How to make bad investments

Photo credit: Wil Stewart

If you have read the classic The Innovator’s Dilemma, you will realize that the reason why established companies can’t innovate quickly isn’t because they are stupid or blind, but because they are efficient and optimized to make their current business more profitable.

Clay Christensen studied companies that were well run and found that they miss great innovations because those areas are initially too small to impact their core business. Paradoxically, the best run companies are often the most effective at building their core business and thus less flexible to pursue new areas of innovation.

Investing in startups has a similarly paradoxical nature. No one wants to make bad investments, but optimizing for the characteristics that make most established companies work well is exactly the wrong way to invest in startups.

Here are a few pairs of myths and realities of investing in startups.

1. Let’s talk about the team. Everyone wants a great team.

Myth: look for a team who has great experience and has “done it before”.

Reality: look for a team who is able to learn and grow the fastest.

In well established companies and industries, leaders need to have significant prior experience to work with a more experienced team. They benefit from industry relationships built up over the years. But in a startup, the crucial factor is speed. No matter how much experience someone has, doing something new will create new problems that requires rapid responses.

Speed and experience are not mutually exclusive, but sometimes having experience creates a sense of “we already know how to do this”. In reality, there will always be many unforeseen challenges so look for the team that is willing to experiment and learn the fastest.

2. People all want to invest in a killer new product or service.

3. Everyone wants to invest in companies that operate and grow in a huge markets.

4. We all want to invest in companies that have strong and predictably business models.

The investor’s dilemma