What Mistakes Has Lateral Capital Made?
Over the years, we have made more than a few mistakes; some more than once! Unfortunately, it’s not possible to say “never again,” as different facts and circumstances can disguise the next situation. More important, a decision to invest is always a function of the “weight of the evidence.” Sometimes we break rules, go off strategy and look past previous learning for what seems like a very good reason. But we do so with great care.
That said, here’s a summary of our biggest errors. The list doesn’t number 100 quite yet, but we expect to get there!!
- Investing when the benefit isn’t big enough to justify the price to the customer. We have sometimes been so dazzled by a product or service that we didn’t do enough work to figure out how the product or service would actually be priced – and then look again to see if there are enough customers to deliver that volume.
- Investing before the actual manufacturing costs are known. Prototypes are notoriously difficult to “bid.” Someone usually has to guess. We look to invest in companies who have identified a contract maker; someone who can actually say “with an order of this many, we will deliver it for this price.” This helps to understand what the pricing structure has to be and whether that’s reasonable for the target market.
- Investing when the company has underestimated their financial needs. The value of Early Stage companies tends to decline for the first 2-3 years, as the promise of new technology runs into the real world ups and downs of technology commercialization. More than once, we have participated in rounds where the company has raised less than they really needed – often in the name of preventing excess dilution. This actually turns out to deliver increased delays and even more equity dilution down the road – when they are forced to raise money during the “dip.” Going forward, we need to be sure we are part of an investment “package” big enough to get the company to the next set of measurable, positive outcomes – a basis for raising new money at a reasonable price.
- Investing in the wrong teams. We have invested several times in teams which turned out to be under-skilled for the work required. The reasons have been obvious in hindsight – except for ethical shortfalls which we have faced in only one very painful situation. The other situations have fallen into three different buckets:
- CEOs that were pig-headed and wouldn’t/couldn’t take counsel – from us or anyone else. These people are hard to spot, as they come across as very open/great listeners in Due Diligence. Once they have funding, however, a different person sometimes emerges.
- Teams who can’t sell their own product, usually because they couldn’t make it simple enough for mere mortals to understand. We can sometimes help on this, as an outsider tends to be much better at understanding what the benefit of the product really is and how to present it in compelling terms. But sometimes it’s so complicated that it literally can’t be sold.
- Businesses where the CEO has something to prove about themselves or to someone else, unrelated to making the company a success. This is also hard to spot. We have invested, for example, in a publicity hound who thought the company was about them personally and one company where the CEO was trying to prove his value to his in-laws.
- Investing in technology not yet productized. We are not startup investors. That is a different business – where the business is still a “technology” and not yet a product or service. Despite our best efforts to be sure the product is really “cooked” before we invest, we have several times found that either ingredients were missing, the process was not understood, the product was under-designed or even that the promised benefit was imaginary. We need to stick to the discipline of investing in products with customers, as even lead customers are easy to interview and harder to fool.
Remarkably, we have made few investments where the technology proved not to “work.” It almost always does what the entrepreneur says it can do. But we have made several investments in technology which had not yet – and may never – be converted into products customers will actually buy. The reason is usually because translating great concepts to actual, manufacturable products or software is very difficult. Just because it should scale doesn’t mean it will scale. As a result, we have learned not to invest unless there is a finished product and at least one customer who wants to buy more.
- Investing in health care. We should just stop, even though we probably won’t. As our long-time co-investor Tom Moore says, technology, “the first rise in the healthcare dough almost always deflates.” First efforts in new healthcare technologies rarely succeed because the human body isn’t understood well enough for that to happen without a lot of trial and error. This happens over a significant period of time, during which being an investor is interesting – if very painful. Devices are easier to produce and predict, and we have made several investments in this space.
- Investing in technology which requires ubiquity to succeed. If the only way for your business to be successful is to achieve ubiquity, to “own” the network effect of your innovation, then we would be crazy to invest in your company. The reason is that when ubiquity is required, there is usually only one ubiquitous player. Yes, Instagram reached ubiquity for whatever series of reasons (being first, raising huge amounts of money early on to drive awareness and trial), but there are very few sets of similar circumstances. One thing that is always required? POM. Plenty O’Money. We don’t have it; most Angels don’t either. These kinds of companies should be “reserved” for Venture Capital, where the mark of success is steadily increasing valuations, not a “quick sale” to a strategic buyer.
- Investing in companies with limited buyers. When companies, particularly in software, say their exit plan is to sell to Google or Facebook, this has mostly turned out to be a pipedream for several reasons:
- Large internet consolidators have their choice of dozens of other small companies to buy, none of which you have heard of and all of which have some product feature better than yours.
- You have no idea which of the features you have developed are important to these large players; either now or at the point you are ready to sell. The one thing you can be sure of is that by then, whenever then is, their interests will be different than they are when you invest.
- The willingness to acquire small companies goes in and out of favor with large companies, for reasons you cannot predict or even imagine.
Net: We have consistently failed to bring these big marquee players to the table, even when they are customers of our invested companies. You can’t depend on them to be your sole “way out.” You need to have more than a few big potential buyers; on a list you continually update.
- Investing in businesses where distribution is too hard to get – or maintain. As it turns out, every business is eventually a distribution business. When we came to Early Stage investing, our going in assumption was that products or services with great design, performance and price/value relationship would be pulled products into the market. This has turned out to be largely untrue, or at least, an inadequate understanding. Broadly speaking, the products we have invested in have “worked” pretty well. But after the product gets to completion, is manufactured at a reasonable cost, etc., the issue becomes distribution. In turn, distribution means push marketing – led by sales people who are very difficult and expensive to find and retain. This has not always been easy, as the examples below will show:
- One company we invested in is probably still sitting on 50,000 units of a product which a large distributor “guaranteed” to buy and then reneged on accepting. The product works very well; the distributor is a well-known player in the industry. And no, you can’t sue your customer to force them to buy things!
- We invested several times in a medical software company designed to meet the needs of physicians who practice away from their offices. It worked great. But none of the big hospital software providers would integrate the software into their products. Our company went out of business with one of the best products in the industry.
- Five successive rounds of sales people for an advertising technology company were unsuccessful at penetrating Google, Twitter or Facebook. This was despite the fact that each of these “super sales people” claimed to have sold products into these companies before. And the companies have said publicly, often more than once, that the product we were offering was exactly what they needed.
What we’ve concluded from all this is that people aren’t everything; they are the only thing. And distribution people, particularly those who can close a sale, are the people most scarce. Going forward, we have decided to rebalance our assessment of new investments based on their ability to both make and sell a solution to a really important problem. These days, we also look for investments that have “natural” distribution channels – perhaps online direct-to-consumer channels like Amazon or B2B channels through players like Grainger.