A very interesting post by Chris Dixon (the product lens) which was picked up by Nic Brisbourne has helped to show that there is more than one way to look at investments in early stage start ups – not only through a finance lens but also through a product lens. (Brisbourne argues that we should use both lenses).
Dixon states that we can use, for instance, the product lens to see that enterprise software is below the quality of consumer software and therefore, due an upgrade. This creates opportunities for new products.
Oddly, I would call this a market lens – especially when I read the frustrated comments of the users in the comments below Dixon’s article who talk about some of the poor quality software they have had to endure, until they began their own startup…
It seems to me that the notion of product here is wrapped up with what the market thinks, or how the market is behaving, or how the market is changing. That is clearly a good way to look at product – only I don’t believe most entrepreneurs see it that way. Or perhaps this is a good distinction between successful entrepreneurs who do and those who are less successful who don’t consider the market adoption of their ideas.
Dixon is writing to balance the recent tendency to see things from the finance perspective – ie. consumer internet companies deliver weaker returns than enterprise companies, therefore avoid. He also uses this discussion to point out that the flood of cash into mobile tech may be dangerously misplaced.
However, there is at least a third lens, and that is the lens of the management team.
Angel investors, however, are slightly paradoxical about management teams. If you ask them outright, is the management team the most important factor, they will almost certainly say yes. Yet, if you suggest they invest in an A team with a B product, they tend to behave differently.
Possibly, we believe that the explanation of an A team holding a B product doesn’t hold water any longer, now that tech products can be iterated on a weekly basis and without costing a fortune. I believe the reality is that we don’t know if the product is A or B or C+ or A-, because, the product will have to develop and get better every week if it is going to thrive. For example, Facebook now isn’t the Facebook of 9 years ago. Does it make sense to think of the original Facebook software as an A class product compared to today’s A class product? Not really.
However, it seems too often that business angels use the product lens as a way of assessing the management team – if the product looks good, the management team that built it, must be good too. Hence, they don’t actually separately assess the management team but see the management team through the product lens too.
I think this is a mistake.
For instance, VCs and experienced business angels will follow a management team for a number of months to see how they perform and how they get on. They will watch how well they communicate with each other, with investors and also potential customers.
They also know that it is common to find a super-expert tech person who is critical to product delivery, but has little idea, for instance, of how to attract future talent into a growing business (without paying a fortune in wages or commission to recruitment consultants).
So, to help, here are 3 different levels of importance that investors might attach to the management team, with different consequences.
1. Cope with success. Assuming this product succeeds, will the management team be able to cope?
2. Act on insight. Assuming this product doesn’t succeed as expected, but shows some interesting insights and potential, will this team be able to spot the insights, ignore the noise/ distractions and take the necessary action (make sales, cut back, pivot etc).
3. Fail well. Assuming that the product fails, will this management team be able to create something of value that can be used in the next stage? In other words, can they fail well*?
Now, depending on your appetite for risk, the business angel or VC can choose to stop at 1 “Cope with Success” – and place the least demand on the management team – by assuming that the product is so good, it really can’t fail, but ask ‘can the management team handle the success’?
Now, this might be less risky if the product is already generating sales and rapid sales growth. It would be an absolute gamble to assume this level of product confidence if the business was pre-revenue and you might do better at the casino.
Equally, the reason that many business angels and VC investors look for entrepreneurs who have built a business before (some prefer those that failed well and some those that exited well) and can “Fail Well” is because they recognise the intrinsic risk that the business will fail. They would rather an entrepreneur who shut down a poor idea (after it was released into the market place, of course) quickly than someone who drew in further money only for it to be wasted.
Hence, the ideal for investors has to be to find management teams operating at the toughest level – and who can fail well. And this is true even if the product looks great and the market conditions seem perfectly aligned and the finance is correct.
This need for the alignment of three key factors is a good explanation of why many ‘great ideas’ don’t get funding. A good idea may have aligned only one of the three key factors.
* by the way, ‘failing well’ is not an excuse for laziness or not testing the business to destruction.