Why don't venture capitalists care about your startup's product?
Challenging the founder-centric investment thesis.
Why don't venture capitalists care about your startup's product?
“We invest in founders, not products or ideas.”
-Almost any venture capital general partner
I thought capitalism worked like a roadside lemonade stand; you made something cool and delicious, and thirsty cyclists threw money at you from the backs of their bikes. (I buy a lot of roadside lemonade.)
Ask and capitalists proclaim the point of capitalism is to control the means of production, pay employees minimally to build a product, and insist customers pay maximally to buy it. Market needs, supply and demand, competition, and plucky entrepreneurship determine your success and profitability.
I understand the entire venture in terms of products because the things I value, bicycles and surfboards, are tangibly valuable. Professionally, such product-centricity translates roughly to ‘builder/maker’ and led me to product management’s gentle embrace.
For me, the point of any software business is to build products.
Unfortunately, not everyone sees the software business this way.
Venture capital is weird.
I am sitting in a conference room on Sand Hill Road when the venture capitalist we meet with says, “We don’t actually care if you build a product; we just invest in founders who know how to make money.”
I’m paraphrasing.
But I heard this sentiment repeated by various venture fund general partners dozens of times.
The meeting started eight minutes late because venture capital GPs are catastrophically busy, and Silicon Valley is a sprint to a receding horizon.
We rushed through our company’s business optics, keeping the details VERY high level based on prior coaching that this particular investor didn’t prefer, you know, details. Identified customer need? Check. A path to share of wallet? Check. A kickass team? Roger that.
And then, it was my turn to talk about the product. I had a slide, a screenshot, and forty-five seconds.
While I talked, the GP looked at his reflection in the conference room window, and I suddenly understood how my wife feels when she talks to me while I am brushing my teeth, the electric toothbrush rendering me deaf and unable to respond even if I could hear.
I wondered how he could accurately evaluate the business opportunity while displaying total disinterest in the product we’d built to support that opportunity. He didn’t ask questions about the product, forcing a simple deduction that what bits he’d listened to sailed over his head.
Many meetings later, I considered altering the product pitch to talk about dump trucks instead of our software. I wondered if anyone would notice. I longed for the hilarity of leaving the room puzzling over whether I was talking about real dump trucks or toy Tonka trucks and asking in serious tones whether we’d considered the difference in our go-to-market motions. Because, hey, a dump truck is a dump truck, right?
Instead, I drove home from those meetings stuck on a single thought: why don’t these guys care about my product?
The practical implications of a founder-driven investment thesis
The logic behind the founder-driven investment thesis is flawed. The train of thought goes something like this. The team is the most important factor because a good team can turn even a bad idea or mediocre product into something extraordinary. A bad team, on the other hand, can fuck up even brilliant ideas and amazing products. What makes a founding team good or bad, or an idea brilliant or lame, is somewhat subjective, and the science behind the assertion resists scrutiny.
Silicon Valley loves serial entrepreneurs. VCs regularly invest in founders because they’ve previously raised venture money. It doesn’t seem to matter if the previous venture succeeded or not. Silicon Valley also loves aphorisms like, “The road to success is paved with failure” and “I love failure, as long as I ain’t payin' for it.”
The predominating model favors founders over products, which might be more palatable if we could count on GPs and their limited partners to do proper due diligence. Over the last few years, however, proper due diligence has been hard to come by.
During the pandemic funding blitz, firms like Tiger Global Management and Coatue Management pushed the envelope, preferring stupid valuations and three-day deals over considered investments backed by deep analysis.
This quote from an investigation by The Information sums up the situation nicely:
“Spurred by a record $128 billion into VC funds, investors moved to win founders with fast decisions and high prices. To get the deals done, they spent less time scrutinizing companies and sometimes didn’t perform due diligence until after making the investment.”
VCs notoriously pattern match. A writer for Venture Capital Journal quoted a venture industry analyst who had this to say:
“For better or for worse, a very common practice in venture capital is trusting another firm’s due diligence,” he adds. “Say that Sequoia is invested in a company. Some firms take that as a stamp of approval and invest without doing their own due diligence. That’s obviously a huge problem and can lead to situations like we’ve seen with FTX.”
Speaking of FTX.
When venture firms rely on founder-driven investment and weak due diligence, you get this band of happy idiots.
It’s not funny and isn’t a joke. This collection of frauds, incompetent lunatics, and liars raised billions of dollars.
We aren’t supposed to judge a book by its cover, but on first impressions alone, I wouldn’t trust Sam Bankman-Fried to park my car. We are learning how clueless and criminally minded he is through current court proceedings. It strains credulity to believe investors deployed an effective due diligence process during any of these transactions.
Even after Hulu and Apple TV blew the lid off the magnitude of Adam Neumann’s crackpot-ery, Andreessen Horowitz still gave him another $350M for a company even Neumann can’t explain.
These episodes make it hard to take investors seriously when they say things like this:
“2022 has certainly seen the big return of due diligence,” said Matt Turck, a partner at FirstMark Capital. “Frankly, it’s been really refreshing.”
To hear them tell it, investors probably believe the lack of due diligence was some external factor out of their control, almost as if someone had done this to them.
Is there a solution?
Of course! Artificial intelligence will solve this problem.
Just kidding.
Most founders/operators I know describe fundraising roadshows and board meetings as heavily focused on their company’s go-to-market with very little attention paid to the product.
The product-minded among us believe the right thing to do is keep our heads down and build better products.
Spend time differentiating your product’s function from its purpose. Use that to understand your product’s actual value and build a go-to-market model around that value. Don’t succumb to the pressure or temptation to invert the approach by inventing a go-to-market, scramble together a so-called MVP, and hope you’ll hit your GP’s investment multiple targets.
Let your product be the vehicle for “returning the value of the fund,” and make the go-to-market a means to an end.
Resources
Sorry, these are all paid.
https://www.venturecapitaljournal.com/ftx-fallout-vcs-renew-focus-on-due-diligence/
https://www.theinformation.com/articles/vc-due-diligence-returns-with-a-vengeance?rc=zqelgh
And this one, well…sorry about the next 53 minutes.
Disrupting the World's Largest Asset Class with Adam Neumann
This article provides a perspective for how and why venture capital makes funding decisions with tech startups. I enjoyed the read because it helped me to better understand real-life examples that previously made no sense to me. Thanks for the insight, Eric.