As investors, we are following what we call the “Rule of the Three ”. For the most part, it is the first set of filters we are using to screen and pre-qualify the investment opportunity. We need to know if it fits our strategy or falls outside the lines. Those filters allow us to frame or position our “Listening” to the pitch in a particular way that creates a safeguard for our decision-making process moving forward. In case you are wondering, we do not possess a crystal ball, and yes there is a method to the madness.
What it means is that we “bucket” companies in one of the following categories:
Each one of those categories or “buckets” comes with a different risk-reward profile that dictates the investment strategy and the deal structure. Each investor and or fund, depending on the scope and the size of their “pocket, relates to those categories in different ways based on their overall investment strategy.
Let me give you our distinctions:
DISRUPTERS. – this bucket typically carries a high-risk profile. Each time that you disrupt the industry or a market vertical you face the “resistance movement” and a higher barrier of entry. In many cases, it comes with a high price tag and will require a deeper pocket which means that the company will have to raise a significant amount of capital and spread the rate of return over a much longer timeframe. If it is significantly different, it may take some missionary work to educate the market and take more funds and time. It is not so much a question; if it will succeed rather; how long it will take? And what will be the total amount of required capital?
ORIGINALS – the investor’s “sweet spot” bucket (ours at least). It represents companies that found an original way to solve or improve on existing products or service categories that do not require disruptive change. Mid-level risk profile. Given that the company addresses an existing market and customer base it typically does not need significant capital and the barriers of entry are much lower.
COPYCATS – the most non-attractive bucket due to the fact that these companies are simply copying others with no real innovation or originality. It is a high-risk profile and most often they will find themselves slowly but surely out of the market. A copycat with only a lower price will not own the market very long, if at all.
It is not to say that there aren’t success stories in each of the categories. Although our data show that the companies that are in the ORIGINALS bucket most often show a higher success ratio in the short term, which is the preferred investment life cycle of most investors. It is not a science by any means, rather a guiding principle we use to manage our investment strategy.
Given that none of us possess a crystal ball the 80/20 rule applies here as well. We have been wrong before, have we missed some opportunities? yes. Yet it allows us to ensure that our 80% will be a very strong investment.