The One-Two Punch: What We Invest In

The One-Two Punch: What We Invest In

 

Our task at Arena is to back the most exceptional entrepreneurs and support their companies through the earliest stages. For us to most effectively do that though, there’s a lot of work that goes into filtering which investments we want to make and can add value to. A small number are perfect fits, but many others – while potentially promising – just aren’t the right match.

Whenever I take my first look at startups, I use a “one-two punch” to quickly weed out most of them so I can focus on the right ones. The first punch is my set of “No Go” rules to quickly and ruthlessly kill deals that will waste both my time and the entrepreneur’s because they are objectively not fit for our strategy. The second punch is to filter the remaining ones through the framework of what we aim to invest in more philosophically – it takes more thought but lets us eliminate another 50% to 75%. Those that survive become official “Opportunities” in our pipeline that we sink our teeth into to reach a final investment decision (see “5 Questions I Ask Before Investing”).

Mark Suster wrote a good post last week encouraging people to focus their time at the bottom of the funnel. To do so, you need to build your own rules and processes that filter the top efficiently. I’m shocked by the number of investors who don’t have No Go rules and end up wasting a lot of time pursuing false leads.

Basic Rules

So to lay them out publicly, these are the basic rules of our investment strategy at Arena Ventures. Deals that don’t fit them get the No Go punch right away.

1. Stage: We only invest at pre-seed or seed stages (unless we’re following-on in prior investments).

2. Geography: Startups must be in Los Angeles or the SF Bay area. We’ll only make exceptions for NYC-based startups led by a founder we know well who also has backing from an NYC-based investor we deeply respect.

3. Allocation: We have to invest at least $400k. Period.

4. Valuation: Internally we have a hard limit on the post-money valuation of a company that we’re willing to accept. While I won’t publish that number 🙂 I can tell you we try to keep our portfolio average under $6MM.

5. Revenue: We want founders who have a plan to generate revenue in the next 6-12 months, otherwise we don’t invest. This means pure content / social media plays that require millions of active users to generate initial revenue aren’t a good match.

6. Software/Internet Companies: Our focus is on internet startups. If you’re manufacturing hardware or physical consumer goods, we wish you the best, but it’s not in our wheelhouse. Same goes for biotech, cleantech, medical devices, etc.

7. Founders: We expect full-time founders who are deeply, deeply committed. A team of 4 co-founders working part-time is a No Go. Also if you and your co-founder raised $300k from friends then paid yourselves $100k salaries – please GTFO.

8. Minimum Viable Product: We expect founders to be able to build something light that tests their idea and generates feedback from a small base of initial customers. Don’t come to us yet if you only have a sketch on a napkin.

9. Unique Businesses: Every creative endeavor draws from existing successes, but a startup shouldn’t be a blatant copycat with marginal differences. Postmates for pet supplies, Tinder for old people, or ProductHunt for hardware aren’t going to spark our interest. (That said, re-approaching someone’s core idea in a unique way, like ProductHunt for People, Laurel & Wolf for weddings, or Plated for Furniture, would be interesting.)

Our Approach

Startups that fit our ground rules go on to get evaluated within the framework of our firm’s particular philosophy as investors. I’ve written a couple posts already about my particular thought process. At a high level though, everyone on our team is looking for startups to match multiple of these tenets:

Unique, Somewhat Crazy Ideas: Does it sound odd, weird, unusual? If so that’s a good sign for us. We see too many safe bets out there. We like ideas that strike us as unusual or weird at first but when you think about the fundamentals (and allow your imagination to stretch a bit) they start to make sense. When Produce Pay first came in the door it sounded a little odd: “payments for farmers”. When Airbnb pitched me in August 2008, staying on someone’s air mattress sounded crazy. Pay attention to the crazy ones – you’ll find gold there.

Unique, Focused Markets: I get a lot of pitches where the founders are serving broad categories like “high school students” or “women”. What I love is a founder who starts by serving a niche they can quickly dominate market share in: “high school athletes in Los Angeles” or “single, gay, male professionals in the Midwest”. We invest early, so we like to see founders who’ve identified a niche group and focus their early work on serving that community effectively before they scale. When Leura Fine of Laurel & Wolf started, she focused on expecting moms and their nurseries, knowing that they have to redesign their home, probably have money saved for it, and can be reached via low-cost content marketing.

Big, Old, Boring Industries: We love founders who are changing old industries – come to us with ideas to disrupt logging, fishing, agriculture, import/export, construction and hundreds of other old sectors that haven’t innovated and we’ll be excited to listen. Lyft and Uber disrupted transportation, Airbnb disrupted lodging, and Postmates disrupted delivery. When Corey Brundage of Honk showed me how he was disrupting the towing and roadside assistance industry, I was blown away by the idea (plus the team, execution, etc.) and stepped up to lead the seed round that same day. Towing is a multi-billion dollar industry; it’s a necessity and a painful customer experience that – until Honk – had almost zero tech innovation. We love these plays and we’ll do them all day long.

Execution-Oriented: We value what founders do as much as what they say. We want to see aggressive, purposeful actions that are guided by creative and rational thought. We’re on the lookout for a common trait among entrepreneurs with many different personalities – that they perform quickly and leanly, evaluating results from customers/stakeholders and iterating right away. Their command of the details often stands out – founders who execute and “fail fast” can describe the intimate details of their first dollar, their first customer, their first MVP. When I first sat down with Michael Schneider last month to discuss Service, I was blown away by his rapid execution on his idea. He and an intern had crawled social media feeds looking for people complaining about poor customer experiences. They had engaged these people online, found out their problems, manually solved their customer service issues, and iterated their approach based on how the customers used their platform. They quickly learned key insights into customer service and user acquisition, and their platform is constantly improving from the hundreds of real-time interactions with users.

 

I’ll continue to write a lot more about what we do and do not invest in (and why), but this is our starting framework. Companies we see need to get past the No Go punch and then meet multiple of the categories above for us to dive in. Most don’t make it through but when they do we’re incredibly excited to dive into the details and get to know the entrepreneurs deeply. So if you come across pre-seed or seed stage startups that check all our boxes, let us know!

 

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  • http://veleza.com aurepavi

    Great to know whats in VC’s mind