Draper: Formulating trust

Venture funds only make money when they place bets. Investors who seek a well-diversified portfolio will add a venture allocation as part of a capital appreciation strategy to achieve “alpha” (exceptional, non-correlated returns). It’s the VC’s job to find opportunities that will hit it big and to be capable of taking the risk. In the Midwest, we must fight against the culture of only seeing the empty bag. We believe in the bird in hand. We earn trust over time. We pay what we owe. We see the downside. Which is why we need a formula to bet big, and to take calculated risks. We need to know when to trust quickly. We need to know which opportunities have the best upside by asking the right questions.

For example, our Venture University FrontierTech team has now whittled our deal flow down to a handful of top companies, and half of them rely on technology that we will likely never really fully understand. This is a situation where no amount of time spent online reading research papers or rolling through competitors’ decks will ever give us the fundamental, scientific understanding we need to really understand the chemical reactions happening on some new chip. While the “Buffett Rule” recommends that you only invest in companies that you thoroughly understand, finding the razor’s edge between cutting and bleeding technology requires trust of the operating team.

The trust to take a risk is based on the team. When you don’t know exactly what you’re looking at, you have to call someone who does. You have to figure out whether the team has the experience that others in the field respect. You have to trust that those investing time, energy, and – most importantly – money are appropriately leveraging their experience. When you can’t assess a core technical feature of a company, you have to trust that the expertise of a company is defined by the team members’ expertise.

This is not to say that every team member must have precisely equivalent experience in order to be trusted. Some of the most successful entrepreneurs are operating in fields where they had never previously worked. So the question becomes: what team qualities define startups you can trust quickly? What is the formula for betting big? The most elegantly simple answer I have heard, which feels embarrassingly obvious in retrospect, came from Mark Archer, Managing Director of MATH Venture Partners, during a recent VC dinner in Chicago hosted by Venture University, when he said, “it’s sales”.

This doesn’t mean that a startup needs to be profitable before you invest. However, as a VC investor, you have to be ready to trust early stage companies with your capital, even if they are lacking significant revenues or a completely polished product. Teams you can trust know that world-changing opportunities don’t change the world overnight or without a grind. World-changing opportunities are rarely seen, and they must be able to be sold well at scale. Teams you can trust open their own doors, fight through the “no’s,” and internalize the discipline of sales.

Every “unicorn” starts in the unknown and follows a path that can rarely be predicted. So when you’re facing two potential unicorns in a forest, trust the better salesman, the one who sells you a pen, because that one will have a better shot at raising capital, attracting the best talent, generating the most revenue, and selling their business for the highest value. At the end of the day, it’s all sales!

Previous coverage

Draper: Is the Midwestern definition of Venture Capital wrong? -Feb. 21, 2019

Draper: It’s all about the X -Feb. 7, 2019

Draper: Venture University could be Iowa’s game changer -January 24, 2019