I am often asked what do I look for in a potential investment opportunity.
In the past I created a matrix, where I scored every investment opportunity vs. around 100 criteria. Not sure it was the right way to analyse early stage companies.
One of the most over rated criteria is market size. The investment thesis on one of my worst performing investment was based on a £50bn market just in the UK, with growth rate of >25% per year expected in the next 5 years. Guess what? The market was big, but I completely overestimated the ability of the founder to execute, the higher marketing budget of the incumbent players and the general negative press for that particular sector (fast fashion market).
Lessons are learnt in life in the hard way and after a summer of thoughts I changed my approach to potential investments.
I now focus on three primary factors: 1) independent thinking entrepreneurs; 2) product differentiation through technology or design; and, 3) new, incremental behaviors in large markets.
Independent thinking entrepreneurs
I always bias towards founders that think from first principles — entrepreneurs that have a strong, clear vision that differs from the consensus view. This independent thinking, coupled with the ability to really listen to the market and to the customer is a powerful combination.
Founders with strong views that are loosely held are most compelling, particularly those that are willing to update their views in the face of new data. If you were to just listen to the wisdom of the crowds you will never build an innovative business; on the other hand, if you’re too dogmatic, you could end up with a beautiful product and no customers. Talented entrepreneurs are able to straddle both, thoughtfully.
Product differentiation through technology or design
Real differentiation is hard to achieve. It can manifest in different ways from brand to business model. I am most excited by products that are differentiated through design or technology. Albert Einstein had a very helpful framework with 5 ascending levels of intelligence: Smart, Intelligent, Brilliant, Genius, and Simple.
Achieving simplicity, particularly in design, is super challenging but it is obvious when experienced. The art of simplicity, — getting the core features right with no added frills, — is critical especially for productivity tools, and the best design-first tools get this just right.
Equally hard to achieve, are innovative new technologies developed by founders with deep technical expertise that often unlock a first principles way of doing things that didn’t exist before and would be hard to replicate. In my view, design and technological differentiation are both the most defensible and most predictive indicators of enduring companies, that go far beyond their first act.
New, incremental behaviors in large markets
Often oversimplified to ‘new’ versus ‘existing’ markets, the most interesting markets are those that replace existing ones, while simultaneously creating new behaviors that lead to more demand and, therefore, increased market size.
Fundamentally, the most attractive businesses are complements to existing markets and not substitutes.
Take Airbnb and Uber as examples — there are ‘stays’ and ‘rides’ that are taking place as a result of these platforms rather than substituting for traditional hotel stays and taxi rides. In the enterprise world, Slack initially addressed the existing messaging market, but it eventually created fundamentally new behaviors that led to engagement far beyond messaging. As the leader in this new collaboration market, Slack inherently scales with increase in demand, which has resulted in a once in a generation business.
I am excited to apply my update investment thesis to the new amazing entrepreneurs that I will go to meet in the future.