Brad Hargreaves | startup adventures in nyc

Both Matt Mireles and Mark Davis write about startups. Both write well, and both are must-reads for entrepreneurs. But their blogs are really, really different. Matt is controversial — he’s gone after a number of high-profile targets over the past couple months, including David Rose, just about every venture capitalist and New York itself. Matt’s writings are about working outside of the system, struggling against larger institutional forces in an attempt to hack together a company. Mark’s (or Larry Lenihan, or Phin Barnes or any number of VCs)’s writings are insightful, but they focus on learning the ropes and working within the existing system to achieve success.

For the visual learners among us, I’ve thrown a few startup and VC bloggers I like to read on a chart. I guess this is my form of a blogroll.  Apologies in advance to anyone not included, I love you too but I budgeted 10 minutes to make this damn thing:

The placement of the dots is a gross estimate, but you get the point.  While those at the VC-oriented side of the spectrum tend toward more educational, less controversial fare, entrepreneurs tend to be a bit more inflammatory.

Does this mean that VC bloggers are more restricted by the environment of the VC firm and the potential downside of annoying entrepreneurs or (worse) LPs or other partners?  Maybe.  But just as controversial writings could be enabled by freedom, controversy is also a tool for gaining pageviews and notoriety.  Just look at compete.com’s chart of The Metamorphosis, Matt Mireles’ blog.  

Plus, you have to consider supply and demand. There are fewer VCs than entrepreneurs, and content written by VCs simply tends to be in greater demand since they are the ones dishing out the money to young entrepreneurs.  So you could say that VC bloggers are don’t need to write controversial content in order to get noticed. It’s certainly true with guys on here like Fred Wilson and Mark Suster — they write controversial stuff when they want to, but they certainly don’t need to start crafting linkbait.

I’d argue that it’s not only smart, it’s necessary for anyone in the startup world to pay close attention to the entire spectrum. Focus too much on the VC writings and you’ll lose sight of the bigger picture and the way founders really think about things. Focus too much on the entrepreneur crowd and you’re just delusional — and missing out on a lot of good posts.

As anyone who has tried to raise angel capital knows, there are strict restrictions on taking money from individual investors. Unless, of course, those individuals are Accredited Investors as defined by federal securities law. That is, unless they are rich enough. If you don’t have more than $1 million in assets or income over $200,000 per year, the law reasons, you aren’t sophisticated enough to understand private equity and should thus be banned from making those investments.

But this goes way beyond startup fundraising. In fact, securities law as it is currently written represents one of the largest transfers of wealth in human history from the middle class to the upper class and is against the principles of our society.

First, some (simplified) background. There are two types of equity (stock) investment: public and private.

Public equity is stock in companies that are “publicly traded” — typically, on stock exchanges. Most of the big companies the average American knows (Google, Apple, Coca-Cola, Boeing, et cetera) are public companies, and their stock is public equity. Mutual funds, options, futures and most other derivatives contracts are forms of public equity. Anyone can buy public equity.

Private equity is stock in companies that are not publicly traded. Facebook, for instance, is a private company, and there are major restrictions on who can invest in such companies. While there are exchanges for this equity — such as SecondMarket — purchases must be tightly controlled to comply with securities law. “Private Equity” also includes the funds that invest in private companies, including venture funds, buyout funds, growth and distressed capital funds and a menagerie of other stuff. With a few exceptions, only accredited investors can invest in private equity.

Yet private equity, as a broad-based asset class, has traditionally outperformed public equity. Data around this is difficult to capture, since private equity is a complex field and there are no requirements for firms to report returns. However, State Street’s Private Equity Index is a good place to start, and they have regularly reported private equity markets outperforming public.

And how were those returns generated? Often, at the expense of publicly traded securities — whether it’s a venture fund selling its interest in a private company to a public entity via an acquisition or a hedge fund creating outsized returns by shorting the market or making algorithmic trades. These abnormally large returns must — by federal law — accrue to wealthier individuals.

The argument for the accreditation requirement goes back to the inherent riskiness of private equity. But given the catastrophic losses individuals have repeatedly taken in public markets, there is simply no longer any logical reason behind the distinction. From John Maudlin‘s testimony to Congress in 2007:

“Why should 95% of Americans, simply because they have less than $1,000,000, be precluded from the same choices available to the rich? Why do we assume those with less than $1,000,000 to be sophisticated enough to understand the risks in stocks (which have lost trillions of investor dollars), stock options (the vast majority of which expire worthless), futures (where 95% of retail investors lose money), mutual funds (80% of which underperform the market), and a whole host of very high-risk investments, yet deem them to be incapable of understanding the risks in hedge funds”

I couldn’t have said it better myself. But at least both public and private equity asset classes have positive internal rates of return — the government actively sanctions lotteries, casinos and other means of fiscal speculation with a negative IRR. In fact, the government actively targets lower and middle class individuals with these schemes — just see all the ads for the New York lottery in the subway. Federal and state governments are telling the lower and middle classes “You aren’t smart enough to understand private equity. Why don’t you put your money in the lottery instead?” This exacerbates the gap between rich and poor, further eroding the middle class.

Not only is this a massive transfer of wealth from the middle to upper classes, but it is fundamentally at odds with a mobile and meritocratic society. Why should the government restrict access to a certain class of investments by wealth? Lots of things are financially risky, like quitting your job and starting a company. Should the government save us from ourselves by requiring everyone to meet certain asset requirements before we can form an LLC, or even quit our day jobs? To take an example from outside of finance, driving a car is extremely risky. The government manages that risk by making all prospective drivers take a test to verify their driving skills. Perhaps those wishing to take part in high-risk investments should take an SEC certification exam such as the Series 7, which is required for those selling securities.

But that is still an imperfect analogy. If a clueless driver is on the road, they put everyone else at risk. If a clueless investor is buying and selling equity, they risk only themselves — especially if they are a smaller player. But at least an exam is meritocratic in nature, whereas an asset requirement is simply oligarchical.

Yet not only will the accreditation requirement be kept, but it is likely to be raised to a minimum requirement of $2.5 million in assets, stripping access to private equity from even the upper middle class. This is clearly a bad piece of legislation, and there are a lot of people betting it will change. Given our leadership’s tendency to respond to specific problems with ham-handed reform, I’m not holding my breath.

Over the last few years (and especially the last few months, it seems), I’ve seen a proliferation of new firms iterating on the traditional venture capital model. This is awesome, but keeping it all straight can be confusing.

First, let’s understand what’s being hacked. The following is a rough oversimplification of the way venture capital currently works.

In the traditional model, the managing partners of a venture firm raise a pile of money ($50 – $500 million) from limited partners (people like state pension funds and university endowments) and put it into a fund. They invest that money in a set number of businesses (typically about 10 businesses per managing partner) over a set period of time (typically 2-3 years). They support those businesses by attending board meetings, making the occasional introduction, and (perhaps) saving some excess capital for follow-on investments in successful portfolio companies.

Many people think that the traditional venture model is broken, at least when it comes to web businesses. I’ll save a full explanation for another post, but it basically comes down to (a) reliance on traditional private equity structures leading to (b) oversized funds, which combined with (c) decreasing costs for building web businesses leads to (d) an overwhelming need to deploy capital and (e) an unhealthy fascination with the “mega hit”, misaligning the interests of founders and investors and leaving venture capitalists frustrated with even a $300 million exit.

So there are a lot of points here to hack. How are different firms going about it?

Hack the Partnership Structure: Betaworks, Tipping Point Partners
Limited Partnerships work for private equity firms and large VC shops, but it may have grown long in the tooth for supporting web businesses. In a limited partnership, managing partners earn management fees from their limited partners (investors), which scale linearly with the size of the fund. Thus, there’s a strong incentive for venture capitalists to raise bigger funds than they need. Betaworks, for example, is actually structured as a corporation and takes “investment” in the same way that a startup would. And just as a startup is incentivized to take the “right amount” of money, these firms aren’t going to raise more capital than they absolutely need.

Hack the Limited Partners: Founder Collective, Zelkova Ventures
But partnerships aren’t necessarily a bad thing. Founder Collective, for instance, has replaced “dumb money” LPs with real entrepreneurs, providing value with more than their money. With a group like Founder Collective, the LPs are much more familiar with the nature of seed-stage capital, and the misalignment of interest is mitigated. And (at least in the case of Founder Collective), they also…

Hack the Size: Greycroft, Andreessen Horowitz
Could Alan Patricof and Marc Andreessen raise more money than they have? Absolutely. Do they? No, because they don’t care to live off of a 2% management fee. And by making that choice, they allow themselves to make small(er) bets on companies that may not be the next Google or Facebook, but have a pretty good shot at a $30 million exit.

Hack the Relationship with the Entrepreneur: Presumed Abundance
I’m not sure how Presumed Abundance’s experiment will work out, but it’s an interesting hack. In an attempt to re-align incentives between investors and entrepreneurs, they have made the entrepreneur a “conditional managing partner” (of sorts) in the fund, where the condition is a successful exit that contributes to the general fund.

Hack the Value: YCombinator, TechStars, DreamIt
Many VCs bring money and little else. Some firms bring lots of “else” and very little money. “Else”, of course, means connections, assistance and (often) space. This is one of the most well-established ways to hack venture capital, although it’s still an experiment in progress.

I think there is still plenty of opportunity out there for entrepreneurs who are interested in hacking seed-stage venture capital. It’s absolutely an industry in transition, and the barriers to entry are high enough to let new entrants carve out and establish valuable niches.

We’ve decided to open up Tipping Point Partners for office hours for any entrepreneurs / friends / ninjas who would like to come in and chat. Our conversation doesn’t have to be about companies, startups or tech. It can really be about whatever you feel like bringing up. Naturally, there will be beer.

Here’s the deets:

Beer and Office Hours with Tipping Point Partners
86 Chambers Street Suite 701
Every Thursday, 5:30 – 7 pm

See you there?

When most venture capitalists think of “barriers to entry”, they think of things like:

- Intellectual property (e.g., patents, copyrights)
- Strategic relationships
- Infrastructure and information

But I think the value of community as a barrier to entry is greatly underappreciated. And I’m not just talking about the network effect that keeps competitors away from Facebook. I’m simply talking about the existence of a community at a particular destination site. When you dive into it, there are thousands of examples of online communities outlasting the purposes and active management of the sites they inhabit.

Take my own GoCrossCampus, for instance. It was a fairly small (100K – 200K uniques / mo) gaming site focused on strategy games and the college market. In Fall 2008, the GoCrossCampus team started building a new site — PickTeams — and greatly scaled down support of the GoCrossCampus community. Yet the members stuck around in large numbers, continuing to play, chat and complain about the low level of support. (I wrote a bit about the reasons why GoCrossCampus failed here).

And GoCrossCampus wasn’t even built to sustain a community of gamers. It was built for large campus events, not a group of dedicated users. Yet the users stuck, even after we wrapped up the company and took the site down to one server.

And it continues. When we took the site down in March of this year, it sent a diaspora of ex-GoCrossCampus users to various sites. To this day, “GoCrossCampus” is still one of the top keywords leading to my blog.

Talk to anyone with experience bringing groups of people together online, and they’ll tell you similar stories. Communities are tough to build and tough to disperse — even when there’s a “better” product or social option out there, and even if the site in question isn’t “capturing the social graph”, so to speak. Look at 4chan, for instance. It’s essentially a klugey, spam-filled message board. There are no accounts. There’s no concept of “friends”. There’s no video support (thank god). Yet millions of people continue to visit it every day.

So is 4chan “defensible”? Not in the eyes of most VCs. It has no specific intellectual property or strategic relationships, and it isn’t capturing any social graph data or asking for any “investment” of profile info from members. Yet it has stuck around for an absurdly long time in the face of intense competition. Perhaps it is worthwhile to take a second look at our concept of defensibility when it comes to online destination sites.

Editor’s Note: This post was created in collaboration with Chris Paik, who was invaluable in helping me crunch the numbers. He’s looking for an internship in venture capital, so if you like this post, get in touch with him via his blog.

Lots of you enjoyed my post a few weeks ago on buzz and fund size among NYC venture firms. But why not take it further? Why not use all the data in Crunchbase of financings of NYC companies over the past five years?

So that’s what we did. And we got data for 814 venture financings since March 2005 worth a total of $3.1 billion. We were careful to exclude angel and strategic investors, since data around those deals are poor and would make the results harder to parse.

To start, let’s look at all venture firms that have completed over 7 financings of NYC-based companies in the past 5 years. Here, you can see how they stack up based on number of deals done:

Keep in mind that there’s a long tail here — this chart represents 300 total financing events, only 37% of all the venture financings of NYC-based companies in Crunchbase. The rest of financings were done by other firms.

But this is just parsed by the number of financings — with no thought given to the size of the deals. Thus, let’s look at the (relative) deal size by the firms listed above when investing in NYC companies:

You’ll probably notice that there aren’t any labels on the Y-axis. In brief, I don’t trust the absolute data here. It’s often impossible to distinguish the relative contributions of investors in a syndicated deal. For example, if Union Square does a $1 MM seed deal, there isn’t any ambiguity there. But if the company’s next round is a $10 MM round syndicated among two growth capital firms and Union Square, there’s no way to really know how much each firm invested. However, it is probably safe to say that the growth capital firms do bigger deals than Union Square, since they first joined the syndicate at a later (bigger) round. Thus, the relative data is accurate, but the absolute numbers are highly questionable.

Since we selected these financings based on the zip code of the funded company’s headquarters, we can drill down a bit further and draw some really interesting conclusions. Specifically, where are funded companies? The following map looks at two factors: the number of financings in the zip code (the color of the dot) and the total amount of venture money invested in the zip code (the size of the dot):

There are certainly some surprising things here, at least to me. This entire map seems to be shifted a bit further north than I expected; are there really that many well-funded startups in Murray Hill? I also expected to see a bigger presence in TriBeCa.

There’s a lot of data here, and I’m sure there will be follow-up posts — especially as we dive into the data on the types of companies that are receiving this financing.

Editor’s Note: This piece was originally published by Greg Costikyan on November 28th, 2007 and dealt with his experiences raising funding for Manifesto Games. I think it’s a wonderful piece that still rings true today, and I’m reblogging it with his permission here.

As a teenager, my subculture wasn’t “punk rockers” or “hippies” or “young Republicans,” but science fiction fandom. I tend to view other subcultures, therefore, from a sort of anthropological standpoint, noting similarities and differences from my own “native” culture. I understand “the science convention” as one of the cultural practices of my own tribe, and therefore perceive other similar cultural practices–such as the trade show, the industry conference, the acadamic conclave, or, in the case of today’s post, the venture conference–as interesting cultural variations on that basic motif.

Earlier this week, I attended the New England Venture Summit–my fifth conference of the venture-investing tribe as an attendee, my third in a money-raising capacity, and the second at which I presented.

As with conferences in other cultures, the focus of the event, which takes place typically over one or two days, is the agenda, a series of speeches and panel discussions. Unlike most other such events (e.g., the science fiction convention or the industry conference), the Dionysian aspect is downplayed–there may perhaps be private dinners sponsored by one VC firm or another after the day’s event itself, but the conceit of the participants is that they are there purely in the Calvinist pursuit of worldly wealth, so that open partying would diminish their own respectability in the eyes of the participants with whom they most desire to build social credit.

The organizers of these event are profit-making enterprises, who charge fairly stiff fees for participation, and target three sorts of potential attendees: entrepreneurs seeking capital; venture investors; and service firms. Under the rubric of “service firms” are included lawyers, accountants, headhunters, providers of outsourced HR services for small businesses, and the like. My impression, in fact, is that half or more of the revenues that such events produce are derived from service firms, both from the (higher) attendance fees they are charged, and through sponsorships.

The events on the agenda are of two types: panel discussions, usually among VCs, and usually moderated by someone from a service firm (who presumably has paid for a sponsorship in another context); and investor presentations.

Panel discussions are common to the conferences of all of the subcultures considered in our current study, but (in all cultures) they vary enormously in how interesting they are. In the worst case, you have as a topic for discussion something that has already been thrashed to death repeatedly at previous events, and a moderator who poses excruciatingly dull questions, eliciting rote answers from the panelists. Whatever your subculture, I’m sure you can bring to mind any number of these, from events you’ve attended. In an SF convention context, I would be very happy never to attend another panel on “Gender in Science Fiction” or “Breaking Into Print.” (Although even in these cases, creative panel members can overturn the conventions; I am unlikely ever to forget Michael Swanwick [writer] on a “Breaking Into Print” panel discussing his relationship with Gardner Dozois [editor], and saying “There’s a reason they call it ‘submission.’”)

The basic problem with the venture conference panel is that the conditions under which they are created mitigate against anything of the slightest interest ever being said. They exist to motivate the attendance of VCs, who may be flattered to participate; to reward service firms for contributing money (by allowing them to provide the moderators); and to attract the interest of entrepreneurs, who may reasonably be expected to find what potential investors say of interest. But the choice of topic is inevitably anodyne (“Emerging Trends” — can’t pass that one up!), and since the moderator is from a service firm, which has an interest in sucking up to both investors and entreprenuers, he is extremely unlikely to ask challenging questions, and is likely to stick to the equally anodyne. E.g., “Which is more important when you’re looking at a company–the finances or the team?” — a question at this actual conference, to which the only honest response is “Which are you, a moron or an idiot?”

(Oh, if you care –So let’s do a gedankenexperiment. 1. My team is Bill Gates, Thomas Alva Edison, and Henry Ford, and my business models is, we sell hot dogs at a loss and make it up on volume. PASS!

(2. My team is three heroin addicts who haven’t bathed in a week — but — wait! Billion dollar oppor… PASS!

( You tell me. Which is more important? The finances or the team?)

So from an entrepreneur’s perspective, there’s only one reason ever to attend these things: To put a face with a name, and know who to button-hole later.

The company pitches are the real meat of this kind of event. Typically, over the course of an hour or ninety minutes, a series of entrepreneurs get up, each allocated something between 6 and ten minutes, to pitch their company. The inevitable tool is the Powerpoint presentation (occasionally you’ll see someone using OpenOffice Impress, and good for them); this is jejune in its own right, and some day I’ll have the guts to do something completely offbeat, like hire a team of mimes and jugglers to provide visual representations of what I’m pitching.

There’s usually a ‘mandatory’ training session the day before, in which entrepreneurs give their pitch to a handful of venture-experienced people and get advice and feedback; this is actually useful, in many cases, since it’s surprising how many entrepreneurs show up under prepared, and quite often advice like “nobody’s going to be able to read 12 point type on your slide, no more than 4 bullets per, thanks” or “I still don’t have a clear idea what you do” is just what they need. For your ultimate six minutes of exposure, it’s a bit of a pain to take half a day off to watch painfully amateurish presentations from other entrepreneurs, but it’s still almost always worth it, even if you’re pretty polished. It never hurts to rehearse before a critical audience. (I didn’t take advantage of that this time, and it was a mistake not to do so.)

Watching entrepreneurs pitch is painful, because each of them has taken months of work and passionate dreams and a universe of ideas and tried to distill them down to six tight minutes. And it’s painful, because so much of what they’re pitching is jejune or just dumb; a minor tweak on the delivery of mobile content, a better way to sell real estate, a mechanism for making mobile games even less interesting than they are already by making them “free” and advertising supported. (Advertising supported inevitably means “dumbed down to the lowest common denominator.”) “Secure DRM,” hah. A mechanism for reducing cigarette theft at convenience stores.

All the kinds of things that maybe might make money, but my god; it makes you despair of capitalism. Is this the best that the Promethean creativity of the market can produce?

But to get back to the anthropological analysis, all conferences, of whatever type, have three purposes, though they vary on which they emphasize: to impart information; to build social ties; and to do business. For me as a teenager, the science fiction convention was first about information; it was an enormous thrill to hear the writers I admired speak, and I learned a great deal about writing, and the business practices of publishing. Later, it served a business purpose; promoting my work in the field, and establishing relationships with editors. And these days, on the rare times I attend one, it’s primarily social–catching up with old friends.

In terms of imparting information, I would suggest that “the venture conference” is a poor medium, except for very naive entrepreneurs. If it has any value as a social event, it is for venture investors (who often cluster and talk shop with each other, even as the entrepreneurs scan badges and try to figure out how to start a conversation with them–the entrepreneurs have little to say to one another). Which leaves the business function, and since these are events built around a business subculture, that is, or ought to be, their main purpose, redeeming the fact that they don’t do so well on the first two scores.

I would argue, however, that they don’t work particularly well in a business context, either.

Let’s start with venture investors. A typical venture capitalist spends the bulk of his days listening to pitches from entrepreneurs. Just as fiction editors are up to their eyeballs in slush, a VC has seen so many Powerpoints he has trouble remembering which is which, and probably has nightmares in which “the opportunity” and “go-to-market strategy” chase him screaming off a cliff, the jaws of negative EBITDA spreading threatening below.

Now let us say that you are, to pull things more or less at random, a VC who invests in, oh, the enterprise software space, specializing in expansion capital to already-established firms, located in Boston and almost never investing in companies farther than drive-distance.

Your expectation–and a reasonable one–is that anyone who has a company dealing with enterprise software, with some solid base of revenues, and within drive distance of Boston either knows you, or knows of you, or will ask around until he finds someone who does know you, and you will eventually see his business plan. Or if not, he can’t be a very competent entrepreneur, because he damn well should be able to find you.

So you learn of some venture conference, in the Boston area, where umpty-dozen companies will given a six minute pitch.

The basic thesis behind the venture conference is that you should be all excited to attend, because here you’ll get quick exposure to umpty-dozen potential investment opportunities, and all in the space of a day! Efficient use of time, yes?

No.

Out of those umpty-dozen, maybe two will fit your investment criteria, and if they were semi-competent, they’d find you anyway.

So… Maybe you send an associate. You certainly don’t go.

From an entrepreneur’s perspective, the supposed appeal to the venture conference is this: I’m pitching to a room containing maybe 200 people, all interested in venture investing, and even though there’s a fee attached (and maybe travel and a hotel room), and even though it’s a couple of days out of my (and maybe my senior staff’s) life, it’s a more efficient way to reach a lot of potential investors at once!

Right?

Well–no. That room of 200 people is maybe 25% other entrepreneurs waiting their turn or listening to other pitches to get a better sense of how to polish their own, and maybe 50% service folks who actually want to sell you stuff, and maybe the other 25% are investors of one kind or another. Of whom the vast majority would never invest in whatever it is you’re pitching. And of the handful who remain, almost all are so junior that unless they go back foaming at the mouth with excitement, it doesn’t really help.

You would be far better off staying at home, figuring out the right VC firm and the right person there, and figuring out how to network to them, so your submission doesn’t fly over the transom and land in the “slush”, but gets a sympathetic read.

As Michael Swanwick said, “there’s a reason they call it submission.”

***

Which is a nice pat way to end it, but leaves two obvious questions, I think. I’ll take them in order.

1. “So… How did you do?”

Ehn. I think the Powerpoint itself was pretty strong, but this is the first time I’ve tried to do this with a partner; Nathan took half the slides, and I the other half. We both floundered a bit, and were not as crisp, clean, and confident as you want to be in this context. We could have used another few hours of rehearsal to get it down pat. We didn’t, for two reasons; one, Nathan and I live in different cities, and our time for rehearsal was three hours the night before. And second, perhaps, I’m skeptical enough about the value of the whole enterprise that I didn’t make it enough of a priority for us to get together with time to do the work we needed to do. Penny wise and pound foolish; if you invest in the money and time to do this at all, you ought to do it well. I take responsibility.

Not that I think we made idiots of ourselves, but we could certainly have been better.

2. “Would you do it again?”

I think I’ve just made a strong argument for why this kind of thing is useless. But… Yes. And probably will. For two reasons.

First, the discipline of trying to distill what you want to do down to six minutes and a handful of slides of worthwhile–and refreshing, in its own way. More than that, distilling it down to a business case; it’s obvious, I think that I’m doing what I’m doing for a slew of reasons, many of which have nothing to do with a business case, and if I were doing a six-minute presentation for an audience of, say, game developers, it would look very different. But if I can’t make a strong business case, I shouldn’t be trying to do this as a business–an art project, perhaps, or a non-profit enterprise. But if I can persuade myself that this makes sense in a business context, that’s self-motivating–and an excellent framework to make a case to people–beyond the context of the venture conference–who are utterly motivated by monetary return, and don’t care as passionately as I about the larger issues.

Second… Even if, as I’ve argued, the venture conference is not an efficient fund-raisng tool, if you’re out looking for money… Well, it’s just one of the things you have to do.

Part of the subculture, you know.

Greg’s original writing can be found here.

I meet a lot of entrepreneurs and hear a lot of ideas and business plans from all across the board. Most have — at the very least — a kernel of a good idea in them. But many don’t know what kind of business they are. There are an unbelievable number of entrepreneurs focused on technology when their entire business model is predicated on the success or failure of a marketing campaign, for instance.

This isn’t to say that technology isn’t important for those businesses, but rather that it isn’t the core differentiator that interests investors and makes or breaks the company. If you are running a sweepstakes business, for instance, I don’t want to hear about your awesome Rails architecture. I want to hear about how you are going to acquire users for $1.50 and monetize each for $3.00. Sweepstakes (in most forms) is a marketing business, and that is really what a potential investor or partner wants to hear about.

I like to put startups in three categories as defined by the core factors driving their success:

Technology Businesses: The core differentiator of your business is your technology. Generally, your company either (a) has real intellectual property around your technology and/or (b) is founded by leading engineers in the field.

Marketing Businesses: Your business is driven by its ability to acquire and retain users/customers more effectively than your competitors.

Relationship Businesses: Your business’s success or failure will be determined by your ability to forge lasting relationships with customers and/or strategic partners.

I’ve rarely found businesses that are truly driven by some combination of those factors. In most, one factor greatly outweighs all the others. And there are patterns behind misconceptions — most commonly, first-time entrepreneurs overweight the importance of technology as opposed to marketing or relationships. This makes sense, as an entrepreneur’s first goal is often to get a product up. But products are hard to build real differentiation around unless you are doing really innovative stuff, like building new database backends or search algorithms. In most consumer internet businesses, marketing is the most critical component. In B2B plays, relationship-building tends to make the biggest impact. And in general, progress on the core differentiator is what VCs mean when they talk about needing to “see traction.”

Want to generate awesome startup ideas? An interesting trick is to identify immature industries where the leading players are focused on the wrong differentiators. My own LabApp is an example of this — while the existing (immature) players are focused on relationship-building, I happen to believe that software commercialization is a marketing-differentiated business. As with all startups, time will tell if LabApp is on the right track, but looking at “differentiation-based” pivot points can be a great way to generate innovative and revolutionary products in immature industries. Some off-the-cuff ideas:

1) Take a relationship-based approach to marketing-driven social games to piggyback off of major brands’ name recognition. This is similar to what Arkadium is doing to much success with the social advergaming concept.

2) Use a marketing-driven model to gain independent adoption to a new CRM software product from the bottom up. Almost all SaaS CRM providers are currently relationship-driven, which leaves open a massive long tail of independent salespeople.

3) Use technology differentiation to pry government IT contracts out of the hands of bloated, relationship-driven contractors. Easier said than done, but someone’s gonna make a lot of money from this in the next 15 years.

Happy differentiating.

I’m just going to leave this here.

Venture Firms with a Strong NYC Presence, by Buzz*

Venture Firms with a Strong NYC Presence, by Size of Newest Fund

* Presence in Blogosphere as measured by TechMeme