As a serial entrepreneur and investor, Sunil Nagaraj has a deep understanding of the ways in which entrepreneurs’ and investors’ mindsets differ. Why does that matter? Founders who understand their investors’ mindsets may be better positioned to succeed. He confesses that, as a founder, he sometimes felt perplexed by—or at odds with—investor’s decisions during the life of his first venture, Triangulate. Now, as Managing Partner at Ubiquity Ventures, a seed-stage institutional venture capital firm that invests in “software beyond the screen”™ startups, Nagaraj understands the VC perspective. He offers key insights that can help founders interact with investors while seeking seed funding. In this informal and unabridged conversation with Shikhar Ghosh, Nagaraj reviews the crucial differences in the mindsets of entrepreneurs and investors. And he shares a simple three-question framework he uses as an investor evaluating startups.
Sunil Nagaraj interviewed by Shikhar Ghosh on the differences between the entrepreneurial and investor mindsets, October 2018, at Harvard Business School. Transcript unedited. Part 2 of 2.
Differences between the Entrepreneurial and Investor Mindsets
Shikhar Ghosh: You went from being a really early-stage entrepreneur, going through the whole sort of cycle of entrepreneurship, not an exit but not a sale, to then switching and everything you did before this was hardcore entrepreneurship. “I want to build something, I want to set up a team, I want to lead my team, I want to do all those things.” Then he switched to the investing side and you’ve stayed in the investing side now for awhile. What’s the primary difference? What is it that people who are on the entrepreneurial side don’t understand about the experience of being an investor and a VC?
Sunil Nagaraj: It’s a great question. Maybe I’ll phrase it as like the biggest thing. One of the biggest things founders may not understand about venture capitalists is the volume of companies they meet, how much of their day is spent saying no, how much of the job is really poking holes and finding flaws. In contrast, something that VCs don’t understand about entrepreneurs is how much of the job is about being an optimist? How much of it is about finding ways to solve something, building something and really pushing forward in the face of no good reason to believe so?
Sunil Nagaraj: These are just fundamentally different mindsets. An entrepreneur is worried about how do you make it work? A VC is worried about how do I make sure not get into a bad investment? Another way to look at it is that as an entrepreneur, I spent two and a half years of my life thinking about nothing but online dating. Now as a venture capitalist, I meet about a thousand companies a year for an hour each. So every few minutes of the day I’m thinking about a totally different topic. So entrepreneurship might be a mile deep and an inch wide, an inch being online dating and going super deep.
Sunil Nagaraj: With venture capital, it’s very, very wide, a very wide breadth of ideas, a very wide breadth of people. That can sometimes be fun, but it can also be exhausting. So they’re both difficult in their own ways, but I think it’s poorly understood how different these two roles are. Finally I think entrepreneurship, especially at the early stages is such a strong team effort where at Triangulate, I’ll speak for myself. My experience with entrepreneurship was in my living room, being physically elbow to elbow with David and Matt, my co-founders, and I’m not exaggerating, all our elbows would hit sometimes.
Sunil Nagaraj: Then going to a nice venture capital firm, much nicer offices. We weren’t in the living room, but it’s a relatively lonely job. Specifically, there is an investment team. But generally, if two people are in a pitch meeting, you’re wasting time. You should be meeting two startups because it’s such a numbers game that you need to be prosecuting so many opportunities. It’s only at the very end when a thousand companies I meet turns into one investment, I pull in other colleagues. So venture capital you prosecute alone, startups you prosecute as a core team kind of locking arms together.
Sunil Nagaraj: I’ll add one extra thing. When I was a founder in Triangulate, I remember distinctly thinking, “Why do these VCs keep saying no? Why don’t they take some risks? Isn’t their job to take risk?” Now that I’m a venture capitalist, I can tell you firmly, my job is not to take risks. My job is to raise capital invested and grow it. My job is to turn money into more money. That’s my job. There’s just a fundamental misunderstanding of what each person’s job is. In that regard, if I were talking to a founder now, I think it would be helpful to understand the day of a VC, how many different ideas they’re looking at, and the lens through which they are viewing this investment.
Sunil Nagaraj: If I were talking to a founder, I would tell them to make sure to include more context because the VC you’re speaking with probably spoke to a totally different company last hour and is speaking to a totally different company next hour. So they need to be informed about the broader context, warmed up to the core idea. Then it’s helpful for founders to understand how rare it is for a company to be successful and how venture capital is purely driven by those successes.
Sunil Nagaraj: Some of the data show that out of 10,000 companies that a venture capital firm might choose to meet, these are the ones that they accept meetings for. They might invest in 10. So 10,000 companies go down to 10 investments, only one out of those turns into a lot of money. It is extremely rare for this process to work. This is why entrepreneurs are. . . It’s extremely rare for this process to work. When I had my company and one of my teammates said, “Sunil, I have great news. We’re going to have a baby. My wife and I are having a baby next month.”
For me to have to know that I’m going to lay that person off is such as orders of magnitude more intense than a VC losing a deal. So VCs often underestimate the emotional rollercoaster of entrepreneurship. And so, ideally, founders can understand more about the risk of being a VC. And VCs can understand more about the emotions of being a founder. I think that’d be very helpful.
Shikhar Ghosh: Great.
Sunil Nagaraj: Whenever I hear a new idea, it’s tempting to assess it by thinking if I would use that product. That is a terrible way as a venture capitalist to decide if an idea is good, if an idea is lucrative. Now I try to apply a disciplined three-question framework. It’s really simple questions. When I hear about a new idea, I ask, “Does anybody want that product? Are there a lot of those people and can you find them? Really simple. I try not to tie things up with jargon too often, but in my role now with Ubiquity Ventures as a seed investor, most of my time is spent on question number one. “Does anybody want this product?”
Nagaraj’s Simple 3-Question Framework to Assess Your Startup
- Does anybody want that product?
- Are there a lot of those people?
- Can you easily find them?
Sunil Nagaraj: The fancy way to describe that is product market fit and there are a variety of methods and signals to determine that. There’s also certain tools to assess product market fit. I think it’s a fallacy that someone needs money to go build a full product before they can assess product market fit. We now have better techniques for prototyping, for running surveys. High fidelity surveys on a low budget for a $100 in one day. You can have a pretty good sense of if what you’re doing attracts third party arms length users. There’s different techniques to assess.
Sunil Nagaraj: A really powerful question. “Is there one person on earth that I’m not related to that I don’t know that doesn’t want to help me, one person on earth that’s arm’s length that wants my product?” Having that puts you ahead of 80% of the startups that I meet. This notion of customer development and starting to figure out who and why people want the product you’re building is so much more important than working on the product itself. But that’s where I live most of the time, “Does anybody want the product?” and “Are there a lot of those people?” correspond to market size. And “Can you find them?” would correspond to unit economics and user acquisition.
Sunil Nagaraj: Of those three questions lightly correspond to the different stages of venture capital as well. At Ubiquity Ventures at ubiquity ventures, I focus on deeper technology investing. So sometimes I have a question zero, “Is it possible?” In technology, in normal tech, everything is possible. Any idea you have for an app somebody can build, but with some of my investments, is it possible and then does anybody want it? That’s where I spend most of my time.
Shikhar Ghosh: You don’t care about the intensity of want?
Sunil Nagaraj: When I think about does anybody want this product, I mentioned a few different techniques to assess the initial spark of interest. Again, it doesn’t require building the product. Although I’d say most entrepreneurs I talked to think that the first step is I need money to go hire a development team to build a product to see if people want it. I think in today’s world you can actually assess demand whether it be through surveys or wireframes or mock-ups or screenshots.
Sunil Nagaraj: If a company is a little farther along, if they’re post-launch, most of my investments that I make with Ubiquity are prelaunch. But post-launch, there’s a whole treasure trove of data. There’s different techniques for understanding how much interest someone has. There’s a great framework called Startup Metrics for Pirates by Dave McClure, and it’s called Startup Metrics for Pirates because the acronym is AARR. So it’s A-A-R-R-R and it kind of corresponds to a user’s journey where they arrive at a landing page so that you would get them there through different acquisition methods.
Sunil Nagaraj: They would decide to sign up, they would then turn into revenue. Then there’s a chance for referral and then there’s re-engagement. Each of these is one way to measure how much somebody wants something. When I think about acquisition, the thing it’s measuring is, “Are there people in the world who like the premise of your product?” They might see a little ad that says, “Come here for discounted shoes or come here to meet a romantic partner.” That would be the acquisition test. That can be measured with conversion rate on ads or CPC clicks.
Sunil Nagaraj: The next piece of the puzzle is what percent of people sign up. That’s a simple metric. Then deeper in the funnel, each one has a conversion metric which assesses how many people from some base move on to the next step. Each of those can be a signal they need to have context around it. So you might know that most dating sites have a 1% conversion rate from free signup to paid. Then with that context, you can see if this site has a 2% conversion rate, it’s actually doing better. It must have more want for this particular product.
Sunil Nagaraj: Another tool that VCs use, especially when there’s several months of data, are retention cohorts where you can start to see how long are users continuing to reengage with the site? That would be one cohort and compare that to a previous cohort of users. For example, users that signed up in May are still using it five months later. Users that signed up in June are using it six months later. So my product is getting increasingly sticky. There’s a variety of tools to try to assess how juicy product market fit is, how intense it is, how much people like it.
Sunil Nagaraj: Each of them when you think of it as a precise signal, they actually hone in on a very specific element. It’s, are you attracting users? Are you holding onto them? Are you activating them so they get so excited they want to share it with others? Each of them is sort of different elements. When they all work in concert, that’s when you have extremely high growth businesses.
Shikhar Ghosh: Most of what you’ve been talking about appears to be for B2C businesses. In B2B businesses, how do you do that? How do you assess need?
Sunil Nagaraj: It’s a good question. The way I think about B2C businesses and B2B businesses with B2C, especially at the early stage, it’s very tricky to determine what consumers will want. Very often VCS will invest after a company catches fire, after it actually takes off. Because understanding consumer trends, is it going to be Instagram or hipster nomadic that takes off is almost impossible, is near impossible. With B2C some of the best consumer venture capitalists are just experts at crunching the early metrics to see if it’s starting to take off.
Sunil Nagaraj: With B2B, it’s a totally different process to try to understand demand. Generally, business buyers of products make rational decisions. I would say consumers don’t always make rational decisions. So when I’m investing in a company, a startup that’s selling to businesses, I go find those businesses that they’re hoping to sell to and ask them what they want the product. It’s a somewhat straightforward process. It usually doesn’t require a lot of vision on the part of the customer.
Sunil Nagaraj: When I’m assessing my first question, do people want this product and thinking about a B2B business, I can actually go directly to those prospective customers, describe the product to them and the bar is really high. They should jump up and down and say, “Oh my gosh, I’ve wanted this for a few months. When is it ready?” Anything less than that, it means it’s not going to be a great business. It’s easier to get a precise signal on the B2B side than on the B2C side, especially pre-launch.
Shikhar Ghosh: Just as an aside, I just saw a blog post on something, Sean Ellis, somebody who has a site and he was talking about his metric for assessing product-market fit. You said most product market fit things come after the fact. He was saying, “So before the fact, what can you do?” He said, “You ask one question which is, would you be really disappointed if this product didn’t exist?”
Sunil Nagaraj: He has that survey product. I forget what it’s called.
Shikhar Ghosh: His number was 40%. He said, “If you don’t hit a 40% threshold, then you don’t have product market fit.” It seems like an interesting.
Sunil Nagaraj: It’s interesting. It’s helpful to put a concrete.
Shikhar Ghosh: He looked at a hundred companies or whatever. He did some kind of pseudo analysis.
Sunil Nagaraj: Interesting.
Shikhar Ghosh: But it seems like good advice.
Sunil Nagaraj: I’ve now been in venture capital for almost eight years and in that time I’ve made several mistakes and those have resulted in companies that failed. I’ve made some successful investments and they’ve gone even better. I do think a lot about calling out the lessons from the diligence process as to what drives a successful investment versus what drives a weaker investment. A key piece of that is founding teams. In particular, there’s a few red flags that come up all the time in pitch meetings that immediately tell me that this is a team that’s not gonna make it through the rollercoaster of startups.
Sunil Nagaraj: Sometimes in a pitch meeting I’ll see two co-founders of a business get into a, what I might call a micro argument. It is something where they say two different answers to the same question, or they get in each other’s way and they do it in a quiet way, but I can already tell that they’re not on the same page. For these founding teams, it’s critical that they’re operating on the same rhythm, that they have the same story, especially when they’re meeting with an investor. But generally on a day to day basis and hour to hour basis that they’re in sync with each other.
Sunil Nagaraj: That doesn’t mean that they do the same thing, but it means that they’ve harmonized already. When they can’t harmonize well or at least hide the lack of harmony for this one hour pitch meeting, it’s a horrible sign. It’s like fingernails on a chalkboard. When I see sometimes a co-founder will say, “Hold on, go back to that slide. Or hold on, actually, let me add one more thing.” This stuff sounds superficial, but it’s always indicative of something deeper underneath where the co-founders have not kind of come together in agreement.
Sunil Nagaraj: Another signal when I’m looking at founding teams is around the commitment level of both of the co-founders. Sometimes there’ll be somebody who hasn’t quite jumped and someone who has. There’ll be disparity in the skill levels. I’ll often try to understand how founders came together and the process which they came together is also telling about how long I think the partnership will last. Sometimes it has to do with a partnership of convenience, and that’s usually a bad sign for the future.
“As a seed investor,” he confesses, “most of my time is spent on question one, ‘Does anybody want this product?'” Watch the video or read the transcript that follows for strategic advice that can help founders understand how investors assess businesses, products, and founding teams. Watch Part 1 of this interview to hear the story of how he started the business, changed directions, ultimately decided to shut down.
Hear more from Nagaraj on assessing co-founder compatibility or find questions to ask potential co-founders before formalizing your partnership in Choosing a Co-Founder? How to Find the Right Person and 3 Topics to Discuss before Writing a Founders’ Agreement. Our Founding Team section provides frameworks for creating a founders’ agreement and allocating co-founder equity. It describes the pros and cons of adding a co-founder vs. becoming a solo-founder.