Investing in Unicorns: Luck or Skill?
The art of picking great startups
Venture investing can be described as a 3-part job: sourcing, picking, and winning1. This post breaks down my thoughts on picking, and how great decision-making in venture capital is harder than it seems.
Years ago, I read Annie Duke’s book Thinking in Bets and one of her core concepts stuck with me. It’s called ‘Resulting’—judging a decision’s quality based on its outcome.
Investors use data available today about a market, team, and product to try and predict a future outcome. The earlier you invest, the less data you have to make your decision.
An idealistic view would be good decision-making = good investment results. But that’s not always the case. The world is constantly evolving and the reason an investment was made may not be why it’s successful.
For instance, at the end of 2019, no one predicted COVID-19. The fact that everyone would be stuck at home and working remote was not factored into investment decisions. And yet, the pandemic was the main driver of many investment successes over the coming years.
Zoom was one such winner. At the end of January 2020, Zoom’s market cap was just over $21B, and revenue was $600M2. One year later, with virtually all work communication happening over video, Zoom’s market cap grew 5x to $109B and revenue to $2.7B!
The 2019 10-K report doesn’t mention “pandemic,” but it appears 52 times in the 2020 report. The single biggest driver of growth was unknown to investors.
There are knowable and unknowable factors when making an investment. The pandemic wasn’t known in 2019, but in early 2020, some VCs made investments into companies like Remote and Deel that paid off as the pandemic made remote work a new normal. But were those investments made with the weight of the pandemic factored in, or did investors just get lucky?
How do you evaluate decision-making when the outcome isn’t the driver?
This is why recording investment decision-making is crucial. Some firms do pre-parades and pre-mortems to try to predict why a company will or will not succeed. Others simply assess the strengths and weaknesses of the investment to guide the reasons for ultimate success or failure.
Admitting the flaws in our decision-making is harder than it seems. As investors, we can easily convince ourselves we knew founders were destined for greatness, or had insight that no one else had into a market tailwind, but we bring highsight bias which is why reflecting on the initial assumptions is critical to improving investment decision-making.
One of the best companies I’ve invested in, alongside my Partner Ted Wang at Cowboy Ventures, is compliance automation platform Drata. The seed was an investment in a team we thought could execute exceptionally well on product (true), there was a rise in data breaches and increasing regulation around data management (true), and achieving and maintaining compliance standards like SOC 2 were incredibly manual processes for customers (also true).
However, while it was clear the team had a unique view on product pioneering the concept of ‘continuous compliance’, the team’s GTM savvy was a key part of their success.
The compliance software space was already competitive, with many well-funded companies in market. Breaking through that noise took skill - and strong GTM muscle. Without it, Drata may not have become one of the fastest growing SaaS companies of all time achieving unicorn status less than a year after launch.
While parts of the investment decision-making were right, I missed a key variable.
I overlooked the team’s GTM thinking and rigor. I could have easily told myself that the investment was good, so I must’ve caught it all, but that wouldn’t be true. The team turned out to be one of the best at selling, marketing, and closing - and I had missed it.
Understanding that now, I can tweak decision-making going forward. Assessing the GTM abilities of technical teams is a major focus today. But without recording the original thinking, it would have been harder to reflect and improve.
Avoiding resulting is hard, but instead of focusing on the result, assess why an investment worked or didn’t, and whether you saw those factors initially. That will be the best training for better decision-making.
Great decision-making can still result in a failed investment. That doesn’t mean the choice was bad—losses are just part of the game. By focusing on the quality of our decision-making rather than just the outcomes, we can enhance our ability to make better picks in the future.
Portfolio support, firm management, and fundraising are also core parts of running a venture firm but sourcing, picking, and winning are the most crucial to driving venture returns.
Per Pitchbook.