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How do you spot a hit like Snapchat? This VC explains the ‘X’ factor

Jim Armstrong, co-founder of March Capital Partners
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Thursday's Snap IPO represents one of the most anticipated and buzzed about events of late in the tech industry, with the stock trading above pricing expectations within hours. As a long time venture capitalist, I can tell you that hits of this magnitude don't come without a lot of misses however and that there is science behind the art. Trite? Sure, but also true, and the science comes in when you look at the precise DNA that powers a company's success.

A common question I'm asked is "what stands out in the companies that you decide to fund?" The stand-out quality (or DNA, or X factor, depending on how you choose to characterize it) that the most successful venture-backed technology companies share is…a keen understanding of their industry above all else.

In the venture-world, which is understandably unique from angel investing or other investment strategies and vehicles, investors are looking for founders that demonstrate a clear understanding of the playing field, and then lay the case for why and how the industry is ready to receive a particular solution.

Will the technology to do this be hard to build? Yes, very. Could Frank show us the product at that time? No. However, Sumant saw enough in the way Frank framed the problem and the challenges to fund the effort. Five years later, The Rubicon Project had its initial public offering and remains a dominant technology in online advertising today.

So what does "understanding the playing field" mean? The most successful founders often share a similar lens in the way their companies are formed, pitched, and how they generate investor interest.

They…

  • Know maturity lifecycles and new disruptions facing a particular industry
  • Assess the opportunity for mass adoption and whether or not their industry is ready to be receptive to their idea(s)
  • Know the major narratives driving the industry
  • Are keenly aware of the top fears and priorities of the C-suite
  • Know where budgets are and how to access those budgets

...as opposed to only creating a great product and then searching for a fit for that need.

The early days of PayPal

When I met PayPal founders Peter Thiel and Max Levchin in 1999, very little of our discussion had to do with the prototype product. That initial product was formatted for an early mobile phone (Palm Treo) and the software was designed to "beam" payments from phone to phone. While the specific product specifications were nearly impossible to evaluate, what convinced me to lead an early round of funding was the entrepreneurs' thoughtful discussion and evidence around the state of payments as being early days, the failure of other start-ups to intelligently or effectively use the ACH network, and the importance of the extra layers of security required to be named the winner in payments. Six months into the project, the founding team decided to launch the same technology on email and the web — eBay users loved it, and Paypal was on its way.

The Rubicon Project

When Frank Addante, the founder of the Rubicon Project, a real-time trading platform for online ads, came into our office some years ago, he spoke to my partner, Sumant Mandel, about the state of the online advertising business and how digital marketers had products to help them place ads but publishers (websites) had to choose one ad network or another. There was no product that allowed them to "play the field" and optimize ads in real time on their behalf.

Frank also explained to us why he believed the industry was in this predicament, and how he thought it would play out over time. Then he pitched us the way he believed a new technology to make publishers' lives easier could be received. Will the technology to do this be hard to build? Yes, very. Could Frank show us the product at that time? No. However, Sumant saw enough in the way Frank framed the problem and the challenges to fund the effort. Five years later, The Rubicon Project had its initial public offering and remains a dominant technology in online advertising today.

While all experienced early stage investors have similar stories, the rage today is to fund product momentum. Investors want to see quick product market fit. Companies raise some seed funding, gain metrics around usage and engagement, and then tout these metrics as product market fit in search of their "Series A." I understand this, and have a few of my own investments in this category. Engagement momentum can be a very powerful tool to build a company.

Invariably, however, all of these companies have to ask themselves the question "why do we exist?" Technologies disrupt, then slow and commoditize. Today's technology "disruption" is a euphemism for correctly timing the changing behaviors and expectation of customers and consumers. What are you going to do with that momentum? Expand the product and move your users to the larger value proposition? Try to keep it going as is and start monetizing?

Which brings us to Snapchat, which started with a micro product/market fit: In a world post-scandalous texts from Tiger Woods and Anthony Weiner, Snapchat posited to teens "in this app, your texts disappear." The company has taken that early momentum and successfully moved its users to a much larger value proposition — so much so that they have dropped "chat" from their name.

Venture Capital is driven by big exits. Design and ambition matter but, time after time, early specifics around initial products and go-to market strategies change and pivot as start-ups rapidly learn how customers want to consume. If entrepreneurs and venture investors have done their work, the fundamentals to drive long-term value remain the same…always leading with "why do we exist?" over "how do we exist?"

Commentary by Jim Armstrong, an early stage venture investor in enterprise and consumer technology and co-founder of March Capital Partners. Armstrong has 19 years of technology investment experience, and has generated multiple large exits through IPOs or mergers and acquisitions from companies he either incubated or participated as the first institutional investor. Follow him on Twitter @jimatrmstrongvc.

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