Editor’s Note: This post was originally published on Seattle 2.0, and imported to GeekWire as part of our acquisition of Seattle 2.0 and its archival content. For more background, see this post.

By Gerry Langeler

Last time (in part 1), I talked about the People issue.  This time, we’ll move on to the second of the four great risks VCs evaluate when looking at a new deal: the Product. 

Because we are technology investors, at OVP this actually means Product + Technology since in many of our investments it is not a certainty the product envisioned by the founding team can actually be delivered, or will work as advertised.
 
In any event, as you are presenting your business plan to us, we are asking the following questions about your product and when appropriate, your technology:
 
1)      If this is an area of deep technology barriers, do you have clear rights to the intellectual property (IP) you need to have freedom to operate?  How much work has been done to validate that assumption?  Who are the competitors most likely to feel threatened by your arrival – especially those who employ more lawyers than you will have total employees? If this is not a patent issue but one of know-how and trade secrets, as in most software companies, what is the evidence that you possess proprietary advantage?
 
2)      How hard is it to do what you are setting out to do?  This actually cuts both ways:  If what you are doing is not hard, that means it is very likely you will deliver, but it will be much easier for someone to come up your tailpipe. If what you are doing is very hard, then you may not succeed in getting it done, but if you do, you’ll be in the clear for a while.
 
Frankly, if we have to choose, we’ll go with the latter. We like tough technology barriers erected for others to have to hurdle. Not all VCs do – another reason to match yourself to your potential funding source.
 
3)      Is your planned offering a “feature”, a “product line”, or a “company platform?”  Most great companies are not built around a single product, but a set of products covering a range of needs across some adjacent market segments.
 
So, we ask ourselves: Is this a capability that we might see subsumed in the next release of some Google or Microsoft offering (a feature)?  Or is this a capability that might be stand-alone for a while, but really needs to be part of a larger more complete offering to succeed (a product)?  Or is this a platform, with a product as its first deliverable, but with a broad foundation that can support multiple products and/or services over time (a company)?  Companies built around a single product can be successful, but they are inherently more risky because a competitor can hurt you much more easily than if you are a platform.  Platforms can be harder to get launched, because they may not address enough of a pain point immediately to get budget dollars.
 
We don’t ever knowingly invest in a “just a feature” deal.  We will sometimes do a “product deal” if we think its space is large enough.  Platforms are our favorite, as long as the first product from that potential platform can penetrate the market on its own merits.
 
4)      However, for those who lean towards a platform play there is a trap.  Somewhere at the outer reaches of a platform you become a “boil the ocean” project. Those companies are simply biting off more than any rational start-up can chew – often more than any large company can chew. (Mixed metaphors are us).  Ask yourself if any reasonable team of people can do all the things you are setting out to do in the time allotted. 
 
That said, the company I helped found (Mentor Graphics) was told by knowledgeable observers that we couldn’t possibly do what we said we were going to do.  When we did, we became the fastest growing software company ever to $200M in sales (to this day, in constant dollars).  So, if you can boil maybe not the ocean but a good sized bay, the rewards can be terrific!
 
5)      Do you have adequate control of your destiny?  One of the very first VC deals I was involved in as an outside board member was planning to build its future success on top of Windows 1.0.  (yes, I am that old) You can guess how that one ended.  This is not to say there aren’t big rewards available for those who build into existing eco-systems.  But betting on a new external eco-system to arrive on your schedule is multiplying your risk.  Betting on an eco-system to spring up around your little piece of the world, as a requirement for your success, is multiplying your arrogance.
 
6)      Does your success require success to be successful?  Huh?  You’d be amazed at the number of Internet deals we’ve seen that essentially posit, “We’re going to do X, and then once we get to 10 million unique visitors a month, we can monetize that with advertising.”  Well, of course you can!  The problem is getting to the 10M uniques. That is damn hard. Assuming you can make that happen by just showing up is naive.
 
7)      Do you have multiple revenue streams?  That’s not good.  What?  Doesn’t that lower risk?  Not in our experience.  There’s a proverb on my wall that says, “Do not try to catch two frogs with one hand.’  As a start-up, you barely have one hand.  Some of us can remember back to the early days of Sun when Scott McNealy was hedging his bets with both the Sparc architecture and Intel architecture….and Sun was struggling.  His famous, “Let’s put all the wood behind one arrowhead” was a key turning point in their ultimate success (until recent times).
 
Again, to be fair many angel investors love multiple revenue streams.  In their world, it does reduce risk.  But, they usually don’t have the diversification we have, and usually aren’t as ready to be totally wrong and lose all their money in that investment in return for a chance to be screamingly right.  So, a project that has multiple revenue streams may be better for angels than for VCs.
 
Final thought, if you do present multiple streams look at your numbers.  Are there some streams that you could just drop and not materially change the top and bottom line?  If so, do that!

Let me leave you with a case study of a deal OVP did that looks as if it will be a huge winner.  I will not name it to protect the innocent, and to not jinx it, either.

This company came to us with a revolutionary product concept that was essentially two orders of magnitude better than the competition.  In fact, it was so much better it would open up potentially huge new demand.  But, to succeed they had to deliver on three separate technology areas, pushing or breaking the state-of-the-art in all three.  This was VERY close to a boil the ocean project, so much so that one of our more risk-averse partners at the time voted “no” on the deal.  But, the rest of us thought the risk was balanced by such a large potential reward that it was worth the chance. In addition, this was (and is) a killer team, so the People risk part helped mitigate the Product risk.

The company had all its IP nailed down and it would be completely self-reliant. Although it might ultimately engender a new eco-system around it, that wasn’t necessary for it to succeed.  A very large company could be built around the initial product concept, but the technology (if all three legs worked) had applicability into adjacent areas.  It had a single major revenue stream, albeit a very different model than its industry was used to.

Time will tell whether this one delivers as it appears it will – but against the criteria above, it made our Product cut-line with ease. 

Next time, part 3 on the VC decision tour will cover Market. And it will contain some controversial positions, you can be sure!  :-) 

 

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