Founder Due Diligence

I read the Pitchbook article Discovering the Next Unicorn Founder with great interest this week and have been giving it consideration over the last few days. It’s been a great one to mull over.

With the abundance of capital being put to work, this moment reminds me of the late 1990s pre-Internet Bubble, although it’s different in many ways too, the primary being that it’s relatively easy for anyone to found a software company today, whereas software entrepreneurs were the only ones who had the know-how to stand-up products quickly in the early 2000s.

Software founders had a reason to start these companies back then too.  At the time, software development was viewed as a “necessary evil” (read: overhead) and not as a value-add.  I don’t know about you all, but every developer I know would bristle at being told that they’re a cost center and nothing more.

Wu and Knott wrote a paper in 2006 titled “Entrepreneurial Risk and Market Entry”, which basically says that there are two forms of uncertainty in entrepreneurial ventures: market demand uncertainty and entrepreneurial ability, and entrepreneurs display risk aversion when it comes to market demand uncertainty but exhibit “risk seeking” tendencies with regards to ability and uncertainty.  Basically, entrepreneurs are willing to bear economic risk when overconfidence compensates for their risk-aversion regarding the market.  Dharmesh Shah, Hubspot co-founder, wrote about this issue also in OnStartups, his MIT dissertation published in the mid-2000s.

Anyways, I have a point here: Piercing an entrepreneur’s shield of confidence (more often overconfidence) is very hard to do and also not my role and responsibility as an investor.  However, diligence can be a good friend here and the article poses a thoughtful insight here: Try to uncover when the founder has created value.  The value-insight is important and the context under which they made the breakthrough is critical.  Was it a pivot? Did they have endless cash at their disposal?  Were they under a deadline? Etc. 

Analyzing founders is a diligence rabbit hole and every venture investor has a lot to say on this topic as you can imagine but the “value question” is an important one that I should begin using.