The start of a new year is a good time to reflect on what went wrong in the prior year and how to avoid making the same mistakes again. For early stage venture capitalists like myself, some degree of failure is inevitable. But, with the clarity of hindsight, here are a few mistakes I plan to avoid in 2016.
1. Founder red flags
The first and largest mistake in my venture capital experience as a whole happened again last year. It’s an easy mistake to identify in retrospect. Sometimes we get excited about the prospect of the problem being solved or the disruption that a particular startup is promising and we don’t listen to that nagging voice in the back of our heads raising concerns about the founder. If there are any doubts about the founder’s character, passion, or investment in the startup’s success, then give credence to that voice raising concerns and move on — do not invest. At my firm, Sand Hill East, we made a couple of investments this past year in management teams that we had some concerns with, but we allowed ourselves to be persuaded because the technology was so impressive or the space was red hot.
Leading a startup is hard and requires the right team. Never settle for anything less than a strong, properly-focused management team from the start.
To borrow and adapt a philosophy from Warren Buffett, my New Year’s resolution is to employ a “20-slot rule.” His rule states that an investor has a 20-slot card for his/her investment lifetime. Every investment made should qualify as a founder and company I view as top 20 for my investment lifetime. Under this approach, you learn selectivity. Don’t invest because it’s a hot space or the technology seems impressive. If the founder/founding team isn’t top 20, then pass on the deal.
2. The “almost done” product
Investing in any technology company that does not have a shippable product is a mistake. Unless the founder is Mark Zuckerberg or Steve Jobs, you are investing too early with way too much risk. Don’t believe it when founders say the product is “almost done.” I have seen “almost done” take anywhere from 3 months to 3 years. Wait.
Warren Buffet said, “I’ve never swung at a ball while it’s still in the pitcher’s glove.” And that’s good advice to follow.
Unless the product is a cure for cancer or a self-charging iPhone, wait until the product is out in the market before investing. I can almost guarantee that you will have another chance to invest in the company at a very similar level after the product has shipped.
Let me qualify this point by saying products are never “finished.” In the words of LinkedIn’s Reid Hoffman, “If you are not embarrassed by the first version of your product, you’ve launched too late.”
Some founders acknowledge the Lean Startup principles of the minimum viable product yet find many reasons to prolong making their product available to the general market. Your product will not be perfect; there will be bugs, there will be dissatisfied customers — that’s a fact. But experience has shown that some early stage companies cannot ship a product that they don’t view as near perfect. In these situations, regardless of how much pressure you apply, they will not ship a product and iterate in rapid fashion.
3. Outsourced tech
Technology is a strategic tool that cannot be outsourced. Think of the situations where technology isn’t a core asset and you most likely have a business that is easily replicable.
Early on, I made the mistake of investing in a company that outsourced the development of key parts of its software product. The developers were top notch with a sterling record of working with many blue chip technology customers, many of whom were public. Their work never had any issues, the problem was, they were not employees of the startup. They were learning and building up skills for other clients while working on the startup’s product.
Regardless of how closely you work with outsourced developers, they are not your employees. Their number one priority is their company, not yours. They are working on your product because you are paying them. The knowledge base and experience they gain while working on the product should be an asset to your company. Rather, it becomes an asset to their development studio. Furthermore, when times are tough, which is quite often the norm in the early-stage world, these developers will not be the ones who will persevere to bring your company through the challenges; they will likely move on to the next job with little regret.
4. Investing outside core competency
The core competency at my investment firm is technology with a particular focus on FinTech, software, and the enterprise. Technology is such a large and ambiguous term that it encompasses companies that are on the periphery of being labeled a “tech company.” We have had some successes investing outside of our core competency. But when you invest in something outside your core competency and trouble sets in, there is little you can do to help, and that can lead to big failures.
I invested in a music technology company that was well outside my core competency, but I was wowed by an amazing video they produced that showed compelling applications of the technology. Instead of stepping back and reviewing my core competencies, I jumped in to be a part of the next SoundCloud without the usual rigor i apply to new investments, partly because I did not know the right questions to ask. Down the road, I showed it to a friend in the industry who was skeptical, asking questions about the music labels’ involvement that I had not thought were germane. The questions were important, and the company did not have good answers. I immediately felt that sinking feeling in my chest that I hadn’t felt since I was a portfolio manager watching helplessly as one of my investments was halted for pending bad news. Lesson: Don’t lose your discipline regardless of how cool and sexy a technology appears.
When you invest in a company that is solving for issues and opportunities in business segments that you know well, you are well positioned to help them navigate when they hit the inevitable twist or turn. Whether it is the right person to talk to inside of a customer prospect, the right hire to fill an identified gap, or simply strategic advice on a product – you are in a position to provide grounded and helpful advice. You lose that edge when you reach outside your core area.
I’m optimistic about opportunities for 2016. Early stage investing is full of twists and turns and, yes, oftentimes failures. But by being reflective and honest with ourselves about past mistakes, we can move forward with greater awareness of our blind spots and help bring some exciting new technologies into existence this year.
Josh Burwick is a managing partner at Sand Hill East Ventures. He previously managed technology portfolios at Moore Capital, Pia Capital, and GLG Partners and worked at Goldman Sachs in the technology sector for the Investment Research and Institutional Research Sales departments. He blogs at http://sandhilleast.net/blog.html, and you can follow him on Twitter: @jburwick.
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