There is a pervasive mythology that startup investing is particularly difficult, and that the people who do it are particularly special. Vaunted names are spoken in hushed tones … Sacca, Doerr, Andreesen. Otherworldly high-performers whose early and growing portfolio of winners cannot simply be explained away by survivorship bias.
Us mortals have neither the deal flow nor the finely tuned pattern recognition of the Sand Hill elite. However, that doesn’t mean that we can’t put together an early-stage investment strategy that inures uniquely to our benefit. At Brandt & Co. we advise our clients to practice their ABCs — Alignment, Basics, and Constraint. This week, we’re going to talk about the most elemental of the three: constraint.
Part of what makes the celebrity VCs so otherworldly is their ability to win across seemingly unlinked sectors and stages. It helps to have the best entrepreneurs in the world throwing themselves at you. It helps to have a team of whip-smart analysts sifting through the chaff, too. But there’s no getting around the fact that pattern recognition is ultimately what’s behind the win column.
By observing thousands of pitches, following thousands of outcomes, and having skin in the game for hundreds of deals, these top VCs adopt a “human machine-learning” approach. That is, they learn implicitly as opposed to trying to write and follow complex discrete steps. They sculpt broad useful principles and put them to work as a scythe, processing their prolific deal flow.
This dominance, powered by prime deal flow and pattern recognition, enables these VCs to seek absolute returns — the best possible earnings agnostic of sector or timing.
Down here at sea level, we cannot reasonably expect the finest entrepreneurs in the world to write us in as their first-choice investor. We also can’t expect our “gut” to be accurate on the early-stage investments that are presented to us. That is, unless we radically constrain the space in which we operate.
2 Questions
Here are a couple of questions to help you assess whether your investment thesis is constrained enough.
1. Ask yourself: “What is the set of circumstances under which I am a better investor for a given entrepreneur than Kleiner Perkins?”
Imagine a company making artificial intelligence “doorman” intercoms. At the seed stage, who’s more useful? Kleiner Perkins, or a family office that owns 1500 units of high-density housing in Munich?
The startup might want KP’s name on their masthead, but they’re not likely to attract such marquis attention at the seed stage. Even if they did get John Doerr to write a check, the best they’ll get out of him so early is a few introductions and a quarterly check-in.
Meanwhile, you’re positioned to organize live tests for the startup and you have hard-earned industry knowledge that could be theirs. When your portfolio company is ready for primetime, you can immediately install them on all 1500 of your apartment buildings, giving them a huge advantage in momentum, data, and reduced sales effort.
If KP had led the seed round, wouldn’t they be hankering to write a juicy A round check if 1500 buildings signed up in the trial period? You already had that in the bag.
2. Ask yourself: “What is the type of pitch wherein my gut reaction or capacity for analysis far outstrips any generalist?”
Imagine you’re a computational microbiologist. Ordinarily, that’s not a recipe for investing success. An aspiring drug maker is pitching a novel pathway for treating pain. When even the finest generalist VCs hear their pitch, they are forced into an uncomfortable binary: pass on the investment due to lack of understanding, or scramble to try to understand even 10% and invest on faith.
This is what VCs refer to as information asymmetry, and it’s almost never working on their side. Meanwhile, you spend all day studying drug pathways. You don’t need to struggle to understand the pitch — you could very well be an advisor to the startup’s technical team if they asked. You implicitly grasp not only the biology but the business space as well. You have a general sense of the pipeline 5 years out, and you know how the current field of competitors is doing. You slot the pitch into your existing mental model, and your investment decision is effortless.
Constraint (C), even absent its good friend Alignment (A), is the non-traditional startup investor’s best tool for transcending mediocrity and sidestepping potholes. Next week we’ll cover the Basics (B) needed to capitalize on our newfound friendly information asymmetry.
