The Ingredients for a Successful Marketplace

Lots of entrepreneurs aim to build a marketplace.  It’s a popular type of startup.  People look at the success of an oDesk or and Uber and think, “I’m going to build the Uber of _______” and they fill in the blank with any category from construction rentals to lactation consultants.  But, not all marketplaces will work.  You need certain ingredients in an industry to have the potential for a successful marketplace.  Bill Gurley did an exceptional job mapping out 10 key factors for marketplaces.  I have my own framework for thinking about different verticals. The following is based on a conversation I had with Semil Shah.  It’s my take on 5 key ingredients.  I left out market size discussion, since I believe you can build a successful marketplace without  shooting for venture size returns.  

Ingredient #1 - Recurring Usage

Much easier to acquire a repeat customer than to acquire a customer for the first time. 

Everyone knows that there is a huge drop-off throughout the customer on-boarding funnel.  Maybe 90% of visitors never sign up, and then a further 60% of those signups may never actually make a transaction.  So, when you do finally convert a visitor to an active participant in a marketplace, you better do everything you can to keep them engaged and making further transactions.  Of course, this is nearly impossible if you’re building a marketplace for wedding photographers since people (theoretically) only get married once.  Therefore, ingredient #1 is Recurring Usage. It is fundamental to a marketplace.  The best marketplaces have high-frequency and highly recurring transactions.  Example: Uber - most of us city-dwellers use taxis all the time, maybe several times every single week. If you’re considering a marketplace, look at the standard buying behavior in that industry: how often do people buy? 

Ingredient #2 - Irregular Usage

This ingredient is less obvious.  Credit goes to Vidur Apparao for articulating this ingredient’s key role in a marketplace.  Irregular usage is important because it: 

1) Increases the need for on-demand resources, and

2) Reduces the likelihood of getting a dedicated resource.

If you don’t know in advance when you’re going to need resources, it’s hard to plan and people would like an instant, on-demand service instead.  Additionally, if you don’t know when the need will occur, you cannot hire a dedicated resource to be available whenever you need it.  

For example, my buying habits for massages are highly irregular.  I get massages from time to time, but it is usually after some sort of strenuous workout or when my body just happens to be sore.  (Of course that seems to be happening more frequently as I get older).  Therefore, I rarely plan appointments for massages weeks in advance.  I strongly prefer to get on-demand resources within a couple hours of when I feel the need. Additionally, since my usage is irregular, I do not have a single go-to therapist that I can expect will be available when and where I happen to want a massage. 

Ingredient #3 - Standardized Work

Standardizing the work means you can guarantee the quality. 

Horizontal markets can thrive in custom environments, eg Craigslist and eBay.  But for a vertical marketplace to work well, the work or items must be standardized.  The more standardized the work, the more a company can control the quality and reduce the effort required by the customer.  If custom work is required, the buyer needs to spec out the work, select an appropriate provider, and carefully manage the process to make sure the requirements are met.  The onus falls on the buyer to manage quality. There is no way that the middleman can guarantee quality since it is subjective for any custom work requirements. In contrast,  if the work is standardized, you can typically measure the quality of the output. If you can measure it, you can improve it. 

As an example, look at Rev — they provide audio transcription and translation.    The inputs and outputs of an audio transcription are consistent - audio files go in, transcriptions come out, and we can score the results.  Rev can manage the entire process since they know what needs to be done at each step and they know the best available transcriptionist to do the job.  The result is a dead simple process for buyers that will have continuously improving quality. 

Ingredient #4 - Little Trust Required

Trust is a barrier to transacting online.  Every time you enter a transaction with a new individual or company, there is some part of everyone that worries about  getting screwed.  If the dollar amounts are small, people worry less.  If they are large, people worry more.  If the transaction involves additional potential loss, such as having your house robbed by giving away a key, the stakes are higher.  If your kids safety is involved, the stakes are at an all-time high.  This last one is why an Uber for babysitters is going to be exceptionally difficult.  Marketplaces work best when there are relatively low stakes involved in the transaction, it gives people the willingness to transact online with an unknown entity.  

There is good news on this front though… Facebook.  Facebook (and to a lesser extent LinkedIn and Twitter), do an incredibly good job at instilling trust in each other.  Airbnb has been masterful at using Facebook connect to instill trust in renters and owners.  I know as an Airbnb user, I feel 10x more comfortable renting to someone who has a well established Facebook presence and is a 2nd degree connection.  These networks increase the amount of trust we will place in an unknown entity, thus enabling more marketplaces to flourish. 

Ingredient #5 - Non-monogamous Relationships

This ingredient is a result of little required trust and highly standardized work.  The result is that the buyer doesn’t care if they have the same provider every time.  This is true for movers, for example.  It is not the case for housecleaners — and I don’t believe the marketplace for housecleaners is a good one even though it is highly recurring.  It also makes a marketplace for something like dog walkers a bit problematic.  My wife and I have a lovely dog named Isabella and we like using the same dog walker every time we need the service.  This is because we’ve given him a key to our house and he takes good care of our dog — we’re not willing to change up service provider every time we need a dog walker.  This is less of an issue for dog-sitters though, because I don’t need to handover a key to my house.

These 5 ingredients aren’t everything that you need, but they’ve always been a helpful framework for me to evaluate whether a marketplace should exist in each vertical.  

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So, I wanted to run a little analysis.  I spent a few hours going through Craigslist service categories and thought through 30+ based on the 5 ingredients above.  I didn’t take market size into account.

A few interesting results as I went through the categories. 

Some of the best: taxi drivers (Uber) and dog sitters (DogVacay).  Some where I haven’t seen success yet: massage therapists and travel agents. 

Some of the worst: wedding planners, interior decorators, and landscapers. 

Lessons for VCs from the Oracle.

I just finished reading the last 50+ years of Warren Buffett’s annual shareholder letters.  

They are… epic.  One of the best reads of my life.  This, for me, falls into an extremely rare class of “books” which actually change the way you live your life.  For me, it’s changed the way I look at my job as an investor in venture capital.  Seems like a good idea to learn from the best investor in the world. 

So, here are my lessons learned and applications to venture: 

1) Extreme Patience & Extreme Decisiveness - Almost every year Buffett prides himself on laziness bordering on sloth.  He describes his deal flow process as simply “waiting for the phone to ring.”  And frankly, I believe it.  There are years in the company’s history where they hardly made any transactions at all.  He waits for the right business at the right time.  

"Be greedy when others are fearful, be fearful when others are greedy."  

The flip side of Warren’s extreme patience philosophy is his extreme decisiveness. He takes pride in telling stories about 5B+ investments that he makes based on a single meeting, no audits, and hardly any diligence. When he finds the right business run by the right type of people, he knows it and acts fast.  He also states that he’ll give a “no” in a few minutes, probably just by looking at the balance sheet and income statement.

In VC: operate on the same principle, incredible patience waiting for the right deal and give yes’s and no’s very quickly. Also, don’t believe the hype.  ”Be fearful when others are greedy.” 

2) Team Matters - We talk about this all the time in VC circles, but I found it surprising to see how much Buffett focuses on this aspect, even once a company is a 10B+ publicly traded company.  Some rules are universal.

Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.”

In VC: Got it. Always remember the first principle —> team first.  If you don’t love the team, nothing else matters. 

3) Great Business @ Fair Price » Fair Business @ Great Price - Buffett is incredibly self-deprecating and uses each annual letter to point out the mistakes that he’s made.  One of his big regrets is investing and sticking with investments in the textile space back in the 60s’ & 70’s.  He made the investment because it was such a great price, but later lamented that that didn’t really matter, the business still wasn’t going anywhere.  His best investments were companies that could get a high return on capital invested consistently over the years and continue to grow. He was happy to pay fair (higher) prices for those deals. 

“The most important thing to do if you find yourself in a hole is to stop digging.” 

In VC: I see a fair number of deals that have reached some point of stagnation that are seeking a flat or down round. This is bad.  Tread very carefully. 

4) High Concentration of Investments - Berkshire Hathaway is massive.  Assets under management are well over $200B.  And yet, Mr. Buffett has a ridiculously small number of individual investments.  He buys big and he tries to buy 100% of a business.  At one point, he had just 5 individual companies representing 70% of his public stock portfolio. He doesn’t seek co-investors.  When he likes something, he wants more of it.  Pretty clear philosophy. 

In VC: Get as much ownership as you can.  If you like it, commit.  If you feel the need to share the risk, run away… it’s not a good deal anyway. 

5) Be Wanted - Berkshire is a unique company.  It’s a unique home for a company that wants to sell. They are the anti-investment bank or buyout fund.  They have absolutely no interest in chopping up a company or taking a ton of debt and flipping businesses.  Their intended holding period is forever.  This gives them a unique advantage when it comes to deal flow.  There are a number of business owners that went specifically to Buffett because of this unique differentiation.  They wanted a good home for their “baby.”  

In VC: Have an angle.  Why do people want YOU (or ME) as an investor / board member.  If you can’t answer that, you’re probably in trouble. Every good founder I know writes a list of names when they are starting to prepare for fundraising.  Why should your name be on that list? 

6) Defensive Moats - Don’t predict the future, just build moats that give you a ton of value and keep competitors at bay.  Then keep adapting as the future unfolds.  Defensibility is really key in any industry.  Buffett avoids tech companies because a) he doesn’t understand them and b) he has no idea how to predict where they’ll be in 10 years.  He likes saying that he knows exactly where Geico and BNSF (railroad) will be in 10 years. 

In VC: Defensibility is critical.  Invest in companies with real tech or real network effects.  Buffett likes to invest in railroads for a reason.  I haven’t seen many startup railroads. 

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I highly suggest everyone read some of Buffett or Munger.  It should change the way you think about investing. 

Get it for Kindle

Or the old fashioned paper version

Crowdfunding is Doomed…

… as an asset class.

(Note: for this article I am referring to equity crowd-funding exclusively.  Not Kickstarter-type pre-orders)

Crowd-funding has a lot of potential at a high level.  It promises increased efficiency in the marketplace as worthy startups may be able to raise money faster and simpler than through traditional channels.

However, crowd-funding faces an inherent quality challenge that may be insurmountable.  If the funding platforms cannot attract the best deals, then investors will not make any money.  If investors do not make any money, then the models are flawed and will eventually fail or adapt.

Let’s discuss the quality challenge.

Consider an early stage company - and assume they have 2 choices, pursue crowd-funding or raise VC money.

The crowd option brings - simplicity, speed, low cost, transparency, and, in theory, means taking money from anyone willing to write a check.

The VC option brings longer cycles and more meetings, but also provides greater control, secrecy, better access to networks, deeper pockets, and experience and advice.


Which path will the highest quality deals choose? The crowd funding platforms are well aligned with what low quality startups are looking for.  And high quality startups will primarily continue to raise money from top-tier VCs.  Consider the following issues: 

 

Diligence

High quality startups don’t enjoy diligence (nobody does), but they’re certainly not afraid of it. Their numbers are great, and they know it.  Their customers are thrilled with the service and highly engaged.  Their team is exceptional and they’re happy to provide references.

Low quality startups, in contrast, may be wary of the diligence process that comes with VC investment.  They may prefer a website’s process that’s based on a static presentation, social proof, and team bios.


Investor Selection

High quality startups choose their investors carefully, because they view their company’s equity as precious and they will only give it out if people can add value beyond just cash. Their rounds are oversubscribed; they have to turn away investors.  When it comes down to picking investors, the crowd will quickly be pushed out.  

Many startups may choose crowd-funding as a path to pursue, but I fear that they will choose that path for the wrong reasons.  They will choose that path because it’s easier and faster, not because they really want those individual investors involved in the company. 

Buzz

High quality startups usually stay quiet and focus on building killer product (at least in the early days). They shun press until they know they are ready for it.  They view press in the early days as meaningless blips of traffic and the potential to invite competitors. Raising money on a website surrenders your secrecy.  If startups want to stay quiet, crowd-funding is not an option.

Later Stages

Let’s look more broadly at later-stage equity financing.  Assume a startup has started to really take off and now they want to raise a $40M round.  Do you think they will turn to the crowd and manage working with 1,000+ investors.  Or will they find a firm or two that’s willing to write some really big checks. If I were in their shoes, I wouldn’t want the burden of dealing with thousands of different individual investors.

Crowd-funding today is just a solution for the first funding round of a company.  If a startup comes back to a crowd-funding site for a later round, it most likely means that they can’t find anyone to write a really big individual check – and probably for good reason.

Fundraising Effort

Everyone wants to focus their energy on product and customers and build the best business.  I’ve never met a good entrepreneur that was excited about spending time on fundraising.  Crowd-funding promises to be low-effort fundraising.  However, the best startups also have low effort fundraising.  VCs approach them. They don’t approach VCs. 

Marketplace for Lemons

Everyone should be familiar with the concept of The Market for Lemons. Basically, when you have information asymmetry in a marketplace – everyone must assume that items in the marketplace are of average quality.  Therefore, people will list items of low quality because the market will overvalue them.  But, people will not list items of high quality, because the market will undervalue them. It’s a critical concept for marketplaces.

Conclusion

Equity crowd-funding as a broad asset class is similar to VC in that it seeks to take a stake in early stage startups and hope for big liquidity events down the road.  However, both of these asset classes are dependent on a relatively small number of home runs to make solid returns.  These home run cases will rarely be open to investment from the general public… and therefore, crowd investors will lose money.  As a result, crowd-funding sites will eventually be in trouble.  Right now, they’re at the Peak of Inflated Expectations, but I suspect that they are headed for the Trough of Disillusionment.

image

Unless… crowd-funding sites adapt to be highly curated and controlled – and focus on brokering introductions and facilitating transactions and less on direct online investments.  AngelList is a phenomenal platform. They understand these issues better than anyone and they are building tools to foster exactly these types of interactions.  They allow startups to be highly selective about who they accept as investors.  And therefore, they will be successful… but their marketplace will look strikingly similar to the way the world works today.  Talented investors with strong networks get access to proprietary deals and make money… and the rest of the crowd does not. 

 

Footnote: equity crowd-funding may work much better in other verticals, like real estate investing, small business lending, or things like CircleUp’s vertical – consumer goods companies.  It will work better there because the small businesses in those spaces have fewer options for fundraising – and therefore the marketplace will suffer less from the quality problem. 

There Should be a Trader Joe’s of Pharmacies

I mean this is just ridiculous.  I spent 10 minutes trying to find the right Advil for me - I’m sure it really makes no difference anyway.  

Curate!

Could probably cut the number of SKUs by 10x, make the experience 10x better, and each store would be 1/4th the size. 

4 Ways to Lose VC Interest Fast

I recently wrote an article for the WSJ Accelerators covering 4 major turnoffs during pitches. 

Here’s the full article on WSJ: Keep It Simple.

Special thanks to Josh Smith, Jennifer Kammeyer, Jason Chicola, Ashley Wilkinson, Carmen Hughes, and Laura Edwards for reviewing drafts of the post. 

My Secret Source of Deal Flow

 

It’s not demo days. It’s not AngelList. It’s not lawyers or bankers. It’s the stuff that happens behind the scenes. 

Due diligence calls.

——

I recently led a $2M Series A investment for my firm, Sigma West.  It’s in a company that’s building a killer analytics and engagement platform (still private, announcement to come soon).  I met the founder of the company (let’s call him “Andy”) about 2 years ago when I was doing due diligence calls on another analytics company.  I was looking for info about how gaming companies were building their analytics tools and what they thought of the various 3rd party solutions out there.  I knew a friend of mine had gone to be a PM at a prominent gaming company - so I asked him who was in charge of analytics.  He referred me to Andy.

When I called Andy it was on the pretense of seeking his advice and information in an important investment decision.  It was a back channel reference.  It was not made by the company we were looking at, but it was made via a trusted mutual friend.  This sets the stage perfectly for a completely open conversation.  The other important note is that Andy was a clear rising star in the company, which is why he was leading a very important department like analytics.  On the first call with Andy he told me candid and detailed feedback and problems with every vendor on the market.  It was information I just hadn’t heard before.  It was clear and succinct.  He clearly had a phenomenal grasp of the space and had a crystal clear understanding of what these gaming companies really needed.  He was years ahead of the rest of the pack in terms of his thinking.  During the call, he also told me about some problems with the company we were looking at, and he explained to me why the system he built internally was significantly better.  I believed it.

So, I was interested to learn more.  We met for a sushi lunch in San Mateo.  We spent most of the time talking analytics - talking about the system he had built.  I was blown away.  I had already looked at a dozen companies in the space, but nobody was doing what he was doing with his internal tools.  At the end of the lunch I picked up the tab and asked Andy if he’d thought about going out on his own.  I encouraged him to pursue building his technology for others and founding a company himself.  I told him to call me if he ever did.

Two years later, he called me.  And I invested.

——
This deal came through a back channel diligence call. I believe that these calls have two very significant benefits that make them good sources of deal flow.

1) Pretense - in normal meetings with VCs and entrepreneurs, someone is always selling.  Selling puts people on the defensive.  Nobody wants to be sold to.  In diligence calls, it’s quite the opposite.  It’s a trusted mutual connection for the open exchange of information.  The conversations tend to be very candid and opinions are shared freely.  Nobody is trying to impress the other person - and as a result, both people are impressed.

2) Quality - any introductions for diligence calls are typically made to the smartest person about a particular subject.  It’s not necessarily the CEO of a company, more frequently it’s the uber-smart director or VP that knows a subject at a deep level.  People are inherently very good at assessing relative knowledge in other people.  If you ask me for a contact who is very knowledgeable in tax issues, or legal issues, or freelance marketplaces, or the solar industry — I will have a specific and immediate response for each one of those.  I will refer you to the best person I know (assuming I think it’s a valuable use of both people’s time).  The same goes for any back channel reference intro.

Due diligence calls are an important part of deciding whether or not to invest in a company.  The best diligence calls tend to be through back-channel references and intros. These intros are made to very high quality people and you start the call with a strong pretense to establish a good relationship.  You’ll get a bunch of good information, and as a nice added bonus, the person you’re talking with may be about to break out and start a company.  And when they do — you have the inside track.  

The lesson for me as a VC is to treat every person you talk with as if they could be the next founder that you’ll back. 

A Critical, but Ignored Metric for Marketplaces

In the press and on home pages across the web you see metrics like 100,000 expert freelancers or over a million sellers or “adding 3,000 new users per day.”  Those all sound great, but they are irrelevant to the health of a marketplace company.  The press and other VCs still eat them up though, and that’s why you keep seeing more of them.  There is a much more critical metric being overlooked because it’s just not as glamorous

That metric is the number of full timers.

What sounds better to the press and investors?  

100,000 experts or 100 full-time experts.

I’ll take the 100 full-timers, but I think most others would go for the big numbers. 

Take a look at successful marketplaces:

  • eBay has power sellers.
  • Etsy has the 10k club - for sellers that have sold over 10k items.
  • Uber has full time drivers.
  • Rev has full-time transcriptionists.

 

oDesk’s core user base in the beginning was a very small (about 50) number of php programmers in Russia that we quickly employed nearly full-time.  I chatted with almost all of them on a weekly basis.  When they were under-utilized, I would work my ass off to find them a new client so they could continue working full-time through oDesk.

Full timers define the health of the marketplace.  The 80/20 rule is in full effect here.  Marketplaces need a metric to indicate how many people are really heavy users of the platform.  In labor marketplaces, you can think of it as the people that are relying on the platform for their primary source of income.  Those people will be incredibly motivated to help the company, to increase their earnings, and to invest in their online reputation. In contrast, if you don’t have people that are relying on you for their primary income, you’ll have a very fickle audience.  They will not care much about their online reputation, they will not drive turnaround times lower, and they will be disintermediation risks. They won’t open your emails, they won’t participate in your community forums, they won’t give you product feedback, and they won’t be telling all their friends about the platform.

It’s the full timer who will do that. 

You can also be sure that if you ask the full timers the Sean Ellis question, “how disappointed would you be without the <marketplace>?” — you’d definitely get the answers you’re looking for.

Second, look at the issue of utilization rates.  When I was in consulting, I had to maintain an 80% billable ratio. Same goes in labor marketplaces.  But, you need to work with the supply side to help them achieve the high utilization.  Make sure you have enough demand to support your network - make sure they can spend most of their time working and earning. In many cases, you need a surprisingly small number of providers to support the demand. 

In the past couple days I’ve had chats w two successful marketplace entrepreneurs. I was amazed to see that one of them had only 12 individuals on the supply side supporting a 32k monthly business.  He knew every one of their names and new that one was having some health concerns.  They were all part of the family.  In another conversation, Chris Waldron from TakeLessons shared that he included every provider in the network in a bi-weekly town hall meeting.  They were treated just as he treats the full employees of the company.  This could only happen with a complete focus on the core full timers of the business.

To judge success, a key metric should be determined for the business - maybe it’s # of people earning more than $500 per week, or # of people working more than 30 hours per week.  I bet Uber has phenomenal metrics in this regard for their drivers.  Every driver I’ve talked to says they get all their business through the platform.  If they had instead added 1000s of drivers before they had the demand to support them - all of the suppliers would lose interest very quickly.

So, the next time a VC asks “how you are going to get the providers” - just tell him that’s the wrong question to ask.

Innovations in Customer Effort - Trader Joe’s

I love anything that lowers the customer effort.  The best companies in the world are on a constant quest to make things easier.  Trader Joe’s has made a very simple innovation to the standard Express Lane.  

What’s easier? 

a) counting the items that you’ve selected to see if you’re under the 14 item limit, and then deciding which items to put back if you’ve accidentally selected 16 items. 

b) know if you’re carrying a hand basket. 

 

Running an Antifragile Startup

I recently finished reading Antifragile from Nassim Nicholas Taleb.  In short - it’s amazing.  Easily makes it to my Top 10 Books Ever Read list.  Everyone should read it for business and for life.  It unifies Wall St bailouts, Silicon Valley’s success, why restaurants are good, and why the Paleo diet is best for your body. 

What does antifragile mean? - It means things that gain from disorder.

Or as wikipedia says: 

"Simply, antifragility is defined as a convex response to a stressor or source of harm (for some range of variation), leading to a positive sensitivity to increase in volatility (or variability, stress, dispersion of outcomes, or uncertainty, what is grouped under the designation "disorder cluster"). Likewise fragility is defined as a concave sensitivity to stressors, leading a negative sensitivity to increase in volatility."

So, I’ve reflected on my time at the early days of oDesk and what we did.  I believe we were doing some practices that were antifragile, we just didn’t have a good way to describe it.  Obviously, Taleb is far more eloquent and intelligent than I am. 

We had some sayings in those early days: 

  • Throw stuff against the wall and see what sticks. 
  • Break sh!t. 
  • Play whack-a-mole
  • Fast fail. 
  • Try before you buy.
  • Be more experimental. 

All of these things have elements of being antifragile.  It’s also basically at the heart of the Lean Startup movement.  Embracing failure and learning by observation tends to be better than lots of theorizing about the best strategy.  

If I were in a startup now, I’d constantly be thinking about how to make the businsess antifragile.  How to make mistakes and learn from all of them.  How to make sure that all employees have “skin in the game.”  How to create a culture of rapid iteration and experimentation. How to limit downside and maximize upside potential. 

Now - go read the book and Be Antifragile

All Introductions are Not Created Equal

Everyone knows that the best way to approach VCs is through an introduction. Mark Suster points out 4 obvious channels for introductions: lawyers, recruiters, portfolio companies, and other entrepreneurs. There is also other VCs and angel investors. But, from a VCs perspective, all intros are not created equal.  There is a huge difference in my level of excitement for a startup based on the person that makes the intro.  

The point of going through an introduction is widely understood: VCs get tons of pitches and going through an intro is a good first-pass filter.  I take meetings with almost all introductions that are made to me (fire away). But, like I said, I place my own filter on the quality of the referrer.  

Here’s a little inside peek into the way I think about it: 

The questions are:

How good is the deal flow of the referrer? Do they hang out in elite circles? Or are they fishing from the bottom of the well.  The quality of the referrer’s network is usually proportional to the quality / success of the referrer.  If the referrer has had great success, chances are their network is damn good.  In addition, seeing a lot of deal flow tends to increase the referrer’s judgment.  As a species, we’re really good at determining relative strength and poor at determining absolute strength.  So, seeing lots of deals means that you’ve seen enough data points to understand which ones are the best, and hopefully you’re helping those companies out with introductions. This criteria is far more important than how well I know the referrer. I have some great friends that make intros, but I don’t necessarily respect their judgment about startups. 

What is the incentive of the referrer?  Introductions are the social capital of the valley.  What’s in it for the referrer?  I want purely intrinsic motivation.  If the intro is coming from an existing investor, it may be great, but they are also protecting their investment.  If it’s coming from a lawyer, they are probably on the startup’s payroll.  If it’s coming from another entrepreneur who is just a friend, the motivation is to improve social capital by making quality introductions on both sides.  I like it when intros don’t have any financial incentive attached to them. 

So, the 2 key things that matter when I assess the intro: 

  1. Quality of Referrer’s Network (their deal flow)
  2. Incentive

Disclaimer: I sincerely hope that nobody is offended by the following statements.  These are simply my candid observations from the past couple years.  These statements are all broad generalizations, of course there are exceptions.  I hope to continue receiving deal flow from all of these groups, so please don’t step sending intros. :)

I took a stab at charting out introduction quality on this 2x2 matrix.  The most interesting finding for me was the VC introductions.  It’s possible that the conventional wisdom about VC introductions is wrong.  (conventional wisdom is that VC intros always beg the question ‘why didn’t you invest’ and therefore are a deal-killer)  If a VC that hasn’t invested in a company refers a deal to me, I have to believe that 1) they see a lot of deals, 2) there is some reason they passed, and  3) the motivation is to strengthen future co-investor relationships.  In order to strengthen relationships, you obviously need to send quality introductions.  Therefore, I have to assume they passed because it wasn’t a fit for industry, stage, or competitive reasons, but not because they thought it was a bad business.  

image

Let’s look at a few categories in more detail: 

Lawyers - I value these fairly low. Lawyers are paid contractors for a startup.  If I’m paying someone and I ask for an introduction to people they know, they’re somewhat obligated to do it to preserve the paid relationship.  Also, since they don’t have the benefit of seeing a lot of the same type of company, they are not great at judging the relative quality of each one.

Bankers - these are the worst. If you hire a banker to try to help raise an early round, it’s the kiss of death.  It reeks of desperation since you can’t get intros without paid help. 

Recruiters - I rarely get these, probably because I don’t know that many recruiters.  I think they fall into the same camp as lawyers though. 

BD folks - these are interesting.  Take for example, a BD director at Salesforce working on the Force.com platform.  They see a ton of startups building apps on top of their platform.  They have inside information about how well these apps are performing in the marketplace.  They have a good instinctive sense of what their customers will adopt and what they will not. 

VCs - As I mentioned above, I think the conventional wisdom might be wrong on this one.  Of course, if everyone believes it then it doesn’t really matter.  VC intros that are looking for co-investors or follow-on investors can be really good intros.  I believe there probably should be more VC to VC intros when someone is passing on a deal and it shouldn’t carry as much of a stigma as it currently does today. 

Angel investors - depends all on how much I respect the angel investor.  Have they done good deals? Are they making the intro because it’s a deal they’ve done and it’s going south? Or because it’s a deal they’ve done that’s doing well and is a unique intro to me because of my expertise.  Is it an angel investor that’s in a ton of companies or is it an angel investor that does a few, focused investments (the latter is better). 

Entrepreneurs that we’ve passed on - We passed.  There was a reason.  These are still usually good and my second favorite source of intros, but it’s a mixed bag.  If the entrepreneur knows me well, there’s a good chance that I was quite interested in the startup and have a lot of respect for the referrer.  If I’ve only had one meeting with the entrepreneur, chances are lower that it’s a strong intro.  You could ask why we passed and that will give you a good hint of whether or not you should ask for an intro from them. Overall, these are my second favorite source of introductions, just be aware. 

Entrepreneurs that we’ve invested in - Well, this is kind of obviously the best. I saved it for last.  We clearly love the entrepreneurs because we invested.  The motivations are very “pure” - they don’t want to send poor quality introductions and will usually apply the strictest filter.  Whenever possible, try to go this route. 

So, my final thoughts: From the entrepreneurs perspective, just know how which introductions are the most powerful and act accordingly.  From my perspective, I welcome all introductions and almost always take the meetings, but the referrer does have an influence on the “starting point” for the startup.  Great introduction - I’m already excited.  Poor introduction - I still need to be convinced.