July 31, 2020

How to Develop an Investment Thesis

Welcome to the third and final installment of this introductory series about startup portfolio management! If you’ve enjoyed these articles, let us know! Or tell us what you’d like to learn about next. Send suggestions and feedback to Aryelle Young, our Head of Content Production, at aryelle@kingscrowd.com.

A Quick Recap

For those just joining us, in my first post we discussed creating a portfolio plan and developed a hypothetical plan in which we will invest $10,000 across 25 companies with a $200 initial investment per company. In the second post, we discussed investor strategy and reviewed the various startup investment vehicles available to accredited and non-accredited investors. Given our relatively limited budget and the need to build a diversified portfolio while we learn the ropes of startup investing, we decided to put our money to work mainly through crowd investing platforms.

The Anatomy of an Investment Thesis

Now comes the fun part — developing your investment thesis (also referred to as an investment themes or investment strategy). Regardless of what you call it, an investment thesis is essentially a method used to narrow the number of companies down to just those that you are willing to consider for an investment. It is about defining what you are interested in and filtering out what doesn’t interest you. An investment thesis is your opportunity to be creative and opinionated about technology, industries, markets, macro trends, and business models. And since all investing is about the future, your thesis is a reflection of your views about what the future holds.

Now let’s discuss the elements of an investment thesis and look at a few examples from venture capital firms before we jump into developing our own thesis. Based on my observations, there are nine commonly used elements in an investment thesis. This list is by no means exhaustive or definitive. 

  1. Product Type — Hardware, Software, Goods, and Services

Hardware or software. This is one traditional way to categorize startups since many are tech-focused. But don’t forget about the direct-to-consumer (DTC) startups that make physical/manufactured goods or startups that offer services rather than goods. More and more companies are using a combination of these methods to deliver solutions to their customers — like IoT and Smart Home companies.

  1. End Customer — Consumer, Enterprise, or Government

Consumer, enterprise, or government. Each of these end customer markets tend to have different solution requirements, procurement practices, and support expectations. Those differences result in specific organizational structures and priorities for the companies competing to serve them. 

  1. Industry — Traditional or Hybrid Sectors

Technology, finance, energy, real estate, communications, transportation, healthcare, retail, advertising… There’s a nearly endless list of industries. Technology has infiltrated many of them to create hybrid industries or sub-industries like fintech, cleantech, ecommerce, and proptech. A lot of startup activity occurs in these hybrid industries. Each industry has unique characteristics and trends that an investor needs to know. Choosing an industry is a good way to narrow the focus of an investment thesis.

  1. Company Stage — Early, Growth, or Late Stage

Early stage, growth stage, or late stage. These are commonly used terms to describe a company’s stage. However, investors often define the stages differently. Many investors use fundraising stages because startups tend to encounter similar challenges at a given fundraising milestone. Thesis-wise, investors often focus on one particular stage, but they often give themselves leeway to drift a little earlier or later depending on the company.

  • Fundraising Stage: Friends & Family, Pre-seed, Seed, Series A-B, Series C and beyond.
  • Product Stage: Pre-product, post-product (pre-revenue), and post-revenue.
  • Fit Stage: Problem-solution fit, product-market fit (PMF), and product-channel fit.
  1. Geography — Local, “2nd Tier” Cities, and International Markets

Geographic focus is often about identifying supply-demand imbalances between talent and funding. It also involves taking advantage of differences in cost of living and business conditions.

  • Local: Some investors may use a “local” market strategy to develop a deep network and strong reputation.
  • 2nd Tier Cities: Some investors focus on “2nd tier” cities like Austin, Denver, Atlanta, Phoenix, or Boise (to name a few) where there is a good supply of talent but disproportionately less access to capital.
  • International markets: Typically the domain of large VCs, investing in international markets introduces risk, cost, and complexity that act as barriers to entry.
  1. Science & Technology — AI, AR, Blockchain, Robotics, and Biotech

Whether technology is the solution or enables the solution, it is hard to deny that technology is a key component of many startups’ strategy. Thus, there are “deep tech” investors that see these “disruptive” technologies as driving the future of the economy. These investors tend to have a strong technical background and domain knowledge that allows them to develop a long-term thesis behind technologies like AI, AR, blockchain, robotics, and biotech (to name a few).

  1. Business & Financial model — SaaS, Marketplace, and Data Monetization

Science and technology are not the only drivers of innovation. Any business function or element of a business model can help differentiate a startup’s strategy. Software-as-a-Services (SaaS) and subscription pricing models are business and pricing model innovations that have attracted a lot of fans and found their way into private and public companies. Marketplace business models have enabled companies to build strong network effects. Asset-light financial models have reduced capital requirements. On the more controversial side, providing free or subsidized services to customers in exchange for collecting and monetizing user data has given birth to some of the largest and most profitable companies.

  1. Macro Trends — Cultural, Demographic, and Regulatory Changes

Many elements of a thesis are about the entrepreneur, product, tech, or business model as the source of innovation and, therefore, the driver of change. However, macro trends are the massive tectonic changes that often spark multi-year or multi-decade opportunities. Smart investors and entrepreneurs respond to and leverage these opportunities in their theses. While technology may be involved in these trends, often the initial need or change originates from cultural, demographic, political, or regulatory changes.

As you’ve no doubt heard before, regulatory changes via the JOBS Act of 2012 was the driver that opened up the crowdfunding movement. Demographic and cultural differences between Baby Boomers and Millennials generations are driving opportunities to address everything from the rising cost of healthcare to changing views about home ownership and lifestyle preferences. Perhaps the most sobering example is the macro event we are living through right now. We are still figuring out how the coronavirus pandemic will affect how we live, work, and socialize long-term.

  1. Impact — Social, Environmental, Equality, Educational, and Wellness

Impact investing attempts to put the philosophy of “doing well by doing good” into action. It recognizes that there are a number of ways to make money, so why not choose a strategy that also positively impacts our communities. In some cases, an impact thesis may add additional hurdles to a startup’s success. But it also has the potential to mobilize a passionate and appreciative customer and stakeholder base. Impact theses often focus on social, environmental, equality, inclusion/access, wellness, and education. In some cases, they have even grown into macro trends.

In recent weeks, we’ve seen several VCs and large companies launch funds focused on backing minority and underrepresented founders. For more than a decade, cleantech and renewable energy startups have worked to deliver a product that the market already has access to — energy — but in a way that is less environmentally harmful (and eventually lower cost). Meanwhile, wellness startups often address personal and mental health needs that were previously ignored and awkward to talk about.

Examples from Venture Capital Firms

Ok, that was a lot of information. Let’s take a look at some real investment theses from well-known VC firms.  These examples show that you can be a successful investor with a number of different approaches.

New Enterprise Associates (NEA)

NEA has developed deep domain expertise and insight into our industries of focus. We channel that knowledge into every technology and healthcare investment we make — at any stage, in any location, around the globe.

NEA — one of the oldest and largest VC firms — has a pretty straight forward thesis. They are focused on technology and healthcare. As they clearly state, they are stage and location agnostic. So their thesis is narrow on industries but broad on everything else.

First Round Capital

Instead of predicting the future, we look to our founders to convince us of what’s next. That’s why we don’t focus on any one sector. The one thing each of our companies has in common — we met them when they were just a couple of people with an idea and a slide deck.

First Round Capital is an early stage VC that is focused on founders and wants to put the first institutional money into a company. That focus tends to make them industry agnostic. First Round’s portfolio reflects a wide range of consumer and enterprise, hardware and software companies.

Union Square Ventures (USV)

USV backs trusted brands that broaden access to knowledge, capital, and well-being by leveraging networks, platforms, and protocols.

While First Round Capital relies on founders to bring the thesis to them, USV leads with their own opinion of where opportunities lie. But rather than naming industries like NEA, USV’s Thesis 3.0 describes the outcome they want their investments to deliver. USV is not picky about how a company achieves the desired outcome. However, they do have preferred business and technology strategies that they look for in prospective portfolio companies.

Madrona Venture Group (Madrona)

Madrona’s thesis is more detailed than our previous examples. Like USV, Madrona brings a holistic view to their investment approach. Their 6-part thesis weaves together a narrative that tells you what they are focused on and why. Below are 3 of the more interesting themes.

  • Future of workBuild and retain diverse and distributed workforces and transition from “in-person” to digital-first workflows and processes.
  • Intersection of innovationBiological and chemical sciences are intersecting with computer and data sciences in precision medicine, digital pathology, proteomics and more.
  • Low-code & no-codeThe next generation of workers is more tech savvy, and there are more “makers” in business teams and organizations who want to build things directly and not wait for IT, engineering or the data science team.

Developing Your Own Thesis

Now it’s your turn. But before you dive straight in, here are some helpful suggestions.

Consider your experience, knowledge, and interests

To be successful, you need to understand the market landscape and trends related to the companies you invest in. If you lack the knowledge or desire to learn a particular space, strike it from your thesis. Since you aren’t a VC fund, you don’t have to please institutional investors or anyone else with your thesis.

Think long-term.

Startups often take 10 years to reach the scale needed for an exit. So make sure you are investing based on an enduring strategy. Consider how the world may change between now and then but also consider what will not change.

Keep it simple.

Don’t try to incorporate all of the thesis elements we discussed into an all-encompassing super-thesis. You don’t want a thesis that is overly complex or specific. You also don’t want one that is so broad that it looks like an all-you-can-eat buffet. Focus on a few, well-defined areas that can serve as a good filter and source of discipline while still providing enough freedom to incorporate interesting companies.

Remember that you should have a well diversified 25-company portfolio. If you form a multi-part thesis like Madrona’s, try to cluster several portfolio companies around each thesis to improve your odds of capturing each opportunity.

Talk to other investors.

It’s normal for investors to share ideas and work together, particularly among individual investors where there isn’t competition for a deal. Ask other investors what their thesis is, share yours, and see what you learn. Use the conversations — along with your experience and knowledge  — to modify or solidify your thinking.

Have fun developing your thesis!


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About: Mike cozart

Mike is a Director of Product Management and part-time start-up investor. Mike started his career as an investment banking analyst and venture capital associate before taking on general management and product management roles with Amazon and Axon Enterprise. He earned an MBA from Columbia Business School in New York City, a BA in Economics from The University of Texas at Austin, and a BS in Geographic Information Science from Texas A&M University at Corpus Christi.

View Mike cozart's articles

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