Contrarian Investing 101

My framework for evaluating weird and wacky startups

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Whenever you hear the story of a venture-backed unicorn, you’ll inevitably hear about the slew of VCs who had the chance to invest and didn’t, missing a huge opportunity.

Perhaps the most painful example is AirBnB. Back when Brian Chesky was nobody, trying to sell 10% of the company for $150,000, he famously got 7 rejections from top investors.

Although each investor gave a slightly different reason for their “no,” I suspect that the core mistake was the same: they put themselves in the shoes of the target customers, and thought, “No frickin’ way would I sleep in some stranger’s spare bedroom. What if I get murdered?”

In VC, it’s our job to imagine a world that might be different from the world we live in. This means being open to ideas that are hard to fit into our world, as we know it, right now. After all, we’re always looking for the non-obvious idea, the “contrarian but right” idea that only looks viable from certain offbeat points of view. Part of the job is appreciating ideas that are strange enough to provoke a reaction of skepticism.

If we anchor ourselves too much in our own personal experiences and feelings, we might miss the bigger opportunities that might be there. This is the mistake I think so many investors made with AirBnB. Their personal doubt and skepticism — because they weren’t the target customers — resulted in a kind of blindness. But as it turns out, there are lots of customers (eg. cash-strapped millennial travelers) who did fit into that target market, even though VCs were not likely to be early adopters.

Snapchat is another one that initially made no sense. Disappearing photos? It was overlooked by a lot of VCs at first, largely because they weren’t part of the target market, which was teenagers.

So, how do you avoid this mistake? When there’s a lot of room for doubt and skepticism, how do you develop the conviction to know that there might be something exciting here if we can get past our initial blind spots? Here are some steps I use to keep myself open-minded and to balance my potential biases, to look for something that isn’t obvious at first.

1. Look at the numbers

Is there growth? Is there customer love and obsession around the product? Is there a cohort of users who are retained, who are coming back to use the product over and over, and having such a great experience that they’re telling their friends?

The metrics can tell you this. You might have an adverse reaction to the idea, but don’t dismiss it without flipping to the middle of the deck and looking for evidence of traction. If the numbers are good, you might want to do a double take.

2. Listen to the founder

If the numbers aren’t there to support the business, then a founder’s storytelling shouldn’t influence you to ignore those. However, if you are seeing some good numbers, even though the concept seems strange, listen carefully to the founder’s story. Let them tell you why this business works. Why does this work for a certain group of customers? Be intellectually curious in those discussions, and let them tell the story of the customers you haven’t met.

Some stories might surprise you — for example, the customers often define the product for the founders during those early stages of a business. Applications of the product that the founders didn’t originally envision can emerge from how customers are using it.

3. Talk to the actual target customers

Any founder who’s building a company needs to go through the process of customer discovery. Who are my customers, how do they live, and what do they value? What pain are they experiencing? What is their underserved need, and how can my solution uniquely solve their problem?

Investors, too, need to go through a similar process of customer discovery. Who is the target audience? What underserved need or problem is this product solving for them? How good is it at solving the problem? Is there customer love and obsession around the product?

Because there are many kinds of customers and demographics, winning in a market is possible even in sectors that seem crowded. For example, even though the food delivery space already had a lot of competition when Doordash was founded, Doordash realized that people in the suburbs had the same pain as people in cities, but the other companies weren’t serving those customers. So, they decided to focus on that underserved group — and as a result, they had no competition. They went after the “blue ocean”: a segment of customers that was wide open to be served. Waitr did something similar by getting away from the top coastal cities and focusing on food delivery in the secondary and tertiary markets in the southeast, where there was no competition.

As an investor, it’s easy to say, “Oh, another food delivery service, no way.” But what you’re trying to discover is whether there’s another segment of customers that isn’t being served today that is clamoring for a solution.

Another route, of course, is the “10x better” solution — this is what you’re looking for when you’re in “red ocean,” an oversaturated market space, as opposed to a wide open blue ocean that hasn’t been served yet. For example, my partner, Tesla co-founder Marc Tarpenning, figured out that in the cutthroat sports car market, it was still possible to win with a well-designed car with super fast acceleration. So, when the original Roadster launched, it was the fastest sports car at that price. On top of that, it just so happened to be electric, which was a fun conversation point for car enthusiasts. That’s how you win with the 10x better solution.

4. Look into the future

What does this company become in the future? What does the product grow into? How could they expand the customer base? Could this eventually have broad mass appeal? Could it create a new market?

I always tell product teams: you want the MVP to solve a problem for a small group of users, but eventually, your product will expand and the lanes will get wider. You can’t get that broad appeal with your first product, but down the line, you’ll expand your offering to solve more problems. But you can only do that when you have love for that narrower product from that targeted, narrow customer base.

AirBnB started with renting a spare bedroom in someone’s home while the host was still there. Eventually, hosts realized they could make more money by renting out the whole apartment and not being there at all. This created a subset of AirBnB hosts who resemble mini-real estate moguls. This is an example of the lanes getting wider.

I use the above framework as an investor to help me get past my blind spots:

  1. look at the numbers
  2. listen to the founder
  3. talk to the target customers to understand the pain that is being solved, and
  4. look into the future to imagine the possibilities.

Often, following this framework on a deal will lead me to the conclusion that this is not the right investment to make. But on a few rare occasions, I come to the “a-ha!” moment that I’m looking for as an investor — the realization that this weird and wacky startup might actually be a breakout company. This is when I develop the conviction to write the check, even if it’s a contrarian point of view.

I always love to learn about new startup ideas and products. If you have a weird and wacky startup that is growing with a product that is seeing lots of customer love with a narrow group of target users, I’d welcome you to get in touch: ha@spero.vc

Ha is currently a Partner at Spero Ventures, an early stage venture capital firm investing in the things that make life worth living.