What Do You Look For To Invest At Seed?

Lyft is going to go public.  That’s great news and I wish they would have done it sooner.  Uber is going to go public.  Same sentiment.

The other day I was doing some mentoring at an accelerator.  The questions were on different topics, but the one we zeroed in on is what do you look for to invest at the seed stage.  B2B Fin Tech is slightly different than other verticals but in this post, I am going to make some generalizations.  This also helps you analyze the merits of going to work for a startup.

We talk about the team a lot at the seed stage.  It’s truly critical but some other characteristics have to be present.  The team is the variance which makes it impossible to know if this one will become a unicorn or not.  You cannot pick a unicorn at the seed stage.   It is helpful to reflect back on how big companies got built.   History doesn’t repeat itself but sometimes it plays a similar melody which is why VCs talk about pattern matching.

Here are some characteristics of companies that have a chance to be blow out companies:

• Transaction volume is high.  There are lots of transactions.  How many times a day would you potentially use Uber?  Paypal?  Quicken?  Snapchat?  Instagram?  Envestnet?  Millions of potential transactions per day.
• Supply and/or demand is artificially constrained somehow.  It could be by regulation which is one of the things we think will give PipIT tailwind.  Maybe supply and/or demand is constrained because big incumbent players have strangled it somehow.  Maybe it’s because of geography.  This is where knowing basic Microeconomics 101 really helps with analysis.
• A technological change has occurred and this startup is taking advantage of it.  That happened with companies like Uber, Google, Microsoft, and Netscape.  Part of the Theranos pitch was miniaturization.    It was supposedly technically possible to take a huge lab and turn it into a personal micro lab.
• There is some sort of problem that is persistent across almost all societies that can now be solved with a startup.  It’s a part of the human condition and technology has made it possible to change it.  Many robotic things and hardware companies are in this camp.  Household appliances were in this camp.
• Switching costs are high.  Competitors might come in but the brain damage the customer has to endure is so high that they don’t want to switch.  Ready to change your entire bookkeeping system?  How about your order management system?
• The company creates standardization that gets integrated into the entire ecosystem.  Fax machines are like that.  This is why it is instructive to look at competitions like Sony Betamax vs VHS.  Once one format wins, it’s hard to change.
• There is a new macro trend that is going to be long lasting and sweeping which will give the business tailwind.

Here are some things that aren’t necessarily characteristics of a unicorn:

• It’s cheaper.  No one has ever built a business only on a cheaper price. That’s a commodity business and when you are a commodity the switching costs aren’t high.  I think a lot of the cannibis and blockchain businesses fall in this category.
• It solves for a pain point.  It might, but it is a one trick pony which makes it a tool and not indispensable.  Great businesses create tremendous customer loyalty.  Figuring out if a customer could live without the new business is often a difficult task.
• It scales, but it doesn’t scale through an entire vertical or across vertical business sectors.

Seed stage investing can be very rewarding although it is risky.  If you invested $25K in Uber at seed, it would be worth close to $200MM today.  Believe me, there were plenty of people that passed.