Q: What qualities do venture capital firms look for in a startup?

If you are talking about early-stage investments, I think VCs break into two groups, roughly:

Strategy A:

  • Insanely smart, driven founders;
  • Pointed in a pretty good direction; BUT
  • Perhaps with very little or no traction.

Strategy B:

  • Very good founders (but not necessarily, at this point in time, the Greatest Ever Adjusted For Time / Stage);
  • In a good space; WITH
  • Early, measurable traction OR
  • The barest bit of traction with a very, very low price.

It might seem like B is just A, but 6 months later … but it isn’t.  It’s a different strategy.

Some VC firms, the ones going for the biggest alpha, tend to bet on the biggest, craziest, absolute smartest founders going for the biggest vision … even if there’s little data to always bet on.  Your loss ratio could be much higher here, however, and often you have to write a bigger check here.  These investments may never get a single customer and it could all implode on you in 12 months.  And these bets, these founders, often are less capital efficient.  They are going for it from Day 0, so often they spend like it, many times.

Most others, a little more conservative … look either for real, albeit early traction, and/or very low prices.  This strategy minimizes your downside and loss ratio.

If you pursue Strategy A, you may end up with an entire fund that is a total disaster.  Many great VCs have ended up with one simply terrible fund (e.g., Accel) or at least one fund that loses a lot of money.  Strategy B probably helps ensure you at least hit 1x in a fund if you have decent enough deal-flow and pick decently.

Strategy B protects your short term viability as a VC fund.

Strategy A may be the only way to make any serious money in early-stage VC.

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