We all use our past experiences and outside examples to help us solve problems or opportunities that we’re currently facing.
Using analogies and history help us develop an understanding of the risks in a business. These tools can be incredibly useful (and efficient) for both entrepreneurs and investors in the early stage. Diving into where past companies succeeded, struggled and failed can help an entrepreneur focus on the right pain points, and borrowing analogies from other industries can really help an outsider quickly understand what the business is all about: this is often exemplified in the “X for Y” tool used by many entrepreneurs raising capital or selling their idea to someone new.
“We’re building the Amazon for legal services”
“It’s kind of like a Netflix for babysitters”
“Picture the Apple of waste management”
When these tools get us all into trouble is when we we engage in lazy thinking and convince ourselves that we’re using our pattern recognition. Here are a few land mines I’ve witnessed in conversations:
1. Using what you knew about acquisition costs five years ago to make assumptions about today.
2. Incorrectly applying dynamics of one industry to another because they ‘seem’ similar. For example, the music industry is not like the film industry in a number of very important ways, but it’s easy to lump them together because they feel like they should be the same.
3. Using big rule of thumb assumptions like “SMBs are hard to market to” without digging into a company’s distribution plan.
4. Assuming complex problems are insurmountable because no one has solved them yet.
5. Using pedigree to drive 90% of your assessment of a team.
6. Assuming the industry dynamics have gone through a recent disruption, are now mature and won’t be changed again.
Google is probably the most famous example of an incredible business that started out as a ‘bad idea’. In 1999 David Cowan from Bessemer famously tried to avoid meeting Sergey and Larry when they were building their search engine. David used pattern recognition and hit two land mines: he assumed because the founders were students they weren’t doing anything serious, and he assumed that the search market movie had already been made. Neither of those assumptions ended up being right, but because 90% of the time those assumptions would have been true, it’s easy to overuse them and miss opportunities.
I think the art in early stage investing is avoiding these land mines – it’s where all of the opportunity lies.