Adding another one to the Investing Lessons from Venture Capitalist series. This time I am looking at Chris Dixon. Chris is a brilliant and interesting character, he shares pretty broadly on his blog and twitter account. He doesn't usually get into too much depth on what he looks for in investments in general, but with enough patience there were loads of good places to find the lessons he has to share on investing.
If it looks like a duck and acts like a duck
You still better make sure it is a duck. As we found with the financial crisis of 2008 and as Chris mentions is a problem for a lot of Venture Capitalists, investing in something because it matches a derivative pattern that seems as though it has been successful does not gaurantee success. Everyone invested in mortgage backed securities during the 2001-2006 period, despite the fact that this pattern of investment and investment returns was changing under the covers. The homes and mortgages under the investment product were changing to feed the appetite of investors hungry to invest in that specific pattern.
The same holds true in startup/VC investing where everyone gets excited by what appears to be a brilliant college dropout looking to build the next great thing - of course if all the investors are excited to invest in college dropouts a la Ron Conway... why not drop out of school and build a startup even if you aren't in the brilliant crowd? It seems there is a lot of room to throw good money at bad investments as a result in startups, just like in the MBS industry, and just like all the other bubbles we have seen over time.
Invest in People
Chris talks a lot about investing in people from his discussion on his blog, talking about dropbox, and talking about the kinds of things that people are focusing on. What is interesting is that Chis's analysis of investing in people is more around finding people who can approach a problem set or an industry in an interesting way and less about the specific subject matter expertise that many analysts of publicly traded companies focus on. Chris talks about not climbing the wrong hill, while analysts of Ford for example focused on whether or not Mullaly would be able to transition from building airplanes to building cars.
Looking at how Chris evaluates the world, the analysts should have been looking at how Mullaly approached the airplane building business and if the thinking and problem solving that Mullaly learned there may lead him to approach a car company in a better manner. Interestingly enough, Chris somewhat disagrees with himself on this point though. He posted that investors should look at the founder/market fit and calls out specifically that the founder should develop themselves for the market and ignores the fact that a founder or executive can be good at solving certain types of problems that apply to several different markets.
Invest for Value
Chris talks a bit more about the difference between asset allocation and investing in companies because of their inherent value. Interestingly citing Facebook and LinkedIn as great value investments back in June 2011. Regardless of private or public markets, I think that this is an interesting point of discussion. I see more and more that Angels and VCs are looking at asset allocation and statistical portfolio returns based on investing on a larger number of startups with smaller dollar amounts. This certainly is more common in public markets, but now with the advent of crowdfunding for private offerings, the ease of investing $5k in ten to twenty startups is much easier for the average accredited investor if they are sufficiently convinced that statistically they will get a good return.
This seems to be drastically different than the value approach to investing a la Warren Buffett (who Chris isn't shy to mention on his posts about value) and many others in search of great businesses that can be purchased for less than their eventual value.
Three reasons to Invest
Chris lays it out pretty simply in this 236 word blog post. Talent - Tech - Business. That is it, those are the only reasons that should drive acquisition investments. Of course if you are making an equity investment and can't relate your investment to one or more of these, that may be problematic.
Talent is the people. Would you hire these people if you were running this company - are they the right people?
Tech is the product. Is this product compelling enough given the marketplace, the innovativeness, etc. despite people and monetization - is this product any good?
Business is - well the business. Is there more value in the business than the cash you will be putting into it?
Economics are Important
It is interesting the amount of emphasis that Chris puts on the economics of the business models he evaluates, there are many other investors out there that perhaps don't get them at the same level or aren't as excited as talking about them - regardless though demand curves and how they affect buying and selling decisions is critically important to any investor of startups or public companies. Chris talks a bit about an example of this and bundling, it is important to understand the macro and micro economics of what should be happening when the company you invest in puts a product on the market.
If you are having a hard time with this, I suggest Tyler Cowen's new project Marginal Revolution University, or any of the other online economics course.
And a bonus video on the benefits of liquidity to founders...