Why focussing on expertise might be the reason to miss your next unicorn.
And how you can overcome your biases.
🖖 Welcome to Closing The Gap by JVH Ventures. After founding multiple companies and investing into more than 50 startups and 9 funds, we realized that a common understanding between founders, angels, and VCs is often missing.
We want to close this gap and combine perspectives from all sides.
Our goal is to look behind closed curtains and tell the honest truth.
Follow along to gain insights from all directions!
Let’s start with the obvious: Expertise is worth a lot. It displays your successes and failures of hard work, and you can always rely on it. Plus it essentially also correlates with your network, which again, is worth a lot as well.
But when it comes to startup investments, your expertise might actually hold you back.
“I generally don’t invest in my former domain anymore.”
VC Partner
What is expertise actually about?
Let’s start with the basics. Expertise can be differentiated in domain and functional expertise.
Domain expertise is your special insider knowledge of a specific industry or market. It’s also closely connected to your specific network, probably.
Functional expertise on the other hand represents your skill set and knowledge around functional challenges (e.g. marketing, finance, HR in general).
Most successful entrepreneurs have plenty of domains and functional expertise. Naturally, most angels get strong deal flow because of their areas of expertise. So right from the beginning, you will be biased towards having more opportunities in this field. So it makes a lot of sense to rely on this as a competitive advantage when it comes to making startup investments, right?
Well, the answer might not be that simple. We actually talked to a very successful investor who entirely diverted from his area of expertise and focuses on completely new areas for his investments.
When you are forming your investments thesis and continue to map out your portfolio approach, while having general knowledge of the power law, you have to consider your very individual biases as well. If you prioritize finding outliers (e.g. breakout cases) it will get very clear to you soon that these are very hard to find. Even harder if you overly rely on your historical expertise.
After all, the future can’t be predicted by looking into past events. And your expertise might actually be just that: Past events. Therefore, it’s extremely important to be aware of the advantages and disadvantages of relevant experience when it comes to venture investing.
The advantages of expertise
The advantages of high expertise are quick to find:
Network and credibility: First, domain expertise almost always comes with network as well. Combining your network and your knowledge, you will gain credibility and reputation. Which of course is very important at startup investing and probably a main source of attracting interesting startups.
More informed decision-making: Expertise equips you with plenty of insider insights to make informed investment choices. You understand the fallacies of the industry better than most
Ability to contribute: An investor with secret knowledge is what all founders are looking for, when they are closing their angel round. And of course, it’s also great being able to help the startup advance.
Competitive edge: In a crowded environment of investors, having high domain expertise can be the tipping point to convince founders to get you on board in their competitive rounds.
The caveats of expertise
However, expertise is not just an asset. It can also hinder you to reach your goal of finding outliers and assembling a winning portfolio.
Path dependency: All the expertise you have in a certain domain can actually be a double-edged sword. Domain knowledge will tend to do lead you down a path that you already know - while the future will most likely be different from the past. When it comes to solving the problems of tomorrow with solutions from the past, this most likely will feature a category changing outlier.
The innovation tunnel: As a variation of this, look into incumbents being unable to change, once their industry is disrupted. The innovation tunnel leads to prioritizing incremental innovations because of existing knowledge and causing you to overlook groundbreaking ideas.
Resistance to change: Also, being an expert can sometimes make you resistant to fresh perspectives. You may hold on too much to your knowledge and established paradigms, potentially missing out on disruptive, industry-redefining concepts.
The silo effect: Expertise often narrows your focus to your specific domain, making you less receptive to insights and trends from other sectors that could revolutionize your own.
Overconfident advice: Your voice of expertise has a heavy weight with inexperienced founders. So be careful that overconfidence in combination with aforementioned biases can also have destructive effect on founders who might actually face different challenges as you did, and hence also need different solutions.
“I used to tell founders what they should do, because I had a lot of domain expertise. But conditions changed over time and sometimes they would have been better off doing things their way.”
VC Partner
Overcoming your fallacies
It’s important to note that most of these disadvantages refer to domain expertise. While it surely is something to pride yourself with, you should be aware of the fallacies, too. Industries and market change over time. And this change is a central part of finding outlier startups that are able to change entire categories.
Only with these outliers, you are able to follow the rules of the power law. Hence, you should be very cautious in overly trusting your expertise, when it comes to judging the future.
This is also true for overly involving industry experts in your investment process and DD. During our annual JVH Backstage event, two VC Partners shared almost the same story of how they missed a few of their biggest investment opportunities because industry experts were not convinced that something like this could work. So be careful when it comes to integrating domain knowledge in your investment decision - always actively reflect about the shortcomings of overly relying on expertise!
The biggest miss in my investment history was partially due to relying too much on a domain expert’s opinion.
VC Partner
We are not arguing to lose your domain expertise and neglecting it, but rather continuously reflecting your views of the world and embracing change. When it comes to applying your domain expertise for problems of the future, we always find it helpful to exchange with other people who are outside your domain. Hear about their views on your specific problems and opening up for alternative solutions will help you to abstractly apply the essence of your domain expertise to new fields.
Leveraging expertise the right way
On the other hand, your functional expertise can be one of your biggest assets. Even though many founders overlook it at the beginning stage (and rather hope for access to potential customers, etc.), functional expertise is more abstract and applicable to fields of the future. If you are good at sales, recruiting the right people and negotiating - it doesn’t matter how an industry changes. These are traits applicable to entirely different fields and times.
In conclusion, while your expertise can be a crucial compass in the journey of startup investing, striking the right balance is the key. It involves reflecting the weaknesses of relying too much on domain expertise, while being open to learn. Also, leverage your functional expertise more than your domain expertise - as it will enable new views on old problems for emerging fields that potentially bear upcoming industry leaders.
Actively reflecting about your expertise, will allow you to spot those extraordinary outliers that have the potential to redefine the rules and reshape the future.
What’s next?
How do you actually construct your optimized personal portfolio? How do you diversify startup investments and what number of startup investments is the best for your budget. We will try to answer these question in our continuous series on portfolio building.
Don’t miss out!
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PS: We are always happy to answer your questions or take on topics you want to hear about to close the gap! Just let us know.