Thursday, May 13, 2010

My comfort zone

I’ve discovered that most VCs have a fingerprint, for investment style. Now, we’ve all heard that venture investing is all about pattern recognition, but there is a certain comfort zone that each VC likes to be in or around. On the pattern recognition side, it might be seeing two founders, one a technical/engineering guru who can not only invent but also create the product, coupled with a second founder with strong marketing experience--ideally both of whom have deep domain expertise in the market they are going after. This is a pretty good pattern, or fingerprint, for an investment basis.

Some VCs like really cocky CEOs who think they know everything; others (like me) hate that, and prefer the quiet achiever who is passionate but knows what they don’t know and is therefore coachable.

Internet deals are usually binary; i.e., they will either be huge like Google or Facebook, or nothing, and if there is nothing, then there is nothing to salvage.

At the heart of the matter is risk-reward, as we all know when you do something really big with a potentially massive payoff, chances are you will fail--that's no reason not to try, but everyone must accept that the potential for failure is great, if you try to do great things. In some countries, failure is a curse, like the black plague and those who fail are ostracized just like plague victims.

The US, in general, is not like that, and the Valley in particular is the reverse of that. Some VCs even look for, say, one failure in an otherwise perfect track record to see that you know how to deal with failure. It's easy to succeed when the market is strong and growing, it's how we deal with failure that makes it true failure or success.

My comfort zone turns out to be more around companies with some sort of baseline business, on top of which they have a stellar growth opportunity that could be a fund maker, but is also high risk. The baseline business will be there no matter what. It's probably not even venture investable because it's unlikely to generate more than 2-3x return, but when you are facing oblivion, 2-3x is pretty attractive.

I have a love-hate relationship with “emerging markets” or paradigm shifts--these are visionary opportunities where the founder thinks he can see a market change before everyone else, and wants to be there to capitalize on it. If he’s right he wins massively, if wrong, you end up carrying the company for years until the market does emerge, at which time his technology is out of date, and a younger smarter competitor eats your lunch--it sucks!

Timing the market is hard, marketing people rarely can do it, which means probably nobody can do it well. In general VCs have little fear of funding technology development, provided the market need is clear--they believe that engineers can solve most technical problems (they don’t like science projects however), but they shy away from funding market development because no amount of cash can change the market (other than kill it as the over-investment did during the telecom bubble).

Many VCs insist on customers and revenue before investment. This seems a little too easy to me, after all, you’ve got to have a little faith in the entrepreneur’s vision and take some risk! It puts a high bar for the entrepreneur who would have to bootstrap his way to product and revenue, after which he hardly needs you as a VC to come help him. Customer calls indicating strong interest and need should be enough, provided the entrepreneur has domain experience in the space.

Like conservation of energy, the risk reward ratio seems to be an invariant ;-)