Inspired by my friend and colleague Andrea Barrica, I want to reflect a bit on what I learned in 2015 about seed investing.
I joined 500 Startups as an investor in April 2015, where I run the Mountain View accelerator. Since then, I’ve led or strongly advocated for 30-40 investments, and I’ve analyzed a lot of data from 500 Startups’ near 1500 portfolio companies.
These are my biggest takeaways:
1. Product-market fit trumps all
As an entrepreneur and now as an investor, I’ve met a ton of highly accomplished, smart founders with strong domain expertise. I’ve also seen many of these people fail to grow their business because they just can’t find product-market fit. A smart founder can increase his/her chances of success by being self-reflective and trying to pivot around to improve the unit economics of a business or finding a peripheral product that has more market demand.
But, at the end of the day, hitting upon a product that lots of people use at the right price point is out of a founders’ control. It’s called luck.
If you ask investors to pick the #1 criteria they look for in a company, many would say “team” or “market” (and obviously, there are many criteria that investors look at – not just one). Having seen so many companies with both great teams and awesome markets fail, my #1 criteria would be product-market fit.
There are a lot of great founders out there in the world and a lot of big markets, but there are not a lot of products that have product-market fit. I don’t want to bet on luck.
2. Speed is the best indicator of an awesome team
When investors say they are looking for “awesome teams,” I never understood what they meant. How do you know whether a team is awesome? (especially if you don’t have history with that team).
Referrals can be an OK vetting source, but having looked at a lot of companies this year from referrals, I’ve found that referrers have very different definitions of who are “awesome teams.” Plus, it can be hard to discern how strong the referral is.
I invest in accelerator companies to learn more about teams. What I’ve learned via the 500 Startups accelerator this year has above and beyond dominated my learnings from doing straight up angel or seed investments. When you do a seed deal, you put money in, and while you might get reports every once in a while, you never really know what exactly is happening at the company.
When teams come to our space in Mountain View, I get to learn in detail about how they think about their business, how they work together, and how they mobilize. I get to see everything – from the wins to the founder drama to seeing founders go through aha or learning-moments.
So who are the best teams? It turns out the best teams are not necessarily the oldest, the youngest, the most experienced, the best-credentialed, or even the smartest.
The best teams are the ones who move quickly; they are fast in all respects. They execute on short time frames – time to push product, time to learn, time to hire or fire, time to resolve founder-drama and morale-issues. They don’t let issues build up. They nip them in the bud. They tackle challenges head on and immediately. They are not afraid to ask questions to clarify what they don’t know and are very quick to learn and get help. How fast a team moves is the best indicator of the greatness of a team, and being quick also helps to extend a team’s runway and try lots of experiments to increase chances of getting to product-market fit.
3. Unit economics > Growth numbers
Although a lot of investors are all about growth growth growth, I’ve seen a ton of high growth companies with poor unit economics get stuck in the later stages of fundraising.
Surprise surprise! Profitability does matter at some point. If a company is losing more money by selling products than not, this is a very bad sign, even if your growth is phenomenal.
To an outsider not in venture-backed startups, this may sound like a ludicrous insight. Afterall, shouldn’t investors be looking at whether businesses are viable? This isn’t altogether obvious in the Silicon Valley. There’s a pervasive mentality that you should grow quickly so that you can be a winner who takes the whole market.
This is fodder for a much longer blog post, however, I think this “growth-at-the-expense-of-unit-economics” is really only beneficial to perhaps 5% of venture backed companies. If you are a business who needs everyone to be using your product in order for it to be valuable, then growing at the expense of unit economics makes sense. Think Uber. Think Facebook. But if you’re, say, a SaaS business or an ecommerce company, your 100th customer’s experience is really not any better because you overpaid for the first 99.
Unit economics for the win.