The Buckets of Business

People have been asking me how I categorize the hundreds of idea/opportunities that I see along the way.  I don’t think this is any different vs. what other VCs do but give em what they want.  This is seriously high level/broad strokes and I hope it is useful.

A Feature

This is an idea that is a feature of another product and probably can’t stand on its own as an investable business.  Usually, these are fillers into various operating systems.  The more public example of this would be all the cut/paste hacks for the iPhone.  Despite some great attempts and a few good solutions, it would be virtually impossible to get “funding” for these attempts.  Funding, by the way, is defined (by me) anything above a credit card level loan from mom.  Angels, Y-Combinator, JLA, etc.

I do pay attention to these opportunities for a couple of reasons. First, the people.  Smart people solving problems are the basis of all good companies and getting to know them is a key component of what I do.  Secondly, having a conversation about a feature can lead into a growth opportunity or a session with causes a game changer to emerge. A gal that knows how to hack an iPhone may be thinking of great ideas which can lead to something huge. 

Power Sellers

I get in trouble when I compare some of the start-ups/businesses I see with eBay Power Sellers.  I mean it as a compliment from the sense that somebody is able to create a software product or service which can generate enough coin that they can live a nice life.  It’s not a bad gig, something to be proud of, but not a VC investable business.  I will almost always tell something when I think a business is in this category and try to do it in a complementary way. These are smart people who can often give you insights into what they need from the perspective of goods and services.

A nice business

Typically these opportunities are those where the founder and one (or two) other people can reliably pull down a million bucks in gross receipts. It’s a sweet gig and can be a good business which grows nicely over time.  When I see these businesses, I focus the team on fairly simple questions:

1. What can change the game and drive this business from 1 – 20 million in 3 or so years (note: these numbers/time will vary).

2. Since nine women can’t make a baby in a month, what does the money do vs. organic growth?

The idea here is to see if there is something that actually can be a good investment which turns this nice business into an amazing business/investment.  It’s important to note that lots and lots of these types can get monumentally screwed by Angel/VC investment. The overhead, meter running (we look for returns/exits), etc, can hurt nice businesses. The world is full of these types of bad deals for all considered.  I’m a bit cynical here only because I’ve see a bunch of ‘nice’ businesses get messed up with “professional” money tossed in.

The growth opportunity

This category is one reserved for those businesses that are on a great run, can be dominate in a category, have lots of exit possibilities, etc.  It is not so much proving out the model rather pure growth.  Values in this category by the way should be good for entrepreneurs (I’d hope) because much of the unknown, will the dogs eat it, has been addressed.  There are lots of spreadsheets, market analysis, projections, sales pipelines, etc, all tossed around during due diligence.  It’s a pain for the entrepreneur. The more experienced ones will have basically put much of this material together prior to starting the funding raising games.  Checklists are available from many VCs, including yours truly, on how to prep this material.

The game changer

The idea/solution that changes the world as we know it.  Google, Amazon, eBay, PayPal, Flickr, Skype, LinkedIn, etc, all fall into this category.  The think that sucks the most about this category is that most of us in the VC business couldn’t see these if our lives depended on it.  We all say this is what we are after but we end up with the “growth business” or the “nice business” transforming into a game changer (hopefully).  This translate into decent returns much of the time but not the out of the park winners.  When there was exactly zero SMS messaging happening in North America, most VCs were calling it the CB radio of it’s day. There was more than one VC taking a dump on LinkedIn when it first started.  Paul Graham in an essay some time back made the observation there were only 20 or so good VCs in the world.  Could be. There are ton of us newbie types trying to get there and I suspect the key is having the foresight and brains to see these game changers and act upon them vs. thinking the idea to death.  For you, this is a tough one because lots of stars have to line up. But this category is suppose to be the essence of Venture Capital.  That change the world hit which is buried in all of the yet another location based social media community of user generated content, just waiting to be discovered with a giant AH HAH, YESSSSS!!  I’m still looking.

 

This is a very broad set of buckets and each investor (Angel, VC) is going to slice and dice their particular deal flow differently.  As I said at the start, I hope this is helpful.

Comments

[Mark]

Great post Rick. I would just add that there are probably different stages of "growth" with the growth business bucket. There is growth that is measured by market reach, adoption and scalability of the product/solution (e.g., Twitter), growth that is measured by the operating margins and profitability of the product/solution (e.g., PayPal) and growth that is measured by the sustainable value of the enterprise (e.g., Google). Companies that can manage through these stages of growth quickly and with as little disruption to the focus and operations of the organization end up being the game changers.

[Bobby Martyna]

Are there no Game Changer VCs, Rick?

Each of these buckets (except the feature) has a return possibility -- where there is a good, safe return on capital potential as well as a return on investor sweat.

A Game Changer VC might spread investments across these buckets, focusing on and going deep in a specific industry sector.

Conventional VCs play for the 1 out of 10 game changer from their portfolio mix, scuttling the rest. Wouldn't it make good business sense to hedge with a few 2 out of 3s from the other buckets? The smaller returns could baseline out the IRR (with dividends or annuities, even!), giving you more freedom to take the bigger risks, while providing a deeper understanding of the entire ecosystem of a sector.

And if you can turn one of the safer investments into a game changer, that's gravy.

Maybe that's not venture capital -- but it's an interesting model.

[rick segal]

Bobby,
Thanks for stopping by. Many VCs do in fact spread it out a little, bet on some things that will have good IRR but also bring other things to the table like knowledge of a space they want to get into, possible companies that could merge into something else, etc.

Your points are good ones.

>R<

[Tom Ortega]

Very nice writeup, Rick. My business partner and I have been discussing this very topic on how to categorize businesses.

A few questions for you:

Which category is Twitter? Feature? Or game changer? Can a company go from feature straight to game changer?

Is it possible (i.e. do you know of examples) where say a nice business is tricked by VC funding into thinking it's a game changer? Are there some business that are never meant to grow beyond nice business? Or can every business grow with the right team in place?