I am an angel investor. I have been investing personally in early-stage companies, Pre-Seed through Series B, since 2015. I do it not for money but for love of the game; the greatest pleasure to me is to learn from entrepreneurs smarter than me, and help them succeed.
Over the last five years, as I look at my wins and misses, one thing seems clear: at the earliest stages, business models do not matter at all. This is a deeply unpopular position, in part because philosopher-king VCs love to talk about business abstractions and ask about moats, network effects, returns to scale, value chains, innovator’s dilemmas and so forth.1 But at the seed stage, very little of this matters.
Startups rarely stick to the original business plan. There’s always a pivot: sometimes in the product, sometimes in go-to-market, sometimes in the whole thing. In addition, exogenous shocks (COVID-19 being a great example) perturb the best laid plans of mice and men, and every startup eventually finds itself in deep and unfamiliar waters. These are the moments that dictate success or failure, and what matters then? Cash in the bank, and the nimbleness and thoughtfulness of the team. Those are the only things.
I’ve had a lot of run-ins with this pattern over the last eight months due to COVID. The businesses that were most vulnerable to COVID (and, inversely, least able to take advantage of COVID) were the ones that were most exposed to their own business plans, that had the least nimble founders, and left the least optionality for pivots.
On the other hand, great teams always have a leg up.2
So, my position is that the business model at the pre-seed/seed stage doesn’t matter. It’s barely worth diligencing. This gets me a lot of flak from other investors, presumably because they feel smart when they write their multi-page memos, and here I am saying that the emperor has no clothes.
A similar, and somewhat more popular position, is that startup financials don’t matter. If you barely have revenue, your future forecasts are worthless. Reality will always differ greatly, and anyone with a pulse knows this. However, looking at a startup’s forecasts is still valuable, because it tells you whether the startup is financially sophisticated and can put together a good financial model, which is a good general indicator of their maturity.
My position goes one step further: it’s not just the forecasts that never survive first contact with reality, it’s the entire business model. Some parts will be harder, others will be easier, and some will change altogether. Add random macro-scale perturbations like COVID, recessions, regulatory shifts, and you can assume that any early-stage business model is subject to great change, so much so that you might discard it altogether. However, evaluating it still has significant value in that it tells you about the thoughtfulness of the founders, which is critical.3
So I don’t invest in business models. I invest in great founders who are gritty, resourceful, and can assemble great teams. I treat finances and business models like brain-teasers in interviews; performative exercises that are fun to debate and tell me a lot about the maturity of the underlying entrepreneur, but I almost completely discard their content.
Finally, don’t believe me? Let’s take a look at these giants and tell me whether you would have “invested in the business model” when they were founded.
- A 2009 2D Browser MMO. Just another video game in an endless sea of competitors. This eventually became Slack.
- A 2012 video conferencing platform, when there were hundreds of competitors and the market was locked down by Microsoft and Google. This moatless company became Zoom.
- A 2005 video-based online dating service. YouTube.
- A 1994 online bookshop. Amazon.
- A 2006 online snowboard equipment shop. Shopify.
Too much business risk? You love the tech but there’s no moat? You want a network effect? Try betting on the founder instead.
I suspect these topics get attention for two reasons:
(a) They add an air of intellectual legitimacy to venture investing. Like technical analysis for stocks, it adds pseudo-rigor, making the process of investing look more scientific. Sometimes these patterns are truthfully there, but they are usually only apparent in retrospect.
(b) It’s just marketing for VCs. In this industry, it takes ten years before you figure out whether someone is actually good or not. In the absence of that evidence, for most VCs the entire game is marketing and making themselves sound as smart as possible, where buzzword business-school theories are very helpful for conning rubes. ↩
There are some counterexamples of “Great Teams that Failed”. General Magic is a good example, but closer inspection usually reveals that part of the team was really lacking. For example, General Magic certainly had the best technologists of the day, but the actual product being shipped, thanks to weak management, was hot garbage. It is a special tragedy when a company has a partially excellent team and a partially terrible team, because the lowest common denominator usually dominates the outcome. ↩
In other words, if I’m not 100% on board with the business model but I believe in the founder, I’ll invest. If the business model is actually implausible, then the founder has not thought deeply enough, and I’m out. ↩