The acknowledged power law in VC suggests that only one in ten venture funded startups will achieve the 10x return profile we seek. It may sound like a cliché, but in venture capital, it’s all about the people.
The success or death of most startups, especially in the early stages, almost always comes down to the people at the helm. Can the founders execute? Can they adapt to market conditions, sell, hire a strong team, and get along with each other? As an investor, can we form a good working relationship with them for 5 to 10+ years?
The attributes of great founders (and how to find them in unlikely places) was the focus of a recent investor education panel I joined for the Wade Institute of Entrepreneurship’s VC Catalyst.
Whilst the investors on the panel each held their own investment mandate, we agreed that for investors in seed and series A deals in particular, our primary role is to assess the founding team for the “X Factor” – that we think will give them the best shot at success.
The Times, They are A-Changin’
Founder ‘X Factor’ is particularly complex in the current market. Much of what made the prior generation of VCs successful was a close-knit group of referrals from people who had known each other for years. In those days, a small, insular group of investors were only looking at a small, insular group of founders.
VC used to be the Silicon Valley old (white) boys club. This unequivocally worked, despite excluding large parts of the entrepreneurial and investor ecosystem.
The next generation of VC and investors is changing for the better by expanding both geographically and demographically. A more diverse next generation of investors means a more diverse pool of founders.
It is worth re-emphasizing to this new breed of VCs that venture capital is ultimately a people business.
Pattern Recognition
Everyone thinks they are good at assessing people. The bread and butter of VCs is “gut” or “pattern recognition,” but this only happens when you’ve had the volume of deal flow, wins and hard losses to develop that gut instinct and recognition of patterns.
Pattern recognition takes time, which for a new investor might mean placing bets on at least 30 companies, which could means evaluating at least 600 companies.
Over time new investors can develop the right people assessment skills to be successful as they adopt an analytical approach to understanding the trends and build out their track record.
A Note on Bias
Pattern recognition is also a complicated double-edged sword in the venture world. After many years in the business, most successful investors also develop a strong sense of pattern recognition for founders that have been successful in the past.
Unfortunately, this has mostly been young, white, Ivy League educated men, who coincidentally look like younger versions of the historical generation of investors themselves.
Most people tend to like people who are similar to themselves and are less likely to invest in people who are very different.
To combat this, investors need to constantly evaluate our own patterns to understand when and if there is bias, thus making sure that there is diversity in the overall pipeline so that new patterns begin to emerge.
This is why it is also extremely helpful to work with partners who come from different backgrounds, networks and perspectives than our own, so we can push each other to acknowledge our own biases.
Table Stakes: the baseline essentials
It should go without saying that there are critical factors beyond the founding team when it comes to making an investment.
Most commonly we look for the 6Ts: In addition to team, the company must have strong technology, traction in terms of users or revenue, a large total addressable market, fit into trends that are aligned with our investment thesis and have clean, on-market terms.
A strong team does not make up for the omission of one of these key factors, but the right people should be able to demonstrate that they can navigate any perceived weaknesses in the other key areas.
A “no a$$hole” policy is an increasingly common and positive change that has followed the “me too” movement.
With the movement’s origins in the VC world with Binary Capital and high-profile founder exits from companies such as Uber, the best VCs today won’t touch a deal when a founder is notoriously difficult or has a track record of harassment or abuse.
Know Yourself, Know Your Founders
What “good people” means is obviously subjective. If there was a single way to assess the quality of founders, then there would be no need for multiple venture funds! This is where investors can differentiate themselves and be successful…or fail.
VCs must take a hard look at their own values for what they believe to be important qualities for founders, then put that thesis to the test by allocating capital to match their stated strategy and founder profile.
For example, I personally look for founders who are intellectually curious, have a bias toward action and learn quickly from their mistakes (and successes), and are smart but not from traditional ‘Ivy League’ backgrounds so that they are motivated to prove themselves.
I also gravitate to those who thrive on operating in the ‘boring’ spaces within enterprise software.
Each investor has to determine his or her own view of the world to understand what they consider to be essential elements or Founder ‘X Factor’.
There is no right answer when it comes to investing in startups, but investors have a better chance of achieving outsized returns if we start with the people. The proof is in the results, but when results can take 5+ years to materialise, it’s definitely a long game.
I look forward to the new generation of investors breaking the old “pattern recognition” trends and developing new and more diverse patterns for what a successful founder looks like.
Jules Miller is an investor, 3-time entrepreneur and ‘intrapreneur.’ She runs the IBM Blockchain Accelerator and was GM of the IBM Blockchain Garage for North America. She is also co-founder and managing partner of Prose Ventures, the first independent VC fund investing legal and compliance technologies.
Jules co-founded and led two legal tech companies: Evolve Law (acquired by Breaking Media/Above the Law), a media and events company for legal innovators, and Hire an Esquire, a venture-backed tech startup providing attorneys on-demand to law firms and in-house legal teams. She also co-founded Carbonado Group, an environmental sustainability consulting firm, and spent 7 years as an ‘intrapreneur’ helping companies including EY, Salesforce.com and Tiffany & Co. to launch and grow new business units around environmental and social responsibility.
