@bznotes @dshen what if one's thesis is to simply find the most exceptional technical founding teams?
I thought I'd run this through some of the process described in that post and in my older post Predicting the Future: Research and Thesis Development. I will use YCombinator as an example, since they are the most visible supporters of this thesis (see disclaimer at end of post).
First, some from "Predicting the Future..":
1. Look at your own personal interests and areas of expertise.
Currently, the most vocal of proponents of this strategy is Ycombinator, who recently announced that they were going to accept founder teams that have no idea. Ycombinator has always looked for hacker credibility in its applicants, accepting only the cream of the crop from top schools all over the world. The Ycombinator group is also composed of hackers as well. Given their experience from a multitude of Ycombinator classes, they have seen that often times all it takes is hyper intelligence plus entrepreneurial traits that can yield a tremendous winner in a startup.
So it would be natural for them to take this leap.
2. What else is unique about you?
a. Do you have a flow of proprietary deals from some source(s)?
Of course YC does. Their brand attracts the best of the best of the best to apply each class.
b. Can you influence outcomes based on your experience, contacts, expertise, etc.?
YC now has amazing support from the community from other businesses, investors and their startup network. They also get amazing press coverage for whatever they do. They are universally respected for everything they say. If you are a startup that has gone through YC, it gives you a badge of honor that you can't get anywhere else. Investors travel great distances to view Demo Day and then pick the best of the best to invest in, no matter what the valuation. These factors give their startups an advantage in the marketplace over those who are not YC alums.
c. Where are you based?
YC was in Boston, then became bi-coastal, then decided to relocate permanently to the Bay area. Being in "entrepreneurism central" helps them in all their operations, and allows them to optimize them without worrying about missing startup resources in other locales.
d. Now, we move into lots of data...
YC has been doing this for 7 years now. There experience in doing this for so many years, through so many classes of startups has led them here.
Moving on to my latest post, here are some analyses from Working on New Investment Theses:
1. Is there a place where it makes sense for us to play? Do we have or have not expertise in that area?
Yes because YC is made of hackers and hackers is what they know best.
2. What about valuations?
This is one of the strongest advantages of YC - they give a low amount of money for a disproportionately large part of the startup. In the early days, this was appropriate for the risk - each YC startup used to start their project from nothing when their class began. Over the years, this has changed dramatically. Many startups coming to YC have been in operation for over a year and often with significant revenue. Still YC invests relatively low amounts of money and gets a big chunk of the company even at this stage; startups come to YC for the advantages of being associated with YC and are happy to pay that price for the value they receive.
The valuation that YC receives is one of its biggest strengths in getting outsized returns for capital deployed and thus makes sense at the riskiest stage of a startup.
3. What do others think?
YC has always had its bit of controversy. Other investors both applaud and ridicule this style of investing. In many ways, YC walks the world very much as an individual and does not march to any other tune. They hold to their convictions and also adapt quickly and nimbly when things need to change. So investing in founding teams with no idea has its detractors but if anyone can make it work, YC can with all their experience.
And as I mentioned in my post, we have discovered in our own portfolio that not following the herd has resulted in the startups doing the best.
4. What does the world need to look like in order for this area to start taking off?
To me, this goes along with my statement:
By socializing the opportunity to both investors and entrepreneurs, is it possible to literally bring the future to life by our own actions?
The credibility that YC has in the industry means that if they take a stand on something, many will simply follow or believe it to be true because YC said so and they trust their analyses. Therefore, even as that post from YC said they were simply trying this and didn't know if it would work, many now have taken this to be truth.
NOTE: Even before YC made this move, there are funds that have shouted the "founders first" mantra. However, I would contend that even though they say this, upon further examination of their startups, they still are picking even if one of their criteria is a rockstar founder team.
Calling out one point which is examining Specific Industry Trends from "Predicting the Future...":
Many things have happened since YC started back in 2005:
i. Development tools became more readily available and it became easier and easier to build high technology startups over time. Amazon's EC2 and AWS then made it so much easier to setup a server and backend and you didn't have to worry about that at early stage to test your concept.
ii. Educational materials got better. Credit Eric Ries and Steve Blank for creating startup manuals and methodologies like the Lean Startup and The Startup Owner's Manual.
iii. The economy went into the crapper. With interest rates near zero and volatility in the stock market going crazy, the only place that seemed to be making money was in startup investing. This meant that the marketplace filled up with eager investors, both large and small, searching for returns in the most riskiest asset class of all.
iv. With so many jobless, and hatred for big corporations at an all time high, and the few outsized returns generated by internet startups of today's internet boom, young people flock to startups and are encouraged to be entrepreneurs. Incubators flourish to help, universities all offer entrepreneurism programs and classes.
v. Celebrity status of both investors and entrepreneurs also drives subtly the urge to become either. Who doesn't want to be famous?
vi. The internet marketplace for startups becomes exponentially filled up with early stage startups. It's so easy to build one now, and there are tons of resources to help people start something. New investors coming to the market help fuel their creation and existence for at least a short amount of time, unless they become successful. Competition becomes ridiculous for most ideas and for each idea, you find many competitors.
vii. Consumers (and the beleaguered IT guy at a big company) are deluged by pokes, flirts, offers, friend requests, requests to join and play - our limited slices of attention are getting deluged by more and more of these interruptions and we can't keep up. Viral loops stop working. Growth gets harder and harder to get.
Given that the world looks like this for internet only startups, I find that there are still the class of investors who believe in this world which i call "true believers." These are the people who still think they can find the next Instagram or Facebook even in today's crowded world.
My contention is this - if you still believe that the internet is place to invest in, and you are a "true believer" and want to find the next Groupon or Zynga, then you have NO CHOICE BUT TO DO WHAT YC DOES - gather all the smart, talented people you can find and then invest in as many as you can, spending as little as possible to get as much % ownership of the company as you can. You have no idea if an idea will work because of market conditions; but there will be some that will even if you don't know which ones. But betting widely means you'll increase the odds that you'll find the next Groupon/Zynga and you need to reduce the chance that you missed one. Rumors say that YC has proven that even with their failure rate, they have gone positive in their return relative to capital that they have deployed.
All investment theses are highly situational - nothing works forever, and something that didn't work before can work again if market conditions change. Or can work for one person but totally impossible for another. And by the way, luck can confound the best of strategies.
As you think through some investment thesis you're thinking about investing against, can you muster up as many advantages as YC has, in investing in awesome technical teams without ideas? If you can't, you might want to think twice about investing against SOMEONE ELSE'S thesis...(yes you do get points for original thinking and for having the guts and conviction to bet against the crowd! Extra points for literally forcing the (your) future into being through your own efforts...)
As I talked about in my latest thesis post, it's all about swaying the odds in your favor. Unfortunately, they are still odds and no matter what you may still roll snake eyes and lose your shirt. Oh, and that other investor who started investing on a thesis you painstakingly built just become an investing genius because he found the startup that gave him 100X return and you passed on it...
DISCLAIMER: This post was written without any discussion with any YC member but only from outside observations as a friend to YC who has studied their growth and ascendance in the entrepreneurial and incubator community. I may be totally wrong in their thinking. If someone from YC reads this and tells me so, I will be happy to edit this post. But readers, please do take this analysis with this in mind.