When a venture capitalist, angel investor, or hedge fund is looking at investing in a company, there are a host of criteria to consider. Who are the founders and what are their backgrounds? What is the size of the market? What is the product? Who will buy it? What is the exit strategy?
Often times, the founding executive team is considered paramount. This is a huge mistake.
Don’t get me wrong, the strength of the team is important. But some venture capitalists get blinded by the star execs that shine so bright. Often times an investment happens solely because the management team has some moderate-level track record and other top tier VCs are interested in the deal. Very little thought is given to the most important piece of the puzzle, the value proposition.
The value prop of a company’s product deserves a lot of attention, and in my opinion, the most attention in any business venture. So much so that if a VC is going to be blinded by anything, it should be the value prop. Why? Because value prop always wins.
Too much attention is given to “A team” vs. “B team” management. If you have an A product, a B team can execute. But if you have a B product or C product, even an A team can’t make it successful. No matter who is selling a bag of shit, it’s still a bag of shit and no one is going to buy it.
A perfect example of value proposition trumping exec team is Google.
In Google’s early days of 1998, Andy Bechtolsheim wrote a $100,000 check to Larry Page and Sergey Brin while they were grad students and before they even had a company name. Top tier VCs followed on the next year in 1999 with a combined investment of $25 million. PC magazine reported in 1998 that Google had an “uncanny knack for returning extremely relevant results” (i.e. value prop). Everyone knows what happened to Google and their market cap is now over $160 billion.
Around the same time in 1999, a company called Inktomi was the back-end search engine component of most major web portals including AOL, Yahoo, and MSN, serving billions of search queries. Along came Google and over the next several years Google displaced Inktomi at all of those portals and became the search engine of choice for millions of people worldwide. How did they do that? Value prop.
Interestingly, when I worked at Inktomi in 1999, none of the management team gave Google a chance. “Google can’t scale” and “we don’t compete with our customers, while Google does” were some of the reasons thrown around (Inktomi didn’t have a consumer facing search page like Google). But the biggest mistake by Inktomi execs in discounting Google was the failure to realize that fundamentally, Google had built a better mousetrap. Google’s search results were better. Not by a little bit, but a lot.
After a bubble market cap of $25 billion in 2000, Inktomi crashed down to earth and by 2002 sold off its remaining search engine assets to Yahoo for a paltry $250 million. Why? Because Inktomi failed to address the issue that their value prop of relevant search results was being outdone by someone else.
Determining a Strong Value Proposition
The reason that many venture capitalists have such a hard time with value proposition is frankly it’s hard to figure out. I feel fortunate that I’ve picked several top early stage companies to work for the last dozen years – going four for four in successful high tech startups.
It takes a good marketing and analytical mind to determine a strong value proposition. There are several things that need to be considered when figuring out what to build, who will pay for it, and what value it truly brings to the customer. One of the reasons that VCs fail to understand the value proposition is they usually outsource this task through due diligence. VCs rely on industry “experts”, often entrepreneurs in residence (EIR) or someone they know, to tell them if the company is building something valuable. A problem with some EIRs and other “experts” is that many are one hit wonders that got lucky with a single entrepreneurial company and then jumped ship to the venture side. If an entrepreneur sold his company in 1999 or 2000 when companies were being bought for a 100x multiple of the number of free sodas they had in the fridge, that entrepreneur’s expertise might be suspect.
In my next blog post, I’ll talk about how you can confidently unearth a strong value prop.
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