Ever since I started working in venture six years ago, I’ve been thinking about what the ideal investment framework and founder profile is. I’ve read countless blogs, listened to countless podcasts, backtested various formulations on our portfolio companies - and in general, ruminated on this a lot. Interestingly, after all this introspection and analysis, I have settled on a straightforward framework (that is specific to the seed stage).
B2B seed investment framework
The problem being solved is a “screaming market need”
The proposed solution is underpinned by a unique insight
The team is well-structured and has the execution skills to get from 0 to 1 (or seed to A)
I also consider a bunch of other factors (like market tailwinds, the founders’ storytelling abilities, the potential moats of the business and the unit economics), but these are secondary considerations. More detail on each criteria below.
1) Screaming market need
Screaming market need simply means there is a burning problem to be solved for customers. This is best assessed through customer calls (or if you already have knowledge of a market). Certain categories are also better suited to demonstrating screaming market needs - namely, one where there is an offline/antiquated solution that currently exists and already proves the need.
It may sound like an obvious criteria, but I believe that many investors gloss over the magnitude of the problem being solved, and instead gravitate towards solutions they want to see exist or that look cool. An example of something that I wouldn’t consider a screaming market need is investing in crypto infrastructure, on the basis that once (if) crypto demand exists, the infrastructure will be an important base layer.
Some examples of screaming market needs from our portfolio:
- Sucasa — Sucasa provides high income Australians with zero downpayment home loans. If you learn about the market, the need becomes obvious: the median house price in Australia is >$1M, house prices have been growing for the last 40 years, there is a structural undersupply of houses, there is a 20% downpayment requirement (i.e. $200K in savings for a $1M home), 40% of the market uses an expensive insurance product because they cannot afford the downpayment, and banks have regulatory prohibitions from lending you the downpayment.
- Freemodel — Freemodel is a pre-sale home renovation marketplace. They renovate homes before they are sold to maximize the sale price, yielding a better commission for agents and a higher sales price for homeowners. This may sound like an obvious win-win, but homeowners typically do not want to spend money before selling their house. Freemodel has an innovative funding solution where they front the cost of the renovation. They also have a managed marketplace of interior designers, who understand exactly what kinds of renovations generate the highest uplift in certain neighborhoods.
Existing market structures are the way they are for a reason, even if they may look silly or convoluted to the outside (e.g. US healthcare). This is why I prioritize the insight so highly: without it, the founder has a very low chance of disrupting the status quo and the entrenched incentive structure. Insight gives you a better chance of succeeding. The founder needs to demonstrate why a certain assumption is misunderstood by the market and thus why a certain wedge product will resonate. Often times the insight is only observable to someone who has been involved in the industry, or had personal experience with the problem.
Some examples of insights:
- Streetfair — Streetfair is a local services marketplace for neighbors to find and hire service providers (e.g. gutter cleaning). The platform allows homeowners to join existing jobs in the neighborhood, getting them a group discount, and giving the service provider increased route density in a region. The insight here was that in comparison to existing options like Thumbtack and Angie’s List - which make the homeowner do all the research and outreach - homeowners actually trust their neighbors for service pro recommendations. This is evidenced by 25% of the comments in Nextdoor community groups being neighbor-led service pro recommendations.
- Statusphere — Statusphere is an influencer marketing platform that connects brands with micro influencers. Statusphere’s insight was twofold: firstly, with the iOS 14.5 updates, advertising on Facebook became significantly less effective and more expensive - and marketers began directing more dollars towards influencer marketing as a category. Secondly, the founder - through her previous experience at a marketing agency - realized that in contrast to macro influencers (e.g. Kylie Jenner) who are perceived as inauthentic, micro influencers actually have more influence on buying decisions.
Execution is a fuzzy and often backwards-looking word, but is the most important trait I want to see in a founding team. Execution is a proxy phrase for “an ability to get from 0 to 1.” A key truth in startups is that a consistent bias towards action coupled with good decision-making trumps nearly everything. And this is a rare skill.
In order to gauge a team’s execution skills, I first assess the team. I like to see:
A well-balanced team(e.g. one cofounder that sells, another that builds) that is appropriate for the market (i.e. founder-market fit)
A team that knows what best-in-class looks like(e.g. through previous founding experience, or work experience at a breakout company, like Uber or Stripe)
A team that will be able to attract talent- as Vinod Khosla says, the team you build is the company you build.
Customer centricity- a team that has a deep understanding of their customers and knows how to turn customer feedback into product
At that point, I assess their execution skills:
A fast shipping cadence— I look for a technical co-founder or early hire because without this person, shipping cadence is hard to maintain
Seeing what they have built or done so far, and their speed of iteration— teams with a bias to releasing quickly and fast iterations are ideal
Execution can be hard to explain, but easier to see in action. For example:
- Kyte — Kyte is a door-to-door car rental company in our portfolio. When my partner Ramy was assessing the company at the pre-seed stage, he used the app to order a car. The app experience worked smoothly and the car was magically delivered to his doorstep. It’s clear that the team had execution skills in spades, as even at the pre-seed stage, they were able to develop both software and handle the operational complexities (e.g. acquiring fleet supply and coordinating their delivery)
There are various other factors I consider when making an investment, but they are secondary to the ones above. Listing them below:
- Market tailwinds — like Elad Gil, I also believe that markets can trump teams i.e. that a great market can make even a middling team successful. Where I can uncover signs of market pull, I certainly lean in - but often this can be quite difficult to uncover at the time of investing
- Storytelling — many investors place a premium on a founder’s ability to tell a compelling story. This is useful to attract investors and future employees. Nevertheless, I would rather invest in a founder with stronger execution than speaking skills, because I believe storytelling (in some cases) can be improved upon or coached - whereas execution skills are much rarer
- Moats — similarly, many investors like to talk about moats i.e. competitive advantages. I tend to discount these at the time of investing primarily because they are often theoretical for seed stage companies. It’s true that moats like network effects are important for sustained long-term profitability, but I think most investors overstate the frequency and power of network effects. I look for the potential for network effects (amongst others), but I believe that most software is replicable, and thus the key moats you build are through execution - doing hard things over and over again.
- Unit economics — these are important to consider, but I don’t anchor too heavily on them at the seed stage (although it’s essential they are never upside down). It’s more important to me that you are solving a meaningful problem with an inventive solution and are able to successfully put the product in the hands of customers
- What the product looks like today — I tend to consider what the product looks like today for the purposes of judging the founders’ execution skills, rather than anchoring too much into its current format
- Market size — many VCs completely eschew market size estimations because of how often generational companies have proven them wrong (by orders of magnitude). The real lesson here is that market sizing is near impossible for businesses that are inventing new categories. What’s more important is to solve a real problem upfront, and have some adjacent areas that you can expand into from there. This has been the playbook for breakout companies like Uber and Faire.