Why do VCs avoid competitive ideas?
What does it actually mean when a VC says an idea/space is too competitive? Here are the 3 reasons I see most often.
🧮 unit economics
🧱 portfolio construction
✊🏽 conviction
Unit economics
Building in a competitive space is like letting your P&L be determined in a live auction. VC funding enables other companies to buy customers, bidding up the cost of acquisition.
ads cost more
content has to compete on keywords with a high difficulty score to get the #1 page rank or featured snippet on Bard-enabled Google
outbound become less effective
you need even better sales people
As the cost of acquisition goes up, the payback period gets extended, requiring a higher price or longer LTV to make the business model work. But it’s hard to increase pricing or drive retention when customers have alternative options. When a product becomes commoditized, users often stick with the first mover or optimize based on:
cost
speed
product availability
All of which fragment the market and make scaling really tough. Scaling is the number one reason we say no to companies!
We often hear from founders focused on a competitive space because none of the existing solutions satisfy needs. And this may be true.
Unfortunately, even if your product is 7x better than any alternatives, it takes $$$ to cut through the noise to get enough initial users to start the word-of-mouth flywheel to derisk the business enough for VCs to be willing to take a closer look.
Portfolio construction
If you’re building in a space where companies are raising $10m, $20m, $100m, funding becomes one of the primary axes of competition.
According to Pitchbook, the median venture fund is $50m. That could dictate a $50k initial check like us at Hustle Fund or $2m. Regardless, with ownership targets and clear goals on return, huge funding rounds are rarely a good fit, and it’s tough to justify investing in a David when Goliath has millions in the bank.
Momentum investors may get comfortable investing at the tail end of a round where a brand name lead has set the terms, wired $$$, and rounded up a cap table of followers. But if you need to raise a lot of capital to compete, your entry valuation is likely driven up as well as the exit valuation required for investors to 10x or 100x their initial investment.
For smaller funds, it’s just hard to make the math work.
Conviction
I shared an amazing company building in a competitive market this am with another investor.
They quickly passed.
When I pressed on why, they shared that while they agree with the problem, they aren't 100% sure that this is the winning approach...and don't have the brain space to get to conviction.
While the macro tailwinds might make an opportunity obvious, it can be hard to know which company - product, strategy, team etc - will win (especially in AI given the pace of innovation and venture $$$ flowing in).
The breakout category leaders with a first-mover advantage start building before a space is hot and VCs/journalists have slapped a name on the trend.
Uhh…now what?
Overcome the competitive objective by figuring out your wedge before going out to fundraise: the specific, underserved user group or problem that you and you alone (for now) are targeting.
There are a lot of productivity apps out there, but not many for zookeepers. There are a lot of personal finance apps out there, but not many focusing on helping you find and pay your parking or speeding tickets.
Alternatively, you may realize through customer discovery the seed of a more painful problem that enables you to create a category.
If you start with a larval market with a low customer acquisition cost, a distribution edge to reach your customers and grow without requiring Daddy Warbucks check sizes, and an earned secret about that market/customer base that will help others get to conviction, you’re already far ahead of many of the pitches we see.
