Inventive Investing: How I Developed A Differentiated Thesis For Picking Startup Companies

Raising a venture capital fund last year taught me not only about successful fundraising, but also about what it takes to maximize the odds for successful investing. Among the insights I gained along the way, I learned the tremendous value of assisting companies post-investment and decided to develop a different process for performing due diligence on potential portfolio companies. I also saw the opportunity to define a more targeted investment thesis that aligns with the characteristics and needs of the most successful startups emerging from Y Combinator, the selective startup accelerator that funded my previous startup before it was acquired.

What The Top Y Combinator Companies Look Like & Need

Data from YC indicates that its biggest successes are predominantly American software companies. Of the companies listed on YC’s Top Companies list, 87 percent are headquartered in the United States. While a majority of these companies are “B2B software and services” companies, only a handful of hardware companies are included. Moreover, many of these companies have had to navigate a complex, often uncertain, and sometimes hostile regulatory environment. Airbnb battles local housing laws. Coinbase grapples with intricate financial regulations. Dropbox faces detailed data privacy and security rules. The list goes on and on.

As a result, YC-backed companies spend millions of dollars on publicly disclosed federal lobbying efforts according to OpenSecrets. They also spend heavily on advocacy activities and state and local lobbying efforts to positively influence regulatory outcomes. These investments underscore the importance of political risk management as part of their strategic planning: for them, political intelligence is business intelligence. Just as large multinational corporations must consider geopolitical risk, small American startups who have the potential to grow may need to consider how the government impacts their business model or broader industry.

Defining Political Risk: Turning Challenges Into Opportunities

Looking over the Top Companies list, as well as the larger YC and startup ecosystems, it became clear that in addition to the other types of risk that startup investors consider like market risk, founder risk, and product risk, another risk lurks: political risk. Think of political risk as the extent to which the government presents challenges and opportunities for startup companies. While some investors consider regulatory risk, there are many more aspects of government interaction with startups than just as a regulator: government plays other impactful roles as a customer, a partner, or even a funder of startups and startup technologies.

Adding consideration of political risk to the due diligence process resulted in a differentiated investment thesis that emphasizes the opportunity to both identify and mitigate this risk while leveraging this risk to drive growth and resilience for these companies. For savvy founders, understanding and successfully navigating political risk can be a significant differentiator to deliver a competitive edge. Engaging with policymakers to build relationships and gain trust has the potential to not only help founders understand policymaker priorities: it can help their companies align their strategies with these frameworks and turn risk into reward.

The Why, Where, & How Of Building A Political Risk Portfolio

The thesis also happens to align with my own experience: my previous company that YC backed helped companies manage political risk, and my idea for this company came about? while I was an advisor to the Majority Leader in Congress. Spending years in Washington, DC not only taught how the political world works: it resulted in a network in and around the government including elected officials, advisors, lobbyists, and public affairs professionals who impact political decisions. I’ve learned that it’s often not what you know, but who you know and what they know that truly matters when it comes to successfully navigating political risk.

With this thesis in mind, I spent the Summer 2023 and Winter 2024 batches of YC investing my own money in a portfolio of companies where I see potential political risk opportunities, in addition to investing outside of YC since the thesis applies to the broader startup ecosystem, too. The thesis has the advantage of being both narrow and broad: narrow in the specificity of its lens of focus to filter dealflow and its value proposition to founders, yet broad in terms of the variety of industries whom it touches. It’s also delivered an unintended advantage: considering a company’s political risk is a useful heuristic for ensuring a huge total addressable market.

Industries like artificial intelligence, fintech/cryptocurrency, and healthcare who face regulation or the threat of regulation have already proven to be well-fitting with this thesis. Cybersecurity, defense/aerospace, energy, and quantum computing may also figure prominently going forward. Companies who rely on public data, who may be able to offer a better user interface or user experience for government services, or who offer alternatives that can substitute for government services are also all of great interest. For instance, Uber and Lyft have helped modernize our transportation system, but not without having to navigate enormous political risk along the way.

Saving A Seat For Founders At The Government’s Table

A few weeks ago, I joined Garry Tan, YC’s President & CEO, and fellow founders from the YC community in Washington, DC for conversations about the importance of engaging with policymakers. Garry has said, “We're trying to get tech people to realize: 'You may not be interested in government, but government is absolutely interested in you.’” When the leader of YC, as well as some of the world’s top venture capital firms, are engaging with the government on a regular basis, the impact of political risk is self-evident. It’s been said, “If you're not at the table, you're on the menu,” so it’s better to have a seat at the table than to be devoured.

It’s a pleasure to serve the incredible founders I work with in a variety of ways: investing capital, finding additional investors, advising on growth strategies, referring potential hires, providing product feedback, and more. But through the political risk thesis, I’ve seen firsthand the benefits of viewing the world differently than other investors and offering unique expertise and access for portfolio companies. Just as I’ve experienced working with limited partners, I love the relational aspect of collaborating with founders and helping them connect with people in and around the government. Together, we can promote American innovation and grow our nation’s economy.

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Steve Johnston is an investor, entrepreneur, and advisor who co-founded GovPredict, a B2B SaaS company that received investment from Y Combinator and went on to be acquired. Prior to his years as an award-winning sales executive at Google, he served as a digital advisor to the Majority Leader in Congress and worked as a product marketer at Quora in Silicon Valley. Steve received an AB degree in Government from Harvard and an MBA in Marketing and Operations Management (joint major) and Entrepreneurial Management from Penn’s Wharton School. Follow him on Twitter/X @StevenEJohnston. This post?is reposted from Medium.