What to Look for When You’re Looking (at Startups)
Notes from a consumer VC scout
Welcome to the ninth edition of Black Box. Last time, I explored the phenomenon of first-best and second-best. This time, I explain some of the things I think about when evaluating consumer startups.
Lately I’ve gotten a couple questions on what being a venture scout is like and what I look for. The former is not terribly exciting, but I have specific thoughts on the latter. I’m sharing them here in case they can be helpful to founders or people interested in joining startups. After all, those who work at startups are investing something more valuable than money: themselves.
A few notes:
This overview is not comprehensive — for example, it excludes market size. Rather, it highlights the least common questions that have proven to be the most valuable for me.
I focus on early stage consumer internet, media, and social companies, but these questions can apply to any startup.
The views in this article are my own and do not represent those of Grishin Robotics or the other VCs I scout for.
Company Considerations
I call these company considerations, but consumer startups are effectively the product or service that they offer. For simplicity, I’ll refer to both as product.
Is this a product or a feature? Consumer products are all about how often users complete what Benchmark partner Sarah Tavel calls the core action:
What is a core action? The action that is the very foundation and essence of your product. Pinterest would not exist without pinning. Twitter would not exist without tweeting. What’s YouTube if people didn’t upload videos? True networks like Facebook and LinkedIn would not exist if their users weren’t friending or connecting.
Core action completion is an extraordinary heuristic because it encapsulates value proposition, product-market fit, and growth potential. (Key metrics like conversion, retention, and purchase frequency are simply quantifications of this idea.) Only the startups with high core action completion growth can be properly called products as they can drive their own success. Companies with lower core action completion growth are features that will eventually need to be combined with products to survive1. Their add-on value makes them great acquisitions and they can still produce respectable returns, but features do not have the potential to become outsized successes like products.
What do users think about the product? It sounds obvious, but prospective investors and employees need to understand what users think of the product; they should ideally try it themselves. In practice, this means App Store ratings and Reddit reviews2, not award lists and vanity metrics. After all, most people don’t use a product because a publication names it a top 20 something or the founder has 20 thousand Twitter followers. People use it because the product does something valuable for them and they enjoy using it.
This doesn’t mean the product has to be perfect — in fact, it shouldn’t be given competing priorities and limited resources. But it cannot compromise on core functions, or functions necessary for users to complete the core action. Some of these are obvious; imagine if the uploading process on Youtube kept failing. But some core functions are overlooked precisely because they are not directly tied to the core action. For example, a consumer app should not take too long to load because users expect apps to display immediately. Such core functions are arguably more important because they are table stakes.
How hard is it to clone the product? This flavor of the competitor question is especially relevant to consumer startups because infrastructure companies have significantly lowered the barriers to entry across the sector. Any sign of success will draw competitors like fresh blood to sharks, and the copycats will eat up the market share and margin that the original had. This is easiest to see in the e-commerce space with DTC companies:
The trick to defending against this is realizing that the moat for most consumer companies is cultural, not technical. I think this is because most consumer tech is not advanced enough to be a differentiator; the compressibility of a Casper mattress comes to mind. Even if this were not the case, companies that build brands and communities are inherently more resistant to competitors because there are no shortcuts for doing that kind of work. This is why many consumer startups are pseudo-media companies like Glossier3.
Founder Factors
The other critical thing to evaluate is the founder. They determine the culture and values of the company and serve as its public face, yet often face minimal accountability4. It is therefore important that the driver seat is filled by the right person from the very beginning — or at least, not by clearly the wrong person.
What type of founder is this? By this question, I mean what kind of a person is the founder? I believe there are three types:
Charismatic founders are characterized by their sales ability and political savvy. They are often very good at fundraising, but their actual job within the company may be less defined. Adam Neumann of WeWork is a typical charismatic founder.
Eccentric founders are marked by their contrarian thinking and behavior. They are often controversial but tend to be very involved in the company. The canonical example of an eccentric founder is Elon Musk.
Normal founders are everyone else. The majority of founders are normal.
People are complex and founders especially so, but in general I think eccentric founders are preferable to charismatic founders because eccentric founders can and do put in the work. Charismatic founders can delay the inevitable thanks to their gift of the gab, but at the end of the day their companies must perform to continue raising capital and win.
How does the founder take feedback? An investor once told me that one of the harder lessons he learned was not even boards can make founders do things they do not want to do. To be clear, sometimes founders must have conviction and insist on their way, but this should not be every time. Even if they choose to override their team, they should hear out and consider other perspectives5.
Is the founder financially aligned? That founders are incentivized to make their startups successful should be a no-brainer, but this is not in fact the case sometimes. While a founder needing to cash out some shares to pay for living expenses is understandable, an early to growth stage founder should not have a house in Tahoe or dial into meetings from country clubs. Conversely, how is the founder spending company money? In particular, if an expense is labeled an investment, who benefits? Theranos situations are rare but undisciplined spending is problematic nonetheless.
I hope this has been useful food for thought. Happy searching, everyone! ∎
What do you look for when you’re looking at startups? Let me know @jwang_18. See you in two weeks!
Even if acquisition is the goal, feature startups are worse investments and places to work because they need to grow quickly enough to be attractive targets yet not so fast that they run out of headroom. This balance is tricky.
Indeed, building an audience around content is such an effective moat that other sectors have adopted it. The classic example is Hubspot articles.
This is an open secret. Internally, the founder has significantly more shares and therefore power than anyone else. The board may have the power, but they are not exactly incentivized to do anything. How would punishing or removing a founder they invested in look externally?
Those interested in working at startups should be especially careful not to join a company with a despotic founder as this will weigh heavily on how empowered people are.
Very well said, Jiarui!