Startup Warts and Investing

I was speaking recently with a seed investor that I respect a great deal about some of the companies I invested in while I was at betaworks. A couple of years since I first started, I’m now getting visibility into which companies might be big. One thing I’ve noticed is that a couple of companies that are growing quickly now had noticeable issues when I was first introduced. I’ll call these issues “startup warts.” Of course, all startups have challenges in the early days, but these ones, in particular, were larger and more transparent than most.

What exactly is a “startup wart?”

I think of a startup wart as something like when the founders can’t get visas to build the company here in the U.S. It’s when the founder is building a hardware company with no previous hardware manufacturing experience. It’s when [Sarah] doesn’t have great references from previous jobs or companies. It’s when a big competitor is expected to get to market before the startup does. It’s when the founders won’t seemingly be able to raise enough capital to get to the next milestone. Startup warts can be a million different little blemishes or a couple of massive glaring cysts.

Estimote is an example of a company that had a couple of big warts when I first invested. Although the company came out of YC and the engineering team was strong, the founders struggled to get visas and the company had no real operations or business / sales presence in the US, their largest market. Many angels and seed investors quickly passed because of these issues. But if they had dug in, what they would have learned is that no one was more keenly aware of these warts (and transparently pushing to solve them) than the founder, Jakub. Since then, they’ve quickly secured pole position to create the API for the physical world, have hired incredible people here in the US like Steve Cheney to run the business, and are selling a boatload of beacons (and SaaS software) every day. If the company isn’t already, I’m confident they’ll wind up in the anti-portfolio for many investors that passed.

What I’ve found is that many investors really hate big warts like the ones once seen on Estimote because they’re really easy to spot. When other investors, LPs, or founders inevitably ask why you made the investment even though there’s that glaring wart, it can be disheartening to justify the thesis. But in many ways I think the small blemishes are worse, too small to spot, and often found in large numbers, that are the real startup killers - death by a million little paper cuts.

Now, a few years after I first started investing at betaworks, I think the companies with a glaring wart or two may actually be the biggest opportunities for early-stage investors, especially because lower valuations typically reflect the added risk. If you can dig in and address these issues head-on, the founders and investors emerge stronger than ever. So bring me a solid team and idea and maybe even a wart or two, and we’ll work on removing them together.