The primary goal of venture capitalists and other early-stage investors is to find home runs – companies that rocket to valuations of billions of dollars.

Sure, they’ll invest in a lot of singles and doubles and certainly some strikeouts, but those are largely by-products of the quest for home run companies. The home runs generate the big returns that pay for everything else. The difference between top-tier VCs and the rest is their ability to more consistently put their money behind home runs.

How do the top-tier investors do that? They tend to listen differently to a company’s pitch to find a key unlock that others often miss. 

Investors listen category-first.

We describe how this works in our book, The Category Creation Formula. 

Most home runs are companies that define and win an important market category – companies like Salesforce, Airbnb or Stripe. Singles and doubles are the copycats – the second- and third-place companies that win some market share but always operate in the shadow of the category winner – or companies that pursue a small category that won’t matter much.

So, let’s say an early-stage startup team meets with a great investor to pitch their company or product idea. While the founders are presenting, the great investor’s first layer of thinking is trying to understand if the founders are describing a new category of product or service that has huge potential. 

At this point, an investor should care less about you and your company than they do the category.

If the category doesn’t seem like a home run, it won’t matter how brilliant the founders are or how cool their product is. A great product in a “meh” category is not going to turn into a home run. The investor is likely to say, “No thanks.” 

On the other hand, the company’s pitch might give the investor an epiphany. Like, “I hadn’t considered that before, but what these founders are talking about could be a really important new category.” And that’s when the investor’s mental wheels shift into a different gear, because the investor then is trying to figure out if the founders in the room are the founders who can win this new category.

Here’s how Scott Kuper, a managing partner at Andreessen Horowitz, put it in his book The Secrets of Sand Hill Road: Venture Capital and How to Get It:

The fundamental assumption here is that ideas are not proprietary. In fact, VCs assume the opposite—if an idea turns out to be a good one, assume there will be many other founders and companies that are created to pursue this idea. So what matters most is, why do I as a VC want to back this particular team versus any of the x-number of other teams that might show up to execute this idea? 

Thus, every investment decision has infinite opportunity cost in that it likely prevents you as a VC from investing in a direct competitor in that space; you have picked your horse to ride.

In light of this, among the cardinal sins of venture capital is getting the category right (meaning that you correctly anticipated that a big company could be built in a particular space) but getting the company wrong (meaning that you picked the wrong horse to back).

Right. A cardinal sin of venture capital is to pick the right category and wrong company.

If the investor believes in the category but not the company, a great investor will dismiss the founders and then go looking for the company most likely to win the category. 

While category-first thinking should be the rule for investors, it also tells founders something important about the way to pitch investors. 

New category opportunities are created when there is an important problem that needs to be solved. A smart founder will start a pitch by describing, clearly and in some detail, the problem that exists, how significant the problem is, and why current solutions don’t fix it. That opens up an investor’s mind to the potential for a new market category of product or service. 

That’s typically NOT how most founders start a pitch. They start by saying here’s our team and here’s our product and what it does. That’s backwards.

As a founder you’d do better starting by convincing the investor the category is important, and then move on to convincing the investor that your company is best positioned to win that category. Show how you are going to design the category in a way that favors your company and gives your company the best chance of setting the category’s rules and making every other entrant follow you.

Your job as a founder is to help the investor believe in BOTH the category’s potential AND your company’s ability to win the category. If you can’t do both, the great investors will send you away and go looking for a worthy competitor.

Your job as an investor is to pick the right category AND the right company.

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To order the book: https://www.thecategorycreationformula.com/

To talk with us about your category strategy: https://www.categorydesignadvisors.com/book-office-hours/