5 Ingredients for Success from a VC Legend of Silicon Valley
You do not get the chance to invest in early stage startups for thirty years without having something special. And as I was listening to Terry Opdendyk's theory for startup success, the reason for his own success became obvious: he seeks entrepreneurs like him—people who are humble, experienced, confident, and human.
Opdendyk’s theory for identifying successful startups is based on both his own academic research and personal experience. It states that successful VC-backed startups share five essential elements.
1. Top 1% Team
Only special people can build successful businesses. The team is clearly a central element in any startup. Since everything has to be built from scratch, there is no organisational inertia on which the team can rely. But building a top team is more than just putting smart people in the same room. Opdendyk emphasises the need for experience, vision, and management skills:
"Repeat entrepreneurs who have failed after a first success."
i) An entrepreneur should know how to deal with scarce resources and how to manage taking risks.This translates into Opdendyk’s choice to favour repeat entrepreneurs. He even prefers repeat entrepreneurs who have failed after a first success. This makes successful entrepreneurs more humble, as they realise that they cannot use the same formula repeatedly.
ii) The team should have a clear vision on where the company is going. Being domain experts—among the top 1% in their field — help to be ahead of potential competitors. Tech companies move fast. The key is to understand future evolutions before others.
iii) The management team needs to be down-to-earth. A startup goes beyond a vision of the future. The team has to know how to make it a competitive and profitable business.
2. Address an Immediate Problem
A startup has to focus on the right things. Opdendyk highlights the critical need to find an immediate source of pain. The team cannot afford taking the time to change the way customers think; it has to find an opportunity. It needs to deal with problems that can be solved now, not in 10 years.
"Big opportunities come from big problems that can be solved now."
This illustrates a sort of capitalistic altruism. The reason customers are willing to pay is because the startup offers to solve immediate source of pain. In other word, a startup succeeds because it opens itself to the world and creates immediate value for others. Big opportunities come from big problems that can be solved now.
3. Market with Real Need
The team should focus on real needs; the customers’ problems must be important. There should be a growing number of customers who really want to buy your solution. As a result, Opdendyk recommends targeting markets that share three main characteristics:
i) The market must be growing. The startup wants to be part of this growth. It cannot afford to compete with big actors in a declining market.
ii) The market must be large enough. It should not be a minor problem.
iii) There should be no dominant player in the market. David did not win against Goliath by facing him directly.
4. Continuous Validation of Business Model
Opdendyk has found that "91 percent of the startups that keep the same business model for 12 months fail". There is a learning curve when you start a business which should lead the team to change its assumptions and modify its initial business model.
"Business model must be established in less than 12 months."
On average, successful startups change their business models four times. However, time is limited, and a viable business model must be established in less than 12 months. Only the market can confirm that the business model works.
One common reason for failure is a mismatch between the discovery phase and the execution phase. The team needs to know in which phase it currently is.
- During the discovery phase, burn rate is the enemy. The team should spend as little as possible. It can afford spending time in discovery face as long as it can limit the cash burn rate. The focus should be on cheap experiments.
- During the execution phase, implementing the right business model is key. This phase is all about acquiring and retaining customers. The team needs to raise more money, and it has to maximise growth by scaling the business model.
5. Good Match for VC Backing
"Their job is to decrease risk by taking advantage of their experience."
The last element for success is a mentor. She is not part of the management team and she should have experience in running a business. This is where a VC can add value. The VC should know more about the industry than the team does. Her ability to add value is essential: Terry Opdendyk only looks at startups to which he can add value. Investing in startups involves a lot of risks, and VCs have to compensate by adding value to their investments. Their job is to decrease their risks by taking advantage of their experience.
However, not every startup is suitable for VC backing. The business model must match the VC’s need for performance. This explains why startups have to focus on solving real and immediate problems.
VCs have high expectations; Opdendyk is very transparent about this. Most of the money they invest comes from limited partners (LP) who are mostly pension funds. LPs choose the VC industry because they want high returns. This requirement for high returns inevitably shapes VCs’ investment strategies.
Fast growth is essential for VCs; they not only need high return but also quick returns. This means that startups have to deliver the expected return in a short period of time (five to eight years). If the business (or the team) cannot handle fast growth, VC funding is not recommended.
These five elements underline the key to understand startup success. Opdendyk uses this framework to focus on excellence and to limit risks.
As a result, from 3,000 opportunities per year, Opdendyk short-lists 200 startups and invests in only 4 of them. This very specific process explains why VC investment is an art that cannot be scaled.
Venture capital and entrepreneurship are large-scale human adventures. The continuous success of ONSET Ventures, Opdendyk’s VC firm, proves it. Adding these five elements to the journey will boost any chance of success.
We would like to thank Terry Opdendyk very much for talking with us and his feedback; and we would like acknowledge Prabha Rathinasabapathy (MBA2015) and Sibo Wei (MIM2015) for making this article possible.