How to Pick the Next Billion-Dollar Company

One of the most common questions I'm asked is what the hottest new startup sector is. Is it crypto? Is it cannabis? How about VR (virtual reality) or AR (augmented reality)?

Many investors have very strong opinions on these spaces and stake their entire careers on the belief that they know the right answer. These types of investors are called thematic investors - and some of the top venture capitalists in Silicon Valley fall into this group.

Here's the thing about being a thematic investor: There's a small chance you will be very rich and close to a 100% chance you will lose all your capital.

I do not teach thematic investing for two main reasons:

  1. It's incredibly risky, and in a way that doesn't provide better returns.
  2. To be a successful thematic investor, you need to have significant experience within the theme you choose (traditionally 10-plus years in one space).

The strategy I prefer is an investment style called generalist investing. Here's what I mean by that - and why it's so profitable...

The Art of Generalist Investing

I've honed my abilities with more than 15 years of experience - and I've been able to invest into seven billion-dollar companies (23andMe, DraftKings, Headspace, Palantir, Robinhood, Wish, and one company that's still in stealth mode).

Three of those firms are now worth more than $10 billion.

I've learned a lot through these experiences, and I can say with confidence that the key to becoming a great generalist investor is to follow an expert entrepreneur down the rabbit hole of a new sector.

The quagmire when it comes to investing into the next $1 billion-plus companies at the early stage is that these companies tend to be category creators.

In other words, prior to the company's founding, there was no industry to study or be an expert in. Two great examples of this are Airbnb and Uber Technologies Inc. (NYSE: UBER), which created the homesharing and ridesharing industries, respectively.

This is the single biggest flaw in thematic investing, since sticking to one existing category often tends to capture everything but the biggest new companies, which make or break portfolios.

So how do you go about finding the best entrepreneurs?

This is the billion-dollar question. The short answer is that you learn by starting to invest and constantly improving your skillset just like any other skill.

The longer answer is that you must learn how to find hardworking geniuses. In other words, finding the right founding team to back...

How to Back the "Perfect" Founding Team

While it may seem relatively straightforward, backing the right team is a very difficult task that continues to evolve alongside the evolution and needs of startup companies themselves.

Rather than tell you what constitutes the "perfect" founding team, I'd like to dig deeper into the actual problem that a startup is attempting to solve and consider the ecosystem in which the startup operates.

It can be argued that some companies, like Uber, which was involved in intense early fighting with the taxi lobby, needed someone like Travis Kalanick, who is the ultimate prototype of a wartime CEO.

Other companies, like Google - which was involved in hyper-competitive recruiting wars with other tech companies - needed two nerdy founders (Sergey Brin and Larry Page) in order to create the right work environment and attract the best talent.

Needless to say, one company's perfect founding team may be completely different from another company's perfect founding team. That's why the concept of founder-product fit is so important to understand. Michael Jordan playing baseball is a very different proposition than Michael Jordan playing basketball.

Outside of founder-product fit, the data shows that founding teams with either one (solo) founder or more than four founders have fared more poorly than founding teams with two to four founders.

For tech companies, a combination of one (or more) engineering founder and one (or more) salesperson has proven to be the most predictably successful, while an all-MBA (Masters in Business Administration) team without any technical founders has been found to fare very poorly.

All things being equal, startups are the ultimate knowledge workforces. Empirically, founders with Ivy League (or equivalent) degrees have done significantly better than those without them.

This is due to a confluence of factors, including the ability to raise capital and recruit early employees, as well as the general competitiveness and high bar of entry at these schools.

Aside from any other data at the early stages, being able to find the best founding team to back is the No.1 leading indicator of a successful angel investor.

Pay careful attention to this question and continue to build your intuition in this area... and it will improve your ability to pick the right companies.

I'll be back soon with more lessons I learned as a VC. Have a great 4th of July Weekend!

Catch all of David's articles for free right here, at The Startup Investor, where he joins startup expert Neil Patel each week to show you how to successfully enter the world of angel investing.

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