Foothills and Basecamps
You can’t help notice the uptick in seed investing over the past five years. We’ve seen the rise of angels globally, and the creation of new genres of venture capital such as seed funds and micro-VCs. We’ve done seeds since the inception of Flybridge in 2002, but certainly the pace has increased substantially since 2007. It’s hard to know the exact number of seed deals committed industry-wide over the part 5 years; Price Waterhouse Coopers MoneyTree reports more than 1,700, but the number is likely far greater, since many companies don’t participate in the survey.
A popular approach to seed investing, and one that I followed for some time, is what I call the “Foothills” philosophy. Invest a small amount in a team that is focused on a defined niche – with expectations that with hard work, nurturing and good fortune, the team will conquer the niche – climb that first hill. And with luck, once that first hill has been scaled, another bigger one will lie in clear view, and maybe another bigger one beyond that, and so on. In this model, the thought is that a collection of more modest hills (niche markets) will sum to equal a big opportunity, or maybe, just maybe, a mountain (massive market) will reveal itself to yield a homerun.
The problem is that many times – ok, to be really cynical, most times – there are no more hills beyond the first, let alone any mountains in the distance. This results in many small seed startups pursuing market opportunities that will never be big enough to justify the so-called “Venture Capital Return” – markets that are sizable enough to grow standalone public companies, $B outcomes, revenues in the 100’s of $M, etc. etc.
Please don’t interpret this as an indictment of seed investing. Not at all. This is a VC-only perspective and mine to boot – and doesn’t necessarily apply to the lenses of angel investors, seed funds and micro-VCs, whose models are fundamentally different than ours. More “modest” outcomes ($10-50M in an acquisition) may work well for founders and these types of investors, where modest capital has been raised and ownership has not been diluted. But this approach doesn’t scale well and therefore doesn’t work for larger VC funds. The data show that the best VC returns are driven by investments in massive opportunities. You can’t hit a homerun unless you swing the bat at homerun pitches; “small ball” – walks, bunts, singles and doubles – usually lead to small outcomes. This is why I think the Foothills approach for VC seed investing doesn’t work.
But clearly seed investing is working across the industry, turning out some great companies and great outcomes – so what’s different in our approach? Continuing the hiking meme, I refer to our strategy as seeking “Basecamps.”
I’m looking for seed-stage startups that seek to conquer Mt. Everest – targeting a massive market they seek to own or disrupt, with conviction about where to setup their initial basecamp, and a set of plans/hypotheses on the routes to ascend – recognizing they may have to adjust or abandon paths based on the obstacles they encounter.
Knowing the giant goal looms in the distance helps nascent companies balance short-term tactical decisions with the longer-term strategic impact. For example, a decision about pricing structure for a first product may not seem too cataclysmic, but if it sets rock-bottom price expectations for all future releases, including ones with true value-added proprietary advantage, you may have inadvertently sunk the ship.
A huge market opportunity provides the basis for growing huge revenues, but also affords startups the latitude to make mistakes, without any single one likely to cripple the company. In today’s hyper competitive markets, when executing in a small sector, even small errors in execution can be fatal.
And finally, being able to articulate a view of a very large market opportunity becomes a competitive advantage in recruiting and retaining talent to a team. Charisma and passion are requisite skills for any successful startup, but world-class entrepreneurs of any genre (engineering, marketing, sales, etc) want to take on big challenges with the potential to change the world and make fortunes along the way. It’s hard enough to compete against incumbents with history and demonstrable momentum. It’s infinitely harder when there are obvious questions about a startup’s “nichiness.”
So as you are forging your plans for world domination, while focus is critical to maintain, keep Everest in your sights.