Investing in dots, not lines

Mark Suster wrote a great post a few years ago on investing in lines, not dots. If you don’t know it, go read it.

Now, I admit to being kind of old school in European venture. I first became a VC analyst at Atlas almost a decade ago. My early venture education came from Fred Destin and Sonali de Rycker, now both at Accel Partners. Much of their teaching mirrored Mark’s advice: you want to invest in traction, ideally accelerating growth where you understand the underlying drivers, understand how the team works, understand the economics of the industry.

Much has changed in our market since then. There’s a lot more capital at the early stage, even in Europe. New funds, new faces, new platforms, and a deluge of new entrepreneurs. Many, many business school graduates eschew consulting and banking because startups are, like, where it’s at now (not hating, just telling it like it is!).

At Sunstone, where we typically raise ~$120M funds and hence invest in both seed and Series A ($100K-$5M), a combination of these market forces and the realization that it’s the very early investments that make us one of the top performing firms in Europe (on paper!), we’ve grown increasingly comfortable in not waiting for traction. In a good third or so of our investments now, we invest in the dot, not the line.

My primary way of dealing with the (perceived?) increased risk of “dot” investments is to become less of a technical trader, who plots a graph through a bunch of data points, and more of an investor in fundamentals. Sure, I want to see a prototype and I do diligence on the market. But much more important to me is to understand the team I will be working with over the next few years:

• how deep is their domain expertise? (a good indicator is whether they’ve worked at or previously started companies in the same segment)
• do they exhibit complementary skills and social cohesion? (a good indicator is whether they’ve previously worked together, started a company together or attended university together)
• do they demonstrate high intellectual honesty and integrity?
• are they thoughtful, self-aware, high energy, low ego (well, low-ish — most entrepreneurs are quite alpha), roll-up-your-sleeves kind of people?

To understand this, I rely extensively on references. Investing in fundamentals means doing a lot of homework, often more than a technical trader does. Dabbling in professional coaching techniques has been helpful — it lets you ask the questions that more quickly get at the core of what truly motivates entrepreneurs. And I don’t discount intuition — so far as to never go against my gut on people.

To quote an inimitable hedge fund founder I once had the pleasure of interning for, “risk is a function of price.” With little money at risk at the earliest stages, and at a great valuation, the upside is huge while the downside — both for us and for the entrepreneur — is limited.

In a latter post I’ll talk about how to manage the resulting tension between “seed investing as an option” and “the social contract with the entrepreneur.” Spoiler: the entrepreneur is the customer, dummy!

Until then, don’t hesitate reaching out to me even if you’re just raising $100K. I might just fall in love with your dot.

Be well.

*P.S.: I’m a big fan of Mark’s. His and our firms’ joint portfolio company Seriously, makers of the Best Fiends games, is on a tear. I have no idea how Mark manages to essentially run a media business besides being a full-time VC, but more power to him and his Snapstorms. Incidentally, the investment in Seriously was also totally a “dot” :)