I started writing about economic moats in September 2014. Since then I have written about Network Effects, Switching Costs, Intangibles, and Efficient Scale and Cost Advantages. The purpose of those posts was to outline how I think about economic moats while I am studying a seed stage startup and trying to determine how things might unfold in the future.

This is how I define an economic moat in relation to early stage startups:

An economic moat is a structural feature of a startup’s business model that protects it from competition in the present but enhances its competitive position in the future.

In this post I will wrap things up with some final observations;

First, in relation to economic moats, my responsibility as a seed stage investor is to identify startups that can build or acquire an economic moat as their business model matures and as the startup becomes a company. Directly tied to this, I have to make an assessment about the founders’ willingness to conceptualize and build such a moat if things go well. There’s no point worrying too much about a moat if the rest of the world is apathetic about what the startup is doing.

Second, An economic moat is not the same thing as a competitive advantage. A competitive advantage is temporary. This is because a competitive advantage is typically designed on the basis of Michael Porter’s Generic Competitive Strategies. A durable economic moat is unique, and typically can not be duplicated by others.

Third, to withstand the effects of sustained challenges from incumbent and new-entrant competitors startups need an economic moat that is derived from more than one source. In relation to Internet and other software technology business models, indirect network effects can prove to be as important as direct network effects.

Fourth, some of the strongest foundations on which a startup can build an economic moat are also some of the most difficult to come to grips with. Mainly, these are lumped together as “Intangibles” . . . Among the sub-items under intangibles Management & Culture, and Research and Development stand out to me as being things I should look out for at the seed stage because everything else emanates from those two.

An organization’s ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.                                                      – Jack Welch

Fifth, cognitive costs are a real barrier to entry and till an early stage startup has established itself within a market, uncertainty works against it but in favor of the incumbents. This is especially true for startups building products for sale to other businesses. These aspects of buyer lock-in might be nearly impossible to articulate or measure, but that does not mean startups and their investors can afford to ignore them. At the outset a seed stage startup must find that niche of potential customers for whom the sum of cognitive costs and uncertainty is a minimum. It is worth thinking about this at the outset of product development.

Sixth, thinking about cost advantages has to go beyond the obvious advantages it confers on the startup in terms of its operations. The most important consideration is how a cost advantage enables the startup to create more value for its users or customers. A cost advantage that does not yield increased value for users and customers is not one that will last.

Lastly, as a startup scales it must pay attention to how that is affecting the macro environment in which it finds itself. A bad market can remain unfavorable far longer than any startup’s ability to scale its way to a profit. It is one thing for a startup to find product-market-fit, but quite another for that startup to scale efficiently in that market. Finding product market fit does not automatically lead to conditions that favor efficient scale. Extended unprofitable growth is one sign that a market might not have the characteristics to support efficient scale, or that the startup has not thought its business model through enough.

When I study a seed stage startup I am trying to answer a number of general questions about how the future might unfold for that startup, thinking about economic moats gives me a useful framework for doing so.

At KEC Ventures, I have been largely focused on finding and meeting the founders that we can become most excited about and partner with. I will continue to maintain that focus over the course of 2016 and 2017.

Here are some notes for the founders of the startups I am most eager to meet.

About KEC Ventures

We are a team of early stage investors based in New York City. We invest in information technology startups that are pursuing business models with the potential to transform the way business is done in their market. In such startups, we generally invest in the first institutional Seed Round or, less frequently, we will invest in the Series A round of financing. Often, but not always, we act as the lead investor. On rare occasions, we might invest earlier than this when we meet a founder pursuing a vision that we believe in. Currently, we focus on investing in startups based in the United States or Canada.

Connecting With Me

If you know someone who knows me, an introduction would help. If you do not, never hesitate to communicate with me directly. I am easy to reach on the major social networking platforms. Also, I hold regular and frequent office hours at various co-working spaces in New York City. Some allow non-members to sign-up and attend.

The best time to start communicating with me is at least 6 – 9 months before you believe you will raise a round in which KEC Ventures might invest because I believe it is important to build trust before entering into the kind of working relationship that exists between startup founders and their early stage investors.

That also gives me sufficient time to understand the problem you are solving, so that if we invest, we are doing so with conviction. Time enables me to become a more effective advocate on the startup’s behalf when my colleagues and I have discussions about making an investment.

Communicating With Me 

If we are not meeting through an introduction, I will respond quickest to founders who get straight to the point, and explain why we should meet in 250 – 400 words in their first email to me. I try my best to respond. However, depending on what else I have going on, I may not respond if I feel the startup is outside KEC Ventures’ areas of interest and that the founder could have easily found that out before emailing me. Please follow up with me once or twice if you believe I have made a mistake.

If you are not connecting with me or anyone else at KEC ventures through a warm intro, you can email me at: pitch@kecventures.com. I’ll go through submissions to that email address every Friday.

Characteristics I Look For in Founders, and Teams 

I look for teams in which the founders have known one another for a considerable amount of time prior to launching their startup. I look for teams in which the level of trust and respect between the co-founders is high. I look for teams that will not have difficulty attracting other great people to join the startup. I look for founders who inspire confidence and loyalty from others because they are good at what they do, the kind of people I could picture myself working for.

I look for founders for whom solving the problem that their startup is solving has become their life’s mission and they plan to solve that problem with or without help from outside investors. I look for founders who have an unconventional opinion about the market opportunity they are pursuing, and can explain why their position is correct with evidence which investors can analyze independently.

At the outset I look for teams that can focus on building a simple product that their initial customers love, and who can focus on a niche within which to launch their product. I look for teams that are judicious and frugal in how they deploy the startup’s resources.

I look for founders who value teamwork, and who can become great leaders if they desire to do so. I value transparency, honesty, and openness. I value self-awareness. I like people who are determined and tenacious, who do not give up just because the going gets get uncomfortable and things seem bleak.

I look for founders who have a hard time doing something simply because it is what someone else expects them to do. I look for founders who are not afraid to be different.

Characteristics I Look For In Markets 

I look for large markets that could ultimately be served by the startup’s product, even though the initial target might be a small portion of the whole. I look for customers capable of and willing to pay for the product, and who are looking for and eager to find a solution to their problem.

I look for markets in which the pain is acute because the problem suppresses customers’ profits significantly, or because the problem makes users less happy than they could be.

If currently the addressable market is between $1B and $10B, I want to see evidence that it is growing quickly enough to support the startup’s future goals, and the competition that I assume will quickly follow if the team is successful.

Characteristics I look For In Business Models 

I look for products and business models that:

• will benefit from network effects as time progresses,
• can scale efficiently and quickly, and
• can eventually benefit from an economic moat.

The Themes I Am Focused On

Notes:

1. These themes cut across different industries and sectors. That is a deliberate choice.
2. The technology sector evolves constantly. Accordingly, our team’s interests might ebb and flow in response. The themes I have described below should serve as a rough guide to how I think about the universe of startups in which we wish to invest.
3. Ideally, a startup raising its first institutional seed round should have raised less than $1.5M – 2.0M or so prior to the round in which KEC Ventures would be investing.

I am currently interested in hearing about:

• Marketplaces: Platforms that enable the participants in large, global markets to interact with one another in ways that reduce waste or create new, untapped opportunities.
• Interconnectivity: Platforms that enable large numbers of different types of connected devices, machines, apps, and websites to communicate with one another and with the people managing or using them within a secure environment.
• Data & Analytics: Platforms or applications that help people or other machines to manage, analyze, interpret, make decisions, and take actions based on vast and growing troves of centralized or decentralized data.
• Effectiveness & Happiness: Products that enable people to accomplish more at work, or to become happier outside work. Products that help large enterprises and other types of businesses and organizations to grow or function more effectively.
• Distribution: Products that make it easier to create, manage, distribute, and consume existing and emerging forms of digital media and content.
• Asset Management: Technologies for managing different forms of enterprise, business, or individual assets. Technologies for managing different forms of enterprise, business, or individual risk.
• Other: New, and as-yet unknown technologies and innovations founders are building to solve problems that exist only because no one else has developed a solution.

Things I am Not Interested In

1. Exploding rounds: An exploding round comes with a caveat like “Seed round in ground-breaking tech startup closing in 1 week!” I do not like exploding rounds, not even exploding rounds that are being led by a name-brand VC. I need time to do my own homework.
2. Meetings led by an advisor: I prefer my first few interactions with a startup to be with the team of co-founders, not with an advisor. It is okay for an introduction to come from an advisor, but I do not like to have advisors or mentors micro-manage my interactions with startup founders. That does not inspire confidence.
3. Lack of control over core technologies: I try to avoid situations in which the startup has a product that has launched to the public, but the startup’s team has no primary responsibility for actually building the core product.
4. Founders who will not share bad news: I only want to work with founders who will not hide bad news until it is too late for investors to do anything that might help the startup make a course-correction. I absolutely want to hear about difficulties, challenges, and problems. I expect the good news, but I think we have an obligation to try to fix the bad stuff before it becomes unfixable.

My Commitment to Startup Founders

Based on Gil Dibner’s VC Code of Conduct;

1. I will be transparent.
2. I will respect your time.
3. I will not ask you for material I do not need.
4. I will not string you along.
5. I will let you know about any competitors in our portfolio.
6. I will be transparent about conflicts of interest.
7. I will not share any of your material without your permission.
8. I will not speak with your customers without your permission.
9. I will educate before I negotiate.
10. I will be honest about what standard terms are.
11. I will not issue a term sheet unless my firm has made a firm decision to invest.
12. I will reflect the term sheet in the final legal documents.
13. I will not seek an unreasonable equity stake.
14. I will avoid surprises.
15. I will always act in the best interests of the company.