From Mathijs de Wit – Newion Investments (@mathijsdewit)
One of the things VCs are confronted with a lot are entrepreneurs with overly optimistic expectations of their growth. Resulting in non-optimised relatively large investments in building an organisation and hiring people. While most of these companies have proof of their product, may have proof of the go-to market and some proof of their business model, the business case to invest large amounts and becoming less lean does not work out due to factors the entrepreneur and company can hardly influence. Making it a wrong way of investing in many cases and creates a situation in which the chances of misaligned investors and entrepreneurs are very high. Lean investing is a way of investing to mitigate many of these risks and create a largely aligned situation for every stake and shareholder involved.
Let us elaborate on the separate topics and acquaint you with what I call lean VC investing. One of the drivers behind seeking VC investment for European software companies often-increasing international sales efforts to gain a stronger position in a certain domain. Often tackled by hiring foreign sales executives for the new regions, partner managers and marketing managers to be able to generate the necessary exposure needed. This asks for a relatively large investment, while proof of the business is often only present on the home turf of the company. The risk of growing the organisation in a less lean way is thus large that it only makes sense for business domains where any regional and culture influence practically does not exist. Unfortunately, most markets are very different restricting the ability to repeat marketing and sales approaches.
Lean investing is a pragmatic approach, where an organisation tries to invest in relatively small batches, and iterates in small steps to find new markets. This way an organisation only invests slightly too much in case where markets do not work out and optimises its investment for cases where they do. The main risk of this approach is that competing companies harvest a market. However, as most software markets have a multiyear lifetime the pros of lean investing way out the cons very often.
Next to neatly optimised investments, the approach creates far less misaligned situations. Heavy investments in non-proven businesses ask for penalties, when a certain growth does not happen. It does not matter in what form the penalties come, the result is that investors and entrepreneurs do not align. The entrepreneur seeks more investment, because it often still sees the opportunity. The investor might seek a higher stake, because its investments has not created the value the entrepreneur told it would. Lean investing creates a situation in which an entrepreneur receives a relatively small investment for a relatively low valuation. As the entrepreneur tests markets in small batches and does it successfully the reason for the investor to do any follow on investments, at higher valuations, increases. The entrepreneur and investor are fully aligned. When the entrepreneur is not successful, and the investments did not result in more value, the entrepreneur luckily still has enough stake to ask for more investment and the investor can do follow on investments at similar or lower valuations to let the entrepreneur keep testing new markets. The entrepreneur and investor are less aligned than in the former case, but far more aligned than in the non-lean invested case.
Note: Newion Investments is an early-stage B2B software focused VC. Lean VC investing is one of its investment beliefs.