Investing in startups with unproven technology can be both exciting and risky. You might be tempted by the potential of a breakthrough innovation, but also aware of the uncertainty and challenges that come with it. How can you make smart decisions and maximize your returns in this scenario? Here are some strategies that can help you as a venture capitalist.
The first and most important factor to consider when investing in startups with unproven technology is the quality and fit of the team. You want to look for founders who have relevant domain expertise, technical skills, and entrepreneurial experience. They should also have a clear vision, a strong passion, and a realistic roadmap for their product. You can assess the team by checking their background, references, and previous achievements, as well as by conducting interviews, surveys, and due diligence.
This is probably one of the toughest parts of any investment decision. The key things I would recommend to focus on: 1. The founders' understanding and experience with the market they are addressing. Dive deep to see if they can articulate the end users/clients problem and evidence it as well as their own insights that no one else sees in this market. 2. How obsessed are they in solving the problem, Obsession with the problem indicates potential for long term grit and open mindedness to adjust the solution based on market feedback. Many founders are in love with their own solution VS users problem. 3. How self aware are they. Will indicate on their own personal ability to grow and evolve in extreme conditions as a team and or founder
First off, check out the people behind the tech - a solid team can make or break it. Look for experience, not just in tech but also in understanding the market they're diving into. If they've weathered storms together, that's a good sign. Dig into their track record, and see if they've tackled challenges before. And hey, if they're passionate and committed, that counts for a lot. Trust your gut on whether you'd want to go to battle with these folks.
The second strategy is to validate the market opportunity and demand for the startup's technology. You need to understand the problem that the startup is trying to solve, the size and growth of the potential customer base, and the competitive landscape. You also need to evaluate the value proposition, the differentiation, and the pricing of the startup's solution. You can validate the market by conducting market research, customer interviews, surveys, and experiments.
In my experience market validation and size of TAM, although important in places is the biggest reason why VC firms miss big outcomes. If you look at the history in the last 10 years of great venture investments, Airbnb, Uber, etc all of them would have been declined on the basis of market analysis at the early stage. VCs need to focus on the people rather than the markets
Would agree on that @reece but at the same time it is not only people it is the vision those people bring to the table and their ability to articulate that vision
Well said @priya. I would simply add that anyone can pull at the treads of a tapestry, but few can weave it in the first place. So for all the startups looking for the right capital partner, "no" doesn't necessarily mean no, it just means not me or not now. Simply move on to the next.
The third strategy is to test the feasibility and scalability of the startup's technology. You need to verify that the technology works as intended, that it meets the customer's needs and expectations, and that it can be deployed and scaled efficiently and cost-effectively. You also need to identify and mitigate the technical risks, challenges, and barriers that the startup might face. You can test the technology by reviewing the product documentation, code, and prototypes, as well as by conducting demos, pilots, and trials.
Before testing the technology, one should validate whether the product is needed or valuable. This is different than validating the market. So often I see companies hire consultants who will say there is a market... sure, we can find a market for almost anything... but is there a real problem? Does the technology solve the real problem? Is this technology something that changes lives, affects quality of life outcomes, or is it required (basic needs like transportation, electric, energy, oil, etc)? If the product is needed and changes the mark of how we see things today, the users will purchase... and they will take the risk by buying and testing the technology.
This one is funny for me, since 99% of investors are non technical and can't understand the tech stack/code. Unless it's a Deeptech startup I would not recommend going into the technical solution and even then only if you have the money to bring an external expert. You don't invest in the "how specifically they solve the problem" the code and product will change and adapt many times over the next 5-10 years. It's most likely the initial product is a half bake semi manual solution so not sure if you can and should assess it. That's why DDing the founders and talking to customers matters so much.
Some other strategies: - Intellectual property (IP) protection: Assess the startup's IP strategy/ patents. This can provide a competitive advantage and increase the barriers to entry for potential competitors. -Competitive landscape: Evaluate the competitive landscape to understand if there are any existing or emerging competitors with similar technologies. -Legal considerations: Understand any regulatory or legal challenges that the startup may face due to the nature of their technology. Evaluate the potential impact of these challenges on the startup's ability to operate and scale. - Exit opportunities:Look at the track record of acquisitions or initial public offerings (IPOs) in the industry to gauge the potential for a successful exit.
Apart from making sure that you have something that will address a problem, you have to ensure that your costs will be lower than the price you will be able to command: i.e. is it feasible?
The fourth strategy is to align the incentives and expectations of both parties. You need to negotiate a fair and reasonable valuation, term sheet, and deal structure that reflect the stage, potential, and risk of the startup. You also need to establish a clear and transparent communication, reporting, and feedback mechanism that fosters trust and collaboration. You also need to provide strategic guidance, mentorship, and support to the startup, as well as to leverage your network, resources, and expertise to help them grow.
The fifth strategy is to diversify your portfolio and spread your risk across multiple startups with unproven technology. You need to balance your investments between different sectors, stages, geographies, and models. You also need to monitor your portfolio performance, track your key metrics, and adjust your strategy accordingly. You also need to be prepared to exit or write off your investments if they fail to deliver the expected results or encounter insurmountable obstacles.
Roughly 2% of startups become successful outliers, given this… that’s means 98% of startups don’t produce VC like outcomes. But some of the best outcomes are from companies that were solving complex, unmet needs in areas with unproven technologies. It’s important to invest in these areas, the tails or edges, but to do that in a risk adjusted manner. Diversifying the portfolio across sectors and enough companies can allow you to capture the upside of a winner but protect the downside of the portfolio.
The sixth and final strategy is to learn from the outcomes of your investments, whether they are successful or not. You need to analyze the data, feedback, and lessons that you collect from each startup. You also need to reflect on your own decisions, assumptions, and biases. You also need to share your insights, best practices, and recommendations with other investors, entrepreneurs, and stakeholders. You also need to continuously improve your skills, knowledge, and network as a venture capitalist.
It’s important to analyse the big misses retrospectively & try to ascertain what questions could have been asked to have changed the decision. Mike Maples at Floodgate has developed a great framework for this process (after passing on AirBnB!). As ex-Benchmark partner Bill Gurley said in an interview: “There's a great reality in venture: you can only lose 1x your money. And in a case like Google, you make 10,000x your money. That asymmetric result means you have to bias towards positive in a situation like that. It’s easy to get into a trap in venture where getting a no right feels like a win. Getting overly jazzed about correctly identifying a no, it’s not that big a deal. It’s not the job. The job is to find the outliers.” ??
I take this from the perspective of having worked at several startups (and loved it). What’s the TAM? Is the go to market plan well defined? Does the leadership understand the “buyer brain” - and is willing to market from the perspective of the buyer (rather lead with the tech advantages)? Another area that I dig into: what other exits has the leadership team had - successful or not?
(a) Encourage or require the development of a proof of concept or prototype to demonstrate the feasibility & potential of the technology before committing significant capital. For an investment in a medical device startup, we stipulated an initial seed investment that was specifically earmarked for developing a working prototype, which later served as a critical tool for securing further funding (b) Facilitate strategic partnerships with established companies that can provide validation, scale & market access for the startup's technology. In a software startup I advised, forming an early partnership with a major software corporation not only provided validation but also accelerated the technology's development & market introduction