Building Your Moat: A Conversation with Greg Gottesman

This morning I attended an event hosted by Joe Wallin, attorney at Davis Wright Tremaine and founder of Startup Law Blog. Joe had Greg Gottesman, managing director of venture capital firm Madrona Venture Group, in the house for a Q&A session that began with some stories about Greg’s background and a successful business that he spawned out of a startup weekend. The session also touched on the importance of patents to early stage companies, what he considers to be differentiating factors of successful companies, and implications of the lifting of the ban on general solicitation (effective today) for companies hoping to rely on an exemption under Regulation D as they look to raise funding.  The hour-long discussion gave attendees the opportunity to present questions to one of the top venture capital funders in the Seattle area. Below are some highlights of the meeting based on my notes and recollection.

Building Your Moat

The session started with a question about businesses with “sharing economy” models, such as Rover.com, and whether Madrona had any others in its portfolio. Greg mentioned this as a growing area, and that he had thought of several other ideas, including connecting personal chefs with hungry households, and renting out extra storage space in people’s garages and homes. The problem was that every time he came up with an idea, it seemed as if someone had already started a corresponding business somewhere, and he then lost interest. One problem with this model, he said, was that it is very difficult to build this sort of company up from scratch and gain a critical mass of users in order to bring the concept to viability. He used the term “moat” to define this critical mass of users (and later applied the term to rare talent at a company, or really anything that gives you a difficult-to-assail advantage over your competitors). I like this metaphor. I suppose I would define it as an aspect of your company that gives you a serious advantage in the marketplace, but does not make you invincible. Your moat is just an obstacle to overcome for your competitors.

Value of Patents

A question came from a participant regarding the value of patents. Greg’s perspective was that they are good to have, but the value to him as an investor really depends on where they sit are in context of the business and the technology. He seemed to look at them as more of an additional data point to consider when looking at an investment, but not necessarily a reason to invest. The conversation then turned to a discussion of the shortcomings of the US patent system, and the increasing pressure that Patent Assertion Entities (PAEs)—companies that own patents but do not actually build anything based on them—are exerting on small companies. Greg said that he sees a lot of his companies getting sued by PAEs asserting their patent rights. Even when the target company could make a winning case that a patent being asserted against them is invalid, they usually lack the resources to litigate the matter.In light of this, any response to the PAE that their patent is likely not valid is an argument that will fall on deaf ears—they know that it will cost the target company a lot of money to prove the invalidity of a patent, and that such small companies are far more likely to try and settle. Since PAEs do not have an ongoing business other than suing other people, there is no opportunity to negotiate a cross license with them.

Greg was careful to note that although many people put PAE Intellectual Ventures (IV) into this same bucket, and that technically they have a similar model, they have not been as aggressive as others in pursuing early stage companies. IV is an interesting case in that they put a lot of money into true R&D and developing many of the technologies they acquire. I recently spoke to a scientist from IV who described large research labs and warehouses full of cutting edge scientific equipment that could be called up on a day’s notice and installed, calibrated, and put to use for seemingly cost-is-no-object research. IV also has a venture funding arm that assists smaller companies in commercializing their business ideas. These elements, to me, serve to differentiate their efforts from those of other companies who have come to be called “patent trolls”.

Greg sees this as a major issue hampering innovation. He mentioned that having patents in your own portfolio can help, but it is important for early stage companies to also look for other ways to build their “moats”.  Getting business traction is one major way to build a moat. Another is hiring and retaining the best possible people for your given niche. Greg used the example of one of his companies, Decide.com, which was recently sold to eBay Inc. One of their moats was having 5 or 6 people who he considered to be the best in the industry at predictive pricing technologies. He encouraged companies to think hard about which pieces of their business give them a sustainable advantage: “That’s a moat”.

My own view on patents is that their value really depends on the type of company you are looking to build. For a social gaming company or sharing economy web site, your model may rely on building a “moat” of users early on and your technology might not even have IP that is patentable. If you are working on a high-end genre-defying security product that requires intensive R&D, however, it may be more useful to explore the possibility of protecting your inventions with patents early on.

The takeaway message for early stage companies was that building a technology company is hard, and you have to do whatever it takes to increase your likelihood of success. Figuring out where your company’s advantages lie and how to build your moat is incredibly important. This might include giving away more equity or spending a bit more to get the exact right person to do the job, or being less sensitive to dilution when the need for funding is critical (N.B. Greg’s one of the people providing capital).

Differentiators of Successful Businesses

An audience member also asked what Greg thought were some of the key differentiators between successful and unsuccessful startups. He gave five very good points (eight if you consider that he reiterated the first point four times).

1. Team. He looks for somebody on the team who he believes will be able to fully execute the company’s vision. This may come in the form of a person with past successes, great references, or even just someone who seems to have the vision and ability to capture their idea. The strength of the team was mentioned as far and away the most important element. This emphasis on team carries over to Greg’s involvement in the Techstars accelerator program, for which Gottesman helps to select partcipants. He mentioned that he sees many selected companies pivot early and fast–something that requires a strong team to pull off.
2. Scope. Is the opportunity itself something big enough to really dig into? Here he used an anecdote from Glenn Kelman, CEO of Redfin. When building Redfin, the way Glenn saw it (and I paraphrase here) as long as he was going to give up all of his time and effort and untold amounts of blood sweat and tears building something, he might as well go after something big. By targeting a huge market from the outset, you don’t have to execute perfectly to have a big business.
3. Market. Does the competitive dynamic make sense? It is important to analyze the market ahead of time and determine if it is already crowded with competitors, and if there is room for a new player.
4. Fun factor. How is the product to play with? Redfin, Haiku Deck, Band Camp, the iPhone are all examples of products that just plain work and are fun to use. When you play with the product, does it just intuitively work?
5. Value. Greg made the point that almost all companies that come to him have an idea or product that creates some value to someone. The bigger issue for 99% of the companies is that they are unable to capture what they create, and lack a business model that addresses the ability to capture the audience for whom they are purportedly creating value. Greg was adamant that the answer cannot be advertising, because these days that model requires too much scale (as we’ve gone from the dollar in print, to the dime in browsers, to the penny in mobile). The company should be able to directly monetize the market that they are pursuing.

The upshot: have a strong team, a great product, shoot for the stars and “prove that you can make some hay”.

The Seattle Scene

Asked about enterprise oriented businesses in Seattle, Greg said that this is an area around which he sees our local talent base uniquely positioned for strong growth. We have large cloud providers such as Amazon and Microsoft already in the region, and strength in storage companies such as Isilon. These companies have brought a very deep pool of engineering talent, and Greg believes that what some of these companies are doing, particularly Amazon, will prove transformative (or indeed already has). He sees Amazon as having the potential to become the largest company in the world within 10 years. That said, he also lamented that we don’t have as many great startups as the talent pool in Seattle might otherwise suggest, and made a “call to arms” for people with the means to take a more active role with companies that are participating in local events such as startup weekend and in accelerators. He noted that Madrona makes up to 50% of their investments at seed stage, and that he thinks they are doing their part. Seattle has all of the fundamental building blocks of a city that could spawn many more enormous growth startups. Indeed, Greg mentioned that many of the largest tech companies are opening their primary non-Silicon Valley offices in Seattle due to the great technical talent here. He’d like to see more local angel investors step up to the plate and support some of the new ideas that are emerging locally.

Many thanks to Joe and DWT for hosting the talk, and to Greg for taking the time to stop by and share his great insights.