Why We Passed on This Startup (Episode 10)

Once upon a time, I met a startup team.

Let’s call it Company X with Sam and Karen, the company’s co-founders.

A Gut Feeling That Signaled… Something

When I first met Sam and Karen, their company was at a relatively early stage. I thought the founders’ energy was strong and made up for earlier stage nature of the company itself. I had several more conversations with Sam and Karen over the course of a year or so.

As I have had conversations with founders over time, I have tried to get super introspective about my gut feel about different founding teams.

Gut feeling is an interesting dynamic of early stage investing.

I’ve noticed that in situations where Tundra Angels invest in a company, it is like the feeling of enthusiasm with the founders and the opportunity builds and increases with each conversation. It’s as if each conversation reaffirms the one before it, why you are talking to this team, etc. That’s how I view one particular tell that we may have a good investment opportunity ahead.

But then there are startups where the feeling of enthusiasm over time is questioned and/or starts to deflate as the conversations continue on.

And in the example of Company X, I noticed that as I had more conversations with Sam and Karen, I started to get more hesitant.

After some self-evaluation, I realized that I was drawn to Karen way more than I was to Sam.

Karen seemed to be rationale and thoughtful, have a decent sense of good execution.

But over our calls and in-person meetings, Sam occasionally came off as brash, and occasionally came off with a hint of manipulation.

But often when I see a signal of something in founders, I don’t know how to categorize it. For example, I wasn’t sure, if this brashness was due to passion for the work and problem they were solving, which was clearly evident. Or, was it due to a deeper character quality… which would be problematic in an investment.

Often times, more time is needed to reconcile this feeling. But I paid attention to my hesitation, even though I didn’t know what to make of it.

An Interested Investor

Later on, I became aware that another investor in my network, Nick, was interested in Company X for an investment. Nick was a strategic investor to the space that Company X was in and was there was also a very real likelihood that one of Nick’s companies could be come a customer/user of Company X’s product.

One day, Nick and I had a call where he laid out how they were looking to integrate with Company X and he shared a vision of what this could look like in the future.

Nick was very bullish on the Company X opportunity. I did a lot of listening to this, and then Nick asked my thoughts.

I shared that I was interested in following Company X’s journey to see how it evolved.

Thankfully, Company X was early stage enough that it wasn’t actively fundraising yet. So I didn’t need to have a full amount of conviction at that time. Time was on my side. They were not raising yet, so I knew that more time would allow me to get a better vantage point into the company.

An Experience Insight

But I also had another question mark on Company X that was unrelated to Karen and Sam. I knew of handful of market actors, customers that Customer X was selling to, and ascertained that the main actors in the market did not have complete trust in each other. Because of that, the market seemed to operate with a degree of information asymmetry. But information asymmetry that both sides found acceptable and a way of doing business.

So in the case of Company X, importantly, Company X was making a piece of data transparent that was not transparent right now. This transparency would blow the cover of different transactions that would happen to the market, and it seemed to put the market actors in a less advantageous position.

This was an experience that I was familiar with.

Previously, I co-founded a bond trading startup. In the bond market, the two main actors were bond buyers and bond sellers. The bond market is very fragmented so that it is hard to get one whole view on the market. Thus, the bond sellers made their money by pitching bonds to buyers and marking up the price a bit to get some margin. In the bond market, the seller kept hidden the actual price that they acquired the bond at, and thus, the bond buyer didn’t know with complete transparency how good of a deal they were getting. The buyer knew that the bond was being marked up, but they didn’t know how much. This information asymmetry was one of the bond market rules, so to speak.

So therefore, my hypothesis of Company X was that the market actors wouldn’t go for having their cover blown. I ultimately did not have conviction that one of these actors was going to want this piece of data to be fully transparent. It seemed to be an unwritten market rule. Now, I was hoping they would be successful. In fact, in my conversations over the months, I warned Karen and Sam that I had concerns that this fundamental piece of transparency would cause friction for them in the market.

This asymmetric information appeared to be one the key axes that the market rotated on. Thus, was my key piece of analysis in evaluating Company X. If this company could reconcile this market tension between the market actors, then I thought they would do something special in the market. If they could not, then I believed the market would swallow them up.

My Asymmetric Insight

But I also had another unique insight. This wasn’t from my own personal experience, but from another startup that I knew.

I was aware of another startup, call it Company Z, that was outside of Tundra Angels’ geographic thesis. Company Z was solving the exact same problem as Company X, but with a slightly different workflow. The customers were exactly the same. These customers would use the product for the exact same use case as Company X. But, the customer’s entry point to the solution was different. But importantly, Company Z’s solution also made transparent this same key piece of asymmetric information in the market that I referenced above.

This company, just like Company X, was early stage enough that neither one was more advanced than the other in terms of traction.

The CEO of Company Z and I had a nice relationship. So the CEO kept me in the loop with their progress and I even jumped on one or two calls to give feedback on the journey.

This unique vantage point gave me the ability to compare the two journeys - which workflow was more optimal, and two shots on goal to see if the unwritten market rule of asymmetric information would be challenged.

Neither company knew each other, nor knew that I knew the other existed. But I kept it close to the vest. Because often asymmetric intelligence like this plays a critical role in an investment or a pass decision.

As I observed Company Z over a similar time frame, it struck me that they had trouble getting the tinder lit in the market. I heard they had customers, but on one of my calls with the CEO said at one time to me that the product usage with their customers was worse then they expected, and were trying to figure out why…

I sincerely wanted both companies to succeed, which is why I gave time to each of them. And even though my view was that the market wanted this asymmetric information to stay fragmented, I couldn’t account for what the founders were seeing when they were on the ground, in the trenches. So, I was watching them execute and watching it play out.

Communicating the Nagging Feeling

As time went on, Karen and Sam continued to keep me in the loop with their progress. I learned via an email that they were fundraising and had money committed.

Shortly afterwards, Nick called me. He was saying that their firm was looking to invest in the company and was basically asking, “This seems like something you’d be into, what gives?”

Venture capital is ultimately a relationship business. When investors have differing opinions and convictions on a given startup, there needs to be a sensitivity to disagree and yet still keep the relationship healthy. It’s often awkward when you don’t see it hte same way, and it’s even harder when you know the investor quite well.

In those moments, I’ve found that when I share your owned conviction. It’s not enough to speak in generalizations like, “I just don’t think the market is big enough,” or, “I don’t like their go-to-market strategy.” I’ve found that it’s important to be very specific, to try to be helpful to your fellow investor but also share why you’re not into the deal.

So I just leveled with this investor on my hesitations.

Me: “I’m just going to be totally honest with you. I like Karen a lot. I like the way that she thinks and brings to the table, but something about Sam just doesn’t sit right. In my interactions with him, he’s occasionally come off brash and somewhat manipulative in our fundraising conversations. It may be just passion for the space. But I don’t know how to think about that.”

This comment allowed Nick and I to speak at the same level.

Nick: “I hear what you are saying about Sam. I think there are times when he does come off strong. I think that Karen is going to start becoming more of the front-person of the company and Sam can focus on other aspects of the business, but not be the primary fundraiser and face for the company.”

That was a bit of a consolation. But I still didn’t know how these odd behavioral signals played out within the company. And ultimately, that is something that an investor has to discern through adjacent and sidebar conversation. But it turned out that I didn’t need to try to discern it. Because the answer came to my flying through the front door.

The Not-Agreed-Upon Beta Agreement

I had a contact, let’s call her Trish. Trish was someone I knew and was a potential customer of Customer X. Karen and Sam were aware that I knew Trish as well. One day, Trish called me up out of the blue.

Trish: “Matthew, I know that you’re talking with Company X. So recently, Karen and Sam had asked me to become a beta user of their product. At the time, I politely declined because of lack of bandwidth and got a “no worries”” response back from Karen and Sam. I thought all was well and good. Then, just a day or two ago, I was reading an update email from Company X and saw my company’s logo under “Beta Users” in the update! I declined to participate as a beta user and now this company is promoting in their company update that we are participating.”

I looked at the company’s email and sure enough. Trish’s company logo was there.

Trish mentioned that she was going to contact them directly and discuss. I asked if she minded if I brought it up with them, and she said, “That’s why I brought it up to you.”

The shoe had fallen with Company X. I requested a touch base call with Sam and Karen. I didn’t specify the agenda.

After making small talk, I jumped in.

Me: “Hey there, so I’m just going to be honest here. Trish mentioned to me that you had asked her to be a beta user, and she declined. I was surprised to see the company’s logo on your beta users list when she explicitly said no. I just wanted to call that out and that shouldn’t have happened.”

Karen and Sam’s faces sunk immediately.

Worse still, they deflected it as they had made a poor assumption about Trish and putting the logo on the sheet, but their body language and verbal backpedaling said otherwise.

Sam, in particular, was quick to apologize on behalf of the two and dominate the response, without letting Karen get much of a word in initially. He profusely apologized that it shouldn’t have happened. This quickness to apologize was a signal to me - this was his idea and doing. Unfortunately, in the following few minutes, I picked up that Karen wasn’t surprised or caught off guard my me bringing this up. She seemed aware of the situation as well, showing that she was an accomplice in the action.

In my mind, I wanted to make sure that they knew that I knew that I was aware of what happened. I wanted to communicate that, “I’m onto you.” With this, it would infer a message that Tundra Angels wouldn’t be investing in their company, ever. And to communicate, “You shouldn’t be doing this.” After some more awkward conversation, we hung up.

As I hung up from the call, I felt very relieved. This lingering hesitancy about Karen and Sam that I couldn’t place for a long time had now come into full clarity. This sense of brashness and manipulation that I picked up on over the previous year had been founded.

I didn’t need to officially pass. That call basically seared my investor response into them. After that situation, I didn’t really hear much from Company X. I certainly didn’t hear from Sam again.

I heard from Karen occasionally, who kept me in the loop with their progress. But then at some point, communicate died off.

Months after this transpired, one day out of the blue, I got an email from the CEO of Company Z, the company in the same market that was out of our thesis and I had observed their journey. The company was shutting down.

The reason that the CEO gave was something to the effect of, “We realized that it was harder than expected to get the two parties to align with each other and to share this data. We were not over to overcome this market dynamic.”

My initial hypothesis from my experience had been justified. This company, as well as Company X, was fighting against the rules of the market. In this case, the market won.

Closing Thoughts

I can’t help but think that Karen and Sam knew that things were not clicking for them in the market, as I had observed from Company Z’s CEO, and made a brash and unethical move out of desperation. One company, in the market, with the same customers, faltered because of founders’ missteps and lack of character.

But another company, in the same market, with the same customers, faltered because their product called the main axes of the market into question - asymmetric information that the market didn’t want to make transparent.

Here is what we need to understand:

✅ Our imagination cannot optimize for market reality. ✅

Founders have vision about a better future. Just because the future may truly be better and more efficient, doesn’t mean the market will go for it.

Truthfully, there may be a time in this market where a startup’s product and business model is so good that it reconciles the lack of trust of these market actors and brings harmony to the need for this asymmetric information.

This is one of the reasons why startups are hard.

✅ Because the market is the great equalizer, and a high caliber team and a strong product workflow are only the part of the entry ticket to get in the game. ✅

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