From time to time, we meet super ambitious teams with a unique insight around a big problem and a roadmap to take their solution to the market. In these cases, teams are complete, the early product is in production and there are signals of some product-market fit, represented by a few loyal, paying customers. They have done a remarkable job taking their idea to this stage and now need venture capital to accelerate their go-to-market. They also rightly expect to be rewarded for the good job they’ve done with a high pre-money valuation.
The scenario I describe above is ideal for us, as an early-stage VC with a fund size of $150m. It ticks many of the boxes we look for in our pipeline and typically we decide to extend a term sheet. However, frequently, the valuation we attach to the business is lower than the team’s expectations.
The primary reason for this is that at the stage we focus on, the ultimate success of these companies is dependent on multiple factors, all resulting in a positive outcome. Not only does the team have to continue to execute brilliantly, but their competition also has to execute more weakly and the regulators need to cooperate and the business cycle has to continue strongly and their market needs to grow as they predict, and so on and so on…
Their ultimate success is predicated on a long list of combined probabilities. Facing these types of “butterfly effect” business models, one needs to take into consideration the resulting long odds of success and price investments accordingly. Compounding probability is a notion that is not obvious to many founders.
2 thoughts on “Butterfly Effect Business Plans”
Makes sense. On the other hand, keep in mind the quote (Fred Wilson) from your previous post, “We made the classic mistake that all investors make. We focused too much on what they were doing at the time and not enough on what they could do, would do, and did do.” Are you investing only for the Success Prob [Team x specific market x specific approach] or also betting that the Team will have the capability to evolve and pivot as necessary with respect to target market and approach?
We always look for signs of adaptability and agility in teams.