It's Logical

That's Not Going To Mean Successful

If you have sat through and read thousands of startup pitches as I have, you start to notice things. More importantly, you start to notice things about yourself as you go through the pitches.

I think it is just as important to recognize your own psychology when people are pitching as it is to understand the fundamentals of the business they are pitching.

Even the greatest all-time startup investors have negative wins and losses on an absolute basis. They invest in more businesses that fail. Far more. Yet, if you talk to them they can make a case for why they won’t. One of my favorite lines about startup investing came from Chicago’s Troy Henikoff when asked which startup was his favorite. He said, “I love all of my children.”

Why do businesses fail?

I think the main reason is the people. They can’t get the job done. What’s the job they fail at the most? Finding product market fit. This Paul Graham graph ought to be familiar to anyone who has done anything with startups.

Over many years of investing, I have had startups find product market fit. When they do, it’s amazing. Entrepreneurs have such a different mental attitude. In the beginning, it is such a tremendous struggle. It affects them mentally, and physically. I am empathetic. When I was trading I lived it. It was never far from my mind. When I lost big money sometimes I felt sick to my stomach. But, man, when things were in the flow everything was rosy. Life couldn’t be better.

I have invested in some businesses that think they have product market fit when they don’t. They are logical businesses. You listen to the pitch and you think, everything seems to fit together logically. X is certainly happening and so then of course Y will happen.

Except startups aren’t always logical, especially at the beginning. If it’s a blowout business, it probably isn’t logical. If you can use simple logic to see it, then everyone will do it. I have printed this graph before but it fits. This graph should be on the wall of every early-stage investor’s office.

Businesses that are long shots are the ones that make up for the ones that lose. That’s why there is a power law of venture. It is also why people like Charlie Munger don’t like venture as an asset class. You lose too much money trying to find the diamond. It’s not an efficient use of capital because the variance is far too large.

I had a business that I invested in. I thought I had peeked into my crystal ball and saw the future. There was buzz around the business and it seemed to be growing. I sunk a lot of money and time into the business. Made a ton of introductions. There were some other personal extenuating circumstances that I ignored.

The entrepreneur posted a lot of stuff on various social media platforms trying to give themselves confidence that what they are doing is scaling. It’s not about the business and creating buzz. My experience with entrepreneurs posting constantly like that is that the posts are about them.

The business was decent at raising capital. When the chips were down, they could find more money. First job as a startup CEO is to raise money so you don’t go out of business. Second job is getting customers that don’t turnover so you don’t have to raise money. That’s why product market fit is so key.

The business never took off. It was too logical. 2+2=4. That’s not a good startup business. 2+2 can’t add up to anything.

Other times, some businesses seem logical and the solution you see is revolutionary. This often happens with a device, or in medical businesses. I saw one once that was mind-blowing. However, it wasn’t a venture backable business because the market size was too small. It’s a wake-up call to many people but there are diseases and medical problems that will not get solved because not enough people get them. I think Gary Sinise did an excellent job talking about that in his public letter about the death of his son.

If you are listening to a startup pitch, and everything seems logical to you. Take a step back and examine yourself. Why doesn’t it sound that way? What else is going on in the world that makes it sound that way? Is this an easy logical step for anyone to see? If you are in a bar and explain it to a friend do they easily pick it up and can they see uses for the business?

If so, it might not be a great investment.