Brandon Mullins

Do as Investors Do, Not as They Say

Do as investors do, not as they say.

As those who know me and my business philosophies can attest, I am a big proponent of niche strategies for start-up companies. This goes hand-in-hand with the need for start-ups to have singular focus in the beginning (and one can argue, perhaps throughout the company life); one market, one solution, one vision. While many investors will shy away from being pitched a niche business and niche solution, this is a very short-sighted strategy. Example below.

I’m an avid fan of Reid Hoffman (Founder of LinkedIn, Angel Investor of Facebook, Ning, Flickr, Last.FM, and many others). To hear him speak on the topic of the consumer internet market and its trends is a great learning experience. He’s got great vision, and incredible grasp on what is required to start, operate, and grow a successful consumer internet solution. However, from an angel investor angle, he too falls prey to the old “do as I do, not as I say” investor philosophy.

About a six months ago, on TechCrunch, Reid wrote this article on “My Rule of Three for Investing.” Read the post in full for more clarity, but as a summary, here were the three rules:

1. How will you reach a massive audience?
2. What is your unique value proposition?
3. Will your business be capital efficient?

While all three sound quite obvious and sound in theory, this framework is hardly ever adhered to in the real world. Using Facebook as a quick example…

1. How will you reach a massive audience?
In this section, Reid describes how Facebook used the shoe-in University market to first lure users onto the site, and then expand the user demographics into high schools, businesses, and eventually your grandmother. He also cites Yelp’s strategy as “good SEO” to attract search engine users from searches on local nightlife and restaurants. These two examples would NEVER work in pitching an early investor on the marketing strategy. Try telling an early-stage investors that your user acquisition strategy will be built upon “good SEO” and see how many thumbs-up that gets you. The truth is, no start-up knows how it will reach massive audience. Try pitching Twitter’s marketing plan in 2007 as “we’ll setup a booth at SXSW, and then get Ashton Kutcher to publicize us for free.” You’d feel pretty stupid saying it. But it happened. Could it have been predicted & pitched to investors? No.

2. What is your unique value proposition?
This is my favorite. Reid pontificates on how a start-up must be “categorically different” than any existing proposition on the market to be truly successful and to garner investment interest; niche or incrementally better just won’t work. Isn’t LinkedIn, his own start-up, “social networking for professionals?” That’s both niche, and incrementally better. Not even close to “categorically different.” If I’m not mistaken, and I’m not, Facebook was created at a time when Friendster and MySpace existed. How was Facebook pitched? “Social networking for college students.” So not only was that not close to categorically different than existing propositions, but it could & would also be considered niche in every context. Sure, it was a great marketing strategy, which is to be said of ANY business (start with a narrow, focused consumer-base, expand out to other markets). At the time, Facebook wasn’t categorically different and it was niche-focused. I guess Reid would have turned it down for investment opportunity.

3. Will your business be capital efficient?
I understand this one, again in theory. SaaS companies do this perfectly. Financially scalable solutions. With every additional sale of product or service, the expenses remain relatively constant. You can sell product after product (or licenses, keys, etc.) without worrying about the relative expense associated, allowing your financial model to scale beautifully. But also, in a bigger aspect of the phrase, capital effiency should also mean that the business as a whole should be capital efficient. Twitter, for example, is burning through $155M in total funding with to-date no revenue streams, and as they continue to grow users, their server costs and employee head count rise. He sums this section up with the quote, “The formula is to build an audience with a great product – then secure enough funding to figure out how to make it pay.” Translation: build something you can give away for free, burn through other people’s money to keep the service afloat, if you happen to obtain lots of free users, then start thinking about how you can make money off of it later. That philosophy seems to contradict the “capital efficient” line of thought.

In conclusion, these “keys to investments” are definitely built on sound philosophies & intentions. They’re smart investment and business management policies. But if investors truly used these three key thoughts and stuck to them in evaluating start-ups, the Facebooks and Twitters wouldn’t have been started of funded.

Starting as a single-focused, niche solution that may be incrementally better or tailored for a different market can definitely be the springboard for a greater business opportunity, such as Facebook’s beginnings as a university-centric social network service. Niche doesn’t have to be forever; it just has to be the incremental differentiator to get your foot in the market, then expand outward quickly.

Do as investors do, not as they say.

Brandon Mullins