Twenty-fourth in a series of weekly posts by myself and Nicholas Lovell of Gamesbrief which answer the fifty questions you should ask before raising venture capital. We expect the series to run for a year after which we will collate the posts into a book. You can find the rationale behind the series here, and the list of questions here. We welcome your comments on any and every aspect of what we are doing.
Market leaders are generally valued at a multiple of their lower ranked competitors which makes understanding the competition a key part of due diligence (see here for more on exit strategy). Generally speaking, VCs are looking to invest in the market leader, or in a company that can become a market leader in their segment, as defined by revenue or occasionally internet traffic. Moreover, once discussions have started to get serious coming to the conclusion that any given company isn’t likely enough to prevail is probably the most common reason for deciding to decline to invest.
The key thrust of due diligence into competition is to establish a ranking of the players in the market. For most industries the ranking is based on revenues, but in consumer internet traffic is often a better proxy for value at the stages at which VCs invest. In the relatively common scenario where revenues in both the target investee and the competition are minimal we will look to a number of other factors including product quality, hype/buzz, amount of capital raised, and the quality and quantity of early partners and customers. These are all pretty subjective measures though and for early stage companies we tend to look more to the team and take a view on whether they will out-execute their competitors.
Having established a rough ranking we will then take a view on which companies will most likely be moving up and which will be moving down, this is generally based on same factors we use when ranking companies in small and pre-revenue markets (listed in the previous paragraph).
We pull together our views on ranking and movement from any and all available sources of information and work hard to leave no stone unturned. Typically we will have some sort of view on the market and players before we engage with a target investee, but in the next phases we rely heavily on the company itself to sketch out the competitive landscape. We are looking for an honest appraisal of the situation which shows both a good understanding of the competition and a high level of awareness of the company’s own strengths and weaknesses. If we like the story we hear the next step is to confirm its accuracy. This we will do via a combination of desk research, polling our networks, and talking to the other players in the market. I have described a two step process (listen and then check) but in practice it is usually more iterative than that as the checking phase throws up new questions and ideas which feed into and develop the competitive story.
All of the above applies whether the competitors are other startups or giants like Google or Oracle, but unsurprisingly we are much more wary of large companies and their ability to move through the rankings in a market by leveraging their existing customer bases and investing at levels that VCs can’t match.
Most of the companies we see have a pretty good understanding of their competition and present their story pretty well. That said, a couple of the more common mistakes are to argue that there are no competitors (no competition generally means there is no market) or paint a competitive picture that is inconsistent with the market size analysis.