Sourcing dealflow

I recently did a talk on dealflow; what it is and how to think about it in early stage investing. Here are the key points from that talk. It is mostly written with startup investors in mind, but hopefully it’s valuable to those on the other side of the table as well.

What and why:

If you’ve made it to my blog you probably already know what dealflow is, so this’ll be short: Dealflow is a term used for the quantity and quality of investment offers an investor receives. The term is mostly used when talking about privately held companies, as public companies are available for everyone. Privately held companies are not, and thus having better dealflow can be a competitive advantage.

You could say there are four stages of startup investing (I first heard this in a podcast with Brian Singerman of Founders Fund), and those are:

  1. Finding companies
  2. Picking companies
  3. Accessing companies (aka “winning deals”)
  4. Helping companies grow into winners

Investing in private companies is just as much about finding and accessing companies as it is about picking and helping. I’d argue it’s impossible to succeed consistently if you don’t master finding and accessing, and I’ll refer to this as dealflow.

There are two extreme ways to think about dealflow. Does the founder pick the investor, or the other way around? These two perspectives should not be considered a dichotomy, rather as end points on a spectrum. We’ve done good investments in companies where nobody else had conviction, and we’ve done good investments in companies where we had to fight to get access. Most investors do both, but having awareness around that there are different is helpful when prioritizing how to work with dealflow.

Inbound deal sourcing

On one end of the spectrum; founders pick their investors. Put differently, the founders who eventually end up building the winners are so obviously good they can choose between every investor out there. If this is your prevailing belief, everything you do should be about making yourself as attractive as possible to make sure you meet these founders - that you have proprietary dealflow.The two questions that should guide your work in this scenario is “why should I be contacted?”, and “how will they find me”. Let’s start with why:

First of all, you have to match with the company. All investors have preferences with regards to investment amount, valuation range, geography and/or sectors, and these preferences exclude some percentage of the total available dealflow. If your filter is too narrow, you end up without any dealflow. Opposite, you become the jack-of-all-trades and nobody comes to you first. Find the balance somewhere in between (and break rules).

Most often, there are many investors with similar preferences, meaning you have to add something beyond capital to be approached. This is normally any of the following:

Competence: experience and advice of benefit to the company, either generic “how to build a company-perspectives” or knowledge related to the specific company’s technology or market.

Network: knowing people (customers, bigger investors, advisors, potential employees etc) that can help the company.

Brand: “we are backed by the founder/investor behind [famous company]” can get a company a long way with regards to recruiting, future fundraising and so on.

Fundraising takes time, and startups can’t afford to search for the perfect investors forever. Put differently, it’s not enough to be the best match for any given company - you also have to be on their radar. The “how will they find me” part:

Doing this means marketing yourself, work that can be done both online and offline. Online it means blogging, newsletters, and being available for interviews and comments when journalists report on topics that you want to match with. Offline it means being at events, participating in panels, hosting meetups and dinners and so on. The whole point is to tell the world you’re looking for startups, and doing it so frequently you’re top of mind when the companies you want to fund start fundraising.

Outbound deal sourcing:

The opposite perspective is that it’s only in hindsight we know who the good founders were - good investment opportunities are accessible for everyone as long as you find them. And there are many supporting arguments: the best returns comes when you’re both right and non-consensus, and the most groundbreaking companies start out looking like toys. And there are plenty of examples of this: the story of Airbnb’s first 1000 days is one of my favorites, another is Robinhood’s 75 rejections.

Outbound sourcing can be done in multiple ways, and both online and offline. Offline means being at events, as well as reaching out to your network directly. Online means browsing relevant social news sites (in Norway: FB, Linkedin, Shifter, DN etc), looking through lists of companies that receive soft funding (Innovation Norway, BIA, etc), and so on. And you can subscribe to my newsletter to get the Norwegian tech stories I find most interesting :)

Doing outbound activities has its benefits. It’s a quick and direct way to approach companies you find interesting without spending time broadcasting your preferences first, and you can very quickly assess a high volume of relevant companies. Timing might be off - you might contact companies when they’re not fundraising - but that’s not necessarily a bad thing. The negative side of this strategy is that you’re most likely not seeing any proprietary dealflow. If you believe the best founders pick investors, they probably don’t see a lot of reason to showcase what they’re building broad enough that you discover them soon enough.

To sum up these few paragraphs, there are lots of aspects to think about when it comes to dealflow. Probably the most important thing is to be aware of the four stages of startup investing, and having a hypothesis around which (ones) you’ll work at improving. I’m continuously iterating as I learn more, and I don’t believe there’s one best way to have good dealflow. There are many ways to win.

Co-founders, part 2

Following up last week’s post on co-founders, and I’ll keep it short this week as well. Let’s say you’ve decided it’s best for your business if you bring on a cofounder, how do you go about finding/selecting such a person?

As with everything in startupland, it’s impossible to generalize. I’ve seen many examples of companies succeeding doing the exact opposite of what follows. But I firmly believe the following approach has the highest probability of success.

The obvious cofounder is someone you’ve known for many years, a friend whom you’ve also worked with, whom you share values and ambitions with, who is adaptable while at the same time has abilities that perfectly complement yours. But of course, such a person does not exist - there are trade offs. Given that, here are the some characteristics I would look for - in prioritized order (list is obviously non-exhaustive):

1. Shares values and vision: This is rarely talked about initially, but can really fuck things up further down the road. Unless you agree on what to build, the journey will be unpleasant. More than it usually is.

2. Chemistry: Someone you work well together with. Can you disagree and argue in a productive way?

3. Adaptability: What you start out doing might not be the thing you end up doing. Being an expert at the former without adaptability might stop you from start doing the latter, even though it’s the right thing for your company.

4. Complementary skillset: If you’re a builder, get a seller. And opposite. Allows for specialization, and with those two roles in place you normally should be able to get a working prototype in the hands of some customers. But diversity is more than that, preferably you also find someone who looks/thinks/acts different from you, due to the many benefits this brings.

Preferably, you find someone who ticks all these boxes in some ways. If you team up with people who are too similar to, you end up with a very expensive machine that’s unable to build or sell. That rarely goes well. But what I find is that most people start out looking for someone with a complementary skillset, not someone with shared values and vision. This is okay if you’re just looking for a job to be done, but building a company is so much more than that.

This is why I, and many others, advocate finding someone you already know. Discovering whether you actually work well together and towards the same thing is hard to discover over coffee, and something you want to know before you embark on your journey (and before most will fund you).

If you agree with this perspective, it has implications for how you go about looking for a co-founder. Activities such as “co-founder dating” and showing up at a technical university should be replaced with spending time with your immediate network. Do 50 cups of coffee with people you know and potentially one degree further (people they know), and chances are you’ll find someone who would be a good match.

Sometimes you find people who are right and available, they just haven’t broadcasted their availability to the world (very few do this). But when you meet them you learn they are looking for their next opportunity. Other times you find people who are a good match, but unavailable at the time (eg. they have no savings and a mortgage). But I’d much rather bring on such a person part-time to start, with an agreement this person will go full-time once funding allows for this. And sometimes this search is unsuccessful. But due to the benefits of having a cofounder, I’d always recommend doing the search.

Co-founders

Often when I meet with solo founders, the question of whether to bring in a co-founder comes up. Should I do it? If so, who, and why? While it’s impossible to generalize as there are many examples of solo founders succeeding , my perspective is usually that it’s a good idea to bring in a co-founder early on.

First and foremost, being more than one person improves output. Not only the quantify (more hands at deck), but also the quality - products get better with more people involved (up until a certain point). And a cofounder does this in a significantly different way compared to what an employee would. The ownership and status that come with a co-founder role typically makes such a person take a longer-term approach to the work.

Starting a startup is very stressful, and nobody I’ve talked to describes it as an easy journey. There’s ups and downs, and you have to cope with that. This is definitely not easy, but having someone to share these issues with tend to make it easier to cope. You can laugh of fucked up situations together, and pull one another up if one person is feeling down.

Having a cofounder also show recruitment power - which is something investors often look for. Are you able to convince others - most often friends - that this is a good idea. This is the same ability that is needed to convince customers, new hires and investors - so a cofounder is some sort of proof you know how to sell your company to others.

If you decide you want to bring in a cofounder, the next question is who to bring in, where to look for this person, also when to start looking. I’ll cover this in a future post.

Book review - The Upside of Stress

Last week I referred to two books I was reading simultaneously. Yesterday I finished the second one - the one on working hard - called The Upside of Stress. This is one of the more important books I’ve read lately. Here are some of my thoughts and why I recommend it.

I first heard of the book in this podcast with Keith Rabois, someone who is very vocal on the topic of working hard - strongly arguing for it’s importance if you want to accomplish something of significance. His advice was to watch the author’s TED talk, and if it sparked an interest - go read the book. So I did both.

The premise for the book is that stress - contrary to popular belief - isn’t dangerous. Research shows clearly that generally, people who feel stressed have more health issues. What’s interesting is that if you divide all stressed people into two groups, those who believe stress is dangerous and those who don’t, it’s only the first group who are at risk. This suggests that stress isn’t harmful, rather it’s the belief that stress is dangerous that is harmful. It’s a mental thing.

My initial to this reaction was “hey, those who don’t believe it’s harmful haven’t experienced real stress”. I guess this is the normal reaction, as everyone I’ve discussed this finding with has reacted similarly. Obviously, that is not the case. Otherwise it wouldn’t be worth writing a book about. And the evidence presented in the book clearly shows that almost all types of stress are perfectly harmless unless you think they are harmful. It’s a mindset thing.

When it comes to physical exercise, we completely understand that in order to grow our muscles we have to stress them. Running intervals or lifting weights hurts as we stress lungs and muscles, but nobody’s alarmed by this. It’s the only way to grow and get stronger.

The brain is a muscle. While I believe most know this, our actions and beliefs does not reflect this. We tend to believe in talent (fixed mindset) over grit (growth mindset). And we believe it’s healthy to stress all muscles except our brain. I’ll be the first to admit that I’ve felt bad about being stressed before reading this book. Going forward, that is not the case.

As with all exercise, too much leads to burnout rather than growth. But there’s no need to be worried about the stress most people experience on a regular basis. Rather see it as exercise, a growth opportunity and something positive. This book has definitely shifted my perspective in that direction.

Working smart

I’ve been reading two books on individual performance lately, one on working hard (The Upside of Stress) and one on working smart (Peak). I finished the latter last weekend, here’s a short review.

There are conflicting views on what makes someone succeed. Talent? Hard work? Smart work? The book completely debunk the importance of talent - and puts forward a lot of evidence to support this claim. Every “natural talent” out there put in tons of hours to get to the point where people believed they had special abilities.

Further, the authors argue that you have to work both hard and smart if you want to do something remarkable. 10 000 hours can make you good, but it’s only 10 000 hours of deliberate practice that make you great.

The concept of deliberate practice was first introduced to me in the book Grit - which overlaps a lot with Peak. But where Grit mostly focuses on effort and not giving up, Peak is all about the importance of deliberate practice. Translated: if you really want to excel at something, it’s not enough to just show up. When you show up, you also have to spend your time wisely.

Deliberate practice means having something measurable to work towards. This could be anything from a 400 metres lap-time to a certain number of chess moves. Without something to measure your performance up against, you won’t see progress - and then stagnation is just around the corner. The book describes the concept deliberate practice in detail, and strongly argues for its importance. It serves as a good reminder that while showing up is necessary, it’s not sufficient alone.

I really enjoyed the book (listened to it as an audiobook), and it’s one I will recommend to others.

Consistency

I believe consistency is one of the most important leading indicators to successful outcomes. This has been said in many ways by many people before me, eg. Woody Allen’s “80% of success is showing up” or the 1.01ˆ365 =37.8 perspective.

Thing is, being consistent is really really hard. It’s about habit forming, and it usually revolves around activities that might be important but arent’ urgent. It’s easy to sometimes not to prioritize such efforts, even though the long-term effects of consistent effort are very positive. This is why I’m spending a lot of time trying to improve with regards to this. I’m having success when it comes to both meditation and my biweekly newsletter, but not with regards to regularly writing here.

I have this blog mostly to improve my writing skills, but also to have an archive of topics I frequently discuss with entrepreneurs. I find it very helpful to put my thoughts in writing, as my perspectives on any topic immediately become much clearer - improving both my understanding and communication around it. Long-term I might try to drive some traffic to this site as well, but for now this is more a public place to post thoughts for my own record.

In other words, the writing regularly is something I know is very valuable for me. Because of this I said to myself beginning of the year that I should publish something here at least every Wednesday (excluding holidays). Four months in that has not happened, and I belive part of the reason is that I haven’t made any public committment to doing it. More people knowing of my committment -> higher cost of not being consistent. So this post is to help me find the time to write stuff here every Wednesday. To help me improve my consistency. Let’s see how it goes.

Convenient truths

I am thinking a lot about convenient truths these days. It’s probably a different way of framing confirmation bias, but in many settings I find it’s a better term to use. Especially in situations where incentives are strong.

One current example being the oil industry, and how they strongly advocate more oil extraction oil while still admitting that climate change is real (at least most of them). They always have very compelling arguments (read:convenient convictions) for such points of view.

Unfortunately, I find that most people focus more on the argument (and why it might be flawed), and (too) little on why it might be the case that a certain person/entity might have that specific point of view.

“Show me the incentive and I’ll show you the outcome”, Charlie Munger is known for saying. In many cases, the outcome is a preference for putting forward convenient truths.

Principles

Over the past few year I’ve started to accumulate a few “principles” that I try to live by. There’s been additions and subtractions to this list over that period, so I wanted to write down my current status - to have something to benchmark against in the future. So in no particular order, here they are:

Don’t cheat: Applicable to both professional and personal settings. For work; don’t try to trick (create fake urgency, nasty terms etc) founders into agreements they might regret later once they get more knowledgeable about the fundraising side of business. It’s not fun to win that way, and more important you win short-term but lose long-term. Outside of work the same: it’s no fun winning unless you actually deserve it. No moral shortcuts.

Founders pick me, not the other way around: My job is to find the best possible founders to invest in. I don’t believe I have special abilities to spot opportunities broadly compared to others, meaning I’ll find founders others might to. The way I get to do good investments is by being a favorable options for those I want to work with. And hence I work to be just that.

I work for the founders, not the other way around: Rule number one: don’t do any damage. Rule number two. Be helpful. Best way to do both is to consider myself a helper to, not a manager of, startups.

Have fun: Whatever you do make sure you enjoy it. It’s the only way to stick to something long enough that you get really good at it.

Be good: Karma has a tendency to bite back. Also, you never know what battle any other person is fighting. So always try to be good.

Work hard: I don’t believe in only smart work, especially if you really want to build something significant. Remember self-care, but don’t go out expecting you’ll build anything important if you plan to work the same amount as every body else.

Be honest: Nobody improves without feedback, and I try to give as honest feedback whenever I can. This is not the same as being mean. You can almost always be both honest and positive. I try to be.

Teach fishing: As in, don’t give a man a fish. Be patient and try to explore underlying dynamics rather than jumping straight to the conclusion. I believe in this, but still often struggle to put it into practice.

Strong opinions held weakly: When the facts change I change my opinion, but before that I try to take clear positions on issues. I find it’s the best way to learn and explore any topic - as long as others involved know that. This one I’ve taken from Bezos, same with the two next ones.

Go with 70% of the information: As long as you are directionally correct you learn more by action. And most decisions are reversible, so no need to slow down to increase accuracy.

Regret minimization framework: When facing multiple options, try to reflect on which alternative you’ll regret the most not choosing. And go with that one.

Do one thing: Focus. Nothing clears the mind like the absence of an alternative.

I look forward to revisiting this one further ahead.

Selecting Beachhead Market

So, this is a post I’ve been meaning to write for a while: selecting beachhead market. Very often when I discuss this topic with entrepreneurs, the discussions are unnecessarily blurry and unstructured. They don’t have to be, and this is what I would do to avoid it:

Before I jump into the details, note that this framework is more useful for entrepreneurs with a “solution looking for a problem” than the opposite . What I find is entrepreneurs most often are somewhere on a spectrum between these two extremes, so my thinking is this should be helpful for many early-stage founders.

As a founder, you have to figure out “who to approach first?”. You have a total addressable market, and it can be sliced and diced (aka segmented) into many pieces. Figuring out which piece to approach first is not always trivial.

While not always intuitive, I strongly believe it’s better to pursue one segment 100% rather than multiple in parallel. This does not mean picking the first one you find, but rather to quickly review the possible segments and quickly decide on one.

Now let’s say you have different segments where your product might be useful, how can you decide on one segment more quickly? The decision should be made with incomplete data (otherwise your decision making is too slow), but I believe you could aid your decision making process by mapping out your market segments. Here’s a walkthrough of how I would do it:

  1. Figure out which market segments you theoretically could approach first - and put them on a list.
  2. Figure out which criteria you should use to evaluate the markets. This might vary, but if I were making the assessment I would include the following:

    • Decision speed: How quickly are you able to go from initiating contact to a purchasing agreement. Quicker is obviously better. One of the most important things in my opinion, and the reason why I rarely recommend going after entreprise-sized clients while you’re a young company - they’ll choke you.
    • Market size: How many customers are there? How much is each customer willing to spend on your product.
    • Competition: How many alternatives does your customers have?
    • Product differentiation: How significantly is your customers’ pain reduced if they switch to the current version of your product.
    • Founder-market fit: To what degree are you able to approach this market? Do you have preexisting network, understanding, experience in approaching it. Are you motivated to approach it?
  3. Rate how important you believe each criteria is. Base level is 1, and if you believe one criteria is twice as important you rate it 2 etc. I don’t have a blueprint on how this should look, but I would probably weight them like this:

    • Decision speed: 2
    • Market size: 1
    • Competition: 1
    • Product differentiation: 1
    • Founder-market fit: 2
  4. Assess the critera for each market segment on a scale of 1-3.

Some would probably argue you should reach out to your potential segments and do some research first, but I think it’s sufficient to take your best guess. I haven’t seen anyone build real confidence around a segment through a short research period - getting to know a market takes a long time. The point is getting to the segment you should thoroughly research more quickly.

Either way, you’ll end up with a table looking something like this:

Market segment assessment

What you now have, is your best guess at what is the most attractive beachhead market segment. But as you are inputting every variable, you already understand you can make this look any way you want.

In other words, what you really have is a better overview of what to take into account when deciding on which segment to focus on. If one segment scores really low, it could mean either that you shouldn’t focus on that market - or that you’ve weighted and assessed the segment poorly. You have to be the judge of which one it is.

The purpose of this framework is not to make the decision for you. Rather, it should make it easier to discuss your alternatives, and thus decide more quickly on which one market to target. And once you have have decided - don’t second guess it all the time, commit to that plan until you succeed or you have clear evidence you should do something else. To end with a Henry Kissinger quote;

“The absence of alternatives clears the mind marvelously.”

Side note: once you decide on one segment, I find this framework to be really good to bring into customer meetings. Eg; if you chose the market because you believed their decision speed was really high, make sure you actively pay attention to this as you talk to your customers. Is that hypothesis strenghtened or weakened as you go on? Should you double down on, or reconsider market segment?

Side note 2: if you’re looking for more on this topic, I highly recommend this article on how SuperHuman built an engine to find product-market fit. An extremely structured approach to the problem, and afaik the results have been remarkable so far.

New funds

So, yesterday we announced something we’ve been working on for a longer period of time:

Obviously, we believe this is very good news. Our mission is to help early-stage founders build great tech companies out of Norway, and capital is a very important part of this work.

It is both humbling and motivating that so many experienced company builders trust us with their capital, name and time. The search for the next 50 companies we’ll fund has already started, and if you believe you might be the founder of one of these companies I encourage you to check out our upcoming accelerator program - application deadline February 1st.

You can also check out the story in Shifter/E24 here.