Hidden in spite of obvious

May 8, 2024

In this episode of my AEC_VC podcast, I share my "Hidden in spite of obvious" framework and how the most promising early-stage companies I invest in often pursue ideas that are obvious to industry insiders but remain hidden from outsiders.

B2B (and AEC) has many nuances

This week's thesis is a framework. B2B, especially AEC, has countless nuances. Nuances that require a dedicated approach to unlock value. It's why generic horizontal software players don't choose AEC as an early vertical. The unique nuances demand a tailored strategy for product and distribution. A strategy that differs from generic playbooks. Problem is, you need to deeply understand these nuances. Not just to have answers, but to ask the right questions in the first place.

My B2B-vertical framework

I've developed a framework for evaluating B2B opportunities, particularly in AEC. I call it "hidden in spite of obvious." Picture a 2x2 matrix. Generic people vs. experts/early adopters across two axes. The categories are whether signals are hidden or obvious to each of them.

Hidden in spite of obvious VC framework

The top-right quadrant is the sweet spot: “Hidden in spite of obvious”. Opportunities that are hidden to generic outsiders but obvious to industry insiders. These are the openings to potentially build a category-defining company early. Without quickly facing a slew of competitors with undifferentiated offerings.

Contrast that with the bottom-left quadrant. I label it "obvious in spite of hidden." Ideas that seem clearly attractive to a generic entrepreneur or investor. But are actually non-obvious to target customers and domain experts. This often happens when someone tries to shoehorn a playbook from another sector into AEC. Without truly understanding the unique customer needs and industry dynamics at play. Avoid this quadrant like the plague. What’s tricky is that you actually need vertical-specific insight to avoid this from happening to you.

The other two quadrants can work in specific cases, but are generally suboptimal. Being hidden to everyone often means you're taking on immense market risk with contrarian assumptions about something that will change big-time in the market - eg. regulation before it is anywhere certain. It can pay off big if you're right, but it's a bet close to playing roulette. On the other side, being obvious to everyone typically means you're either investing in a late-stage category leader (great for growth funds, but comes at a price). Or, if this happens early, you're a "me too" category-clone copying an established model (not a recipe for outsized returns and very likely going to face stiff competition early).

For founders and early-stage investors, "hidden in spite of obvious" is the quadrant to target. It's where you can get in early on an emerging opportunity. Build a moat around it, and scale into a breakout business. But identifying these opportunities requires a keen eye for the non-obvious. Which brings me to the importance of strong vs. weak signals. And which ones to use to identify a “hidden in spite of obvious” opportunity early.

Strong signals v. poor signals

It’s mind-boggling to me. Most people look for the wrong signals when evaluating early-stage B2B opportunities. They focus on things like fundraising amounts, flashy press releases, rapidly growing team size, or call-off contracts a startup has signed. I call these "poor signals." While they're highly visible, they're not very correlated with real traction and potential in AEC (and B2B in general).

Strong vs. poor signals in early-stage VC investing

Tons of early fundraising, for instance, can be more a function of a compelling narrative and social signals that work in the background than an actual working business model. Press releases are carefully crafted to paint a rosy picture. Headcount growth can just reflect a bloated org chart, and it actually in many cases comes with averaging-down on team quality. And call-off  contracts, upon closer inspection, are often "empty shells" with no real committed spend and a gated call-off process.

Instead, I try to rely on "strong signals." Data points that are much harder to access but far more telling. I dive deep into early customer references. To gauge not just if they've bought, but why, and what they are seeing that their peers do not see yet. I also talk to suppliers and partners. To understand their motivation for dedicating scarce resources and capacities to an - in the market’s eyes - unproven startup. More than anything, detailed P&L and cash flow data allows me to find pockets of substance, in margins, working capital structures, and metrics I like per model. To assess underlying unit economics and capital efficiency. Not much gets me more excited than an early net profitability.

Perhaps most importantly, I track the movement of truly A+ talent into a startup. Looking not just at quantity but quality. When I see a handful of experienced, discerning operators joining a young company after conducting extensive diligence, that speaks volumes. They're not just betting their careers, but often their personal capital and reputations.

A great example is one of my best investments to date. At the pre-seed stage, every other investor passed. Because it looked like a services business to them. But the strong signals were there if you knew where to look. Excellent cash flows, early net-profitability, a clear path to a scalable software model, and a small cadre of ultra top-tier talent coming aboard. Today, that company is a breakout success. But it was hidden in plain sight to those who didn't dig past the surface.

So while strong signals are tougher to access than poor signals, that's exactly why they're so valuable. They cut through the noise and misdirection. To reveal the real potential of an early-stage company. It takes work to uncover them, but it's the key to identifying the "hidden in spite of obvious" gems.

Empathy matters early !

Specialized vertical investors and dedicated founders can spot strong signals earlier. Through hard-earned sector empathy. Routinely seeing the same things breeds an ability to ask key questions sooner. And know your unknowns. That's a huge edge. Since generic investors often don't even know what questions to ask in a space like AEC early on. Founders, even if you're new to AEC, invest the time upfront to build that nuanced empathy. It makes all the difference. Portfolio company Monumental spent a full year deeply learning construction before committing.

Founders in AEC: Follow my framework

So my advice: pursue "hidden in spite of obvious" AEC opportunities. Take the time to unearth the strong signals. Cultivate deep sector empathy. It's the surest path I've found to building a pioneering AEC technology company. Reach out if you're a founder heeding this approach. I'd love to hear your story and perhaps partner in shaping the future of AEC.

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