly spawn a diaspora of talented entrepreneurs — look no further than PayPal, Uber, Google, Facebook, Amazon, and Netflix for proof of this. As I’ve said before:
Which matters most among markets, products, or people? I’ll take people because the best ones find ways to carve out a niche in existing markets or develop new ones, and products are only as good as the market execution behind them. Companies are made of people who execute according to their ideas and abilities. The success of companies will ultimately depend on the investments they make in finding the best people, developing their capabilities, and looking for ways to help them take the next steps on their journeys.
Like an orchestra, the quality of the team depends on its composition. Each person should play a role that is uniquely suited for the company they seek to build and the market they seek to dominate.1 Zooming out, you’ll notice that each one of these sections describes the characteristics and by-products of critical thinking among the members of the team. This single observation underscores the most important thing I’ve learned since becoming an investor: Focus on the people.