August 9, 2011
Forming an investment philosophy
I met with a young venture capitalist today who has been investing aggressively in consumer internet over the past 18 months. We discussed investment philosophies and it got me thinking about my own. I began making angel investments in 1999 through Bayview Partners, the Robertson Stephens partner fund. Some went well. Most did not. After leaving Robbie Stephens, I made a few investments on my own. A higher percentage of these went well (Wayport, Cars Direct), but several went to zero or returned less than my invested capital. Over the past two years, as startup fever has consumed New York City, with a front row seat, I’ve resumed angel investing on a selective basis and feel as though my chances for success continue to improve with each successive investment made. Much has been written about venture investing theory, pattern recognition and the like, and I agree with most of it, but I think it takes some actual investing experience over several years to establish a sound approach and philosophy, including a few mistakes along the way. As James Joyce famously said: A man’s mistakes are his portals of discovery. Sadly (for their LPs), some of the new players in venture capital are diving in head first, learning as they go and most likely losing gobs of money in the process.
Roger Ehrenberg, one of the smartest investors in New York City, has written extensively about his investing philosophy and how it’s evolved after dozens of investments made from his personal account (and now IA Ventures) over many years. As I contemplate investments I’ve made historically, and opportunities I’ve passed, I’ve formulated the following theses which resonate with me today. 99% of the angel investments I make over the next year will fall into one of these four categories:
A Home Run Transactional Model (50%) This category of business involves selling something of value and getting paid for it. A novel concept to be sure, but one that has proven to work over the years. The best (and most extreme) examples of these businesses involve selling something of little objective value for lots of money, ie: Zynga. There are lots of other less extreme examples, where businesses are trading a valuable good or service for real revenue. My current employer, Outbrain, is one such example. Another is ZocDoc. My friend, Cyrus, launched ZocDoc four years ago and pitched me on the idea when they were fundraising. The concept made logical sense and I had confidence in their ability to execute based on track record and personal reputation. I referred it to some VC friends, but none bit. Unfortunately, I wasn’t making investments at the time as they’re quietly approaching $1 billion in value.
Duh – Why Didn’t I Think of That? (20%) This is my favorite kind of investment. When I hear the story, it’s so obvious and makes so much sense that I feel like an idiot for not having done it myself. The product solves an obvious problem for lots of people and adoption seems like a given. The most glaring and persistent example in this category for me is EZ Pass, but there are others. If I hear a pitch that triggers this emotion and I believe in the founder and terms of the deal, it’s a no-brainer. These are also the rarest of deals and the hardest to find, which is why they don’t represent a larger percentage of my pie.
Media Business with Early Traction (20%) This category is plentiful in the NYC ecosystem right now. They are social or viral or both and have a clever way of attracting users and building loyalty. Revenue opportunities are often loosely defined or tabled for later and investors often assume that they’ll figure it out or have a good shot at getting acquired based on product traction or cache. Many of these will go out of business when they run out of cash before figuring out a revenue model, but a few will build products that are wildly successful. Betting on an acquisition is inherently difficult for me and feels like a low probability for a successful outcome so I approach these opportunities with trepidation. The product and team need to be “special” and in a space that is overwhelmingly attractive and growing. These three boxes require a 
with every investment, but the threshold for greatness is even higher in these cases.
Special Founder/Flyer (10%) These are the ballsiest deals to do, but can also be the most rewarding. During coffee today, we discussed Andrew Mason pitching The Point to the NY Tech Meetup back in 2007. The idea seemed crazy (maybe overly ambitious), but the site was well-designed and there was something about the pitch that resonated. In this case, the story is legend and folklore, but I believe it makes sense to back an inspired founder with a crazy idea 10% of the time. The Lightbank guys did exactly this and ended up with a once in a lifetime investment in Groupon.
Investment philosophies evolve over time and mine surely will too, but this feels like a great starting point as I consider angel investments over the next year. To pass muster, there are many more boxes that need checked to be sure, but if it doesn’t fit neatly into one of these four qualitative categories, it probably isn’t worth the consideration time for me.
If you’re an investor reading this, please let me know your thoughts.