Yesterday I answered a question on Quora concerning VC attention in the wake of endless meetings. My post Many ideas + few vcs = :-( was my response.
However, a participant in the discussion wrote a comment that was cynical about the venture selection process, partly due to lack of domain knowledge and partly due to the impact of “social proof.” The example for lack of depth of knowledge and in thought was the following:
If I went to a VC and showed them a technology that used key-value stores and novel caching mechanisms to speed up SPARQL queries on large RDF data sets by 10,000x, and then showed them a graph of the revenue growth of comparable semantic web infrastructure companies; what would the VC take away from that? If you are lucky, he will remember “they make something go faster,” and “other companies in this market are growing at 30 per cent a year.”
My answer is below.
You raise an interesting point about the value of domain specificity (versus the generalist approach) to venture investing. You have a healthy cynicism and I’m sure it’s well-founded based upon your experience. In my fund, for instance, we are laser-focused on big data tools, technologies and applications. If you came to us with an idea that involved the technical depth you jokingly referred to above, it would be screened by my colleague Brad, who has his Ph.D in EE, signal processing and machine learning, worked at Lockheed and Microsoft, and was Craig Mundie’s technical adviser for six years. Would he be able to assess the potential impact of your idea? He would certainly understand the approach; whether he made the go/no go decision you would like is another matter entirely, but his domain expertise would render understanding a non-issue. This is one of the reasons why I think domain knowledge in venture investing is really important.
However, it is also incumbent upon the entrepreneur to choose the right VCs to target and to leverage their networks to get the warm introduction you mentioned above. And make no mistake, I agree with you that the warm introduction likely improves a VC’s receptivity to a pitch by 100 times. But if an entrepreneur can’t figure out a way to get to me or one of my colleagues then they’re not trying very hard, and these people don’t possess the kind of persistence and determination I am looking for in an entrepreneur. You might think this is stupid; I don’t. It’s simply reality. This is very different, however, then the “follow the herd” mentality of social proof to which I believe you are referring. I’ve routinely done deals that many have thought were less attractive because I’ve believed in the entrepreneurs an the idea. This is also something you should be validating when you approach a potential investor. Have they led stuff? Do they have the courage of their convictions?
As to your final point, we listen to lots of pitches from companies, most of which we won’t invest in, because it’s our job: it’s fun; it’s stimulating; and it makes us better at picking the right companies and helping those companies to our fullest ability. True dat.
The commenter goes on to discuss the seeming randomness of the venture investment process and the apparent meaninglessness of meetings:
VCs are not domain experts. They are not qualified to critique the content of your pitch and evaluate the economic potential of your technology or business model. Even the top tier and exceptionally experienced VCs are often surprised at the success or failure of their portfolio companies; companies they believed were sure bets are often lackluster and near write-offs — like Cisco — turned out to be a goldmine.
When making an investment decision, a VC must integrate information from a very large number of very fuzzy factors, each of which has little predictive validity. Hopefully in aggregate these factors will result in a better-than-random investment decision.
Overall, I think pitches and communications outside of the boardroom are used as a screening mechanism, as a formalized way for a venture capitalist to evaluate you and your company against his internal factor model.
The material content of your pitch is almost irrelevant. I have no idea what most venture capitalists would gain from attentively listening to pitches instead of playing with their Blackberries.
There are some bold statements in this comment. VCs are not domain experts? Really? Hmmm…There are those who are not, though I know many who are. Whether a VC is a domain expert or not has little bearing on whether or not one is surprised by outcomes: EVERY venture investor has surprises on the upside and the downside, and myriad factors well beyond domain knowledge impact the success or failure of a business. HOWEVER, I’d argue that domain expertise helps mitigate randomness, but is not in and of itself the determining factor in venture outcomes. But it is certainly an important piece of the puzzle in my experience. Finally, I’d agree that pitch materials are of limited value, but are far from irrelevant. They help the investor understand the entrepreneur’s passion, vision and current thought process. I have worked with founders on establishing plans that are markedly different from those they came in with, because they had the domain knowledge and fertile mind to recognise a potentially better approach to addressing a market need. Other times the pitch was pretty much the business that got built, and with great success. Like everything in the venture business, and as noted in the comment above, venture investors go through an implicit factor analysis of which the pitch is a part. But on a stand-alone basis it is of limited value.
Bottom line, I’ve found that domain expertise has added a lot to our portfolio companies and has played a role in de-risking seed stage investments. I believe our entrepreneurs would agree. Perhaps there are those whose generalist knowledge is so vast and powerful that they can overcome gaps in domain expertise, and that they are comfortable subbing out this part of the due diligence process, but I don’t roll that way.
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