What Matters Most – Market Size, Barriers or Team?

When I was in business school at Columbia, I took a class on venture capital taught by some of the partners at RRE (Will and Stu).  One of the case studies we did in the class asked you to read the profiles of three companies and then select the one you would invest in.

The first company had an unstoppable team.  The second had a huge market.  The third had novel technology that created a substantial competitive barrier.  All three had material gaps in other areas.

I had a really hard time picking.  All three had merit; all three had weaknesses.

As the exercise unfolded it became clear that all three companies were real-world success stories.  All had IPO’d making their investors a lot of cash.

The point of the exercise was to force us to think about what we were most comfortable investing in: teams, markets or barriers.  The thinking is that you rarely get it all, so investors need to specialize in understanding specific types of risks in order to make smart bets.

At the time I leaned more toward barriers.  I had noticed that some of the companies that generated outsized returns had big barriers fending off competition.  Companies like eBay, Facebook and others had network effects.  And some, like Google, had IP in spades and significant upfront costs protecting them from new entrants.

But there were companies with weaker barriers that made it to the promise land.  The email companies like Constant Contact had succeeded despite having lots to competitors.  Their markets were simply big enough to accommodate everyone.

And, of course neither type of company can succeed without great execution.  You have to have a great team.

I was perplexed.

For each investor there’s a different view on how to prioritize or reconcile these tradeoffs; for me I think about it this way.  First, a great team is a must.  But unlike some VCs who bet just on the team, I won’t bet on a great team with a bad idea.  I’ve seen too many talented teams run into a brick wall over and over.

For me, in addition to a killer team the idea needs to have either material barrier or a huge market associated with it.  So I suppose, I need two out of the three variables to get excited.  Team plus a large barrier or a large market.  But, of course, I prefer to have all three.

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