Different ways of looking at investment opportunities

Chris Dixon wrote an interesting post yesterday which described two different ways of thinking about startup opportunities – the finance lens and the product lens. Put simply, his point is that entrepreneurs typically look at opportunities from a product perspective, asking the question ‘is there an opportunity to build something people will really want?’ whilst investors typically look at opportunities from an investment perspective, asking the question ‘is there an opportunity to make a lot of money from this investment?’.

Chris concludes by saying that over-use of the finance lens can result in big mistakes and that often it is enough to identify a great product opportunity.

At the highest level I think Chris is right. Too often the finance lens leads investors to jump on bandwagons and invest in sectors which are hot and where companies look like they will be able to pull in hot money at big valuations and get premium exits, even when the underlying product proposition isn’t very strong. When the going is good you can make great money like this, (and I suspect that more money is made riding bubbles up than at any other time) but when the party stops these companies rarely work out and therein lies the rub. Investing in startups is a long term game and my belief is that the only way to make money over the long term is to invest in sustainable businesses, and that means companies whose products deliver a lot of value to their customers.

But that doesn’t mean that the finance lens should be ignored. Or put differently, having a great product is a necessary, but not sufficient, condition for success. From my position as an investor good answers to the following are also important (not an exhaustive list):

  • If the company will need more money will funds be available?
  • Will it be possible to get the product to market cost effectively?
  • Are there any dependencies on third parties which might undermine value as the business scales?
  • Will the product command a price that allows for good profits to be made?
  • Are there barriers which will stop other companies competing (i.e. a source of sustainable competitive advantage)?
  • Are customers ready to buy the product?

To wrap up, I think that great product is increasingly the biggest driver of startup success, and I agree with Chris that blindly using the finance lens can result in some very poor investment decisions, but making good decisions requires that a long list of factors be considered, and I don’t think there are any shortcuts.