How to Create an Investment Thesis
What it is, why you want one, and how to create it
One of the essential elements in a venture capital firm is the investment thesis. The thesis can come in many varieties, from broad and loosely defined focuses to a specific vertical and company stage. On the other hand, some investors choose to allocate capital without a core thesis driving their decisions and see success in this strategy. This post will define an investment thesis, why investors decide to develop one, and some tips on creating one.
What is an investment thesis?
Simply put, the investment thesis is an assumption made about a market, vertical, or trend that will drive the strategy for a particular firm or fund. Just as a startup will assume a problem or market need and build a product around solving that problem, an investor will consider various markets and trends and develop an investment strategy focused on that assumption.
Why develop an investment thesis?
The thesis is the driving force behind what a firm chooses to focus on to generate returns. It will be a fundamental part of how VCs decide what to look for in specific markets, source deals, and where they ultimately decide to invest their capital. The thesis helps keep a firm focused, allowing investors to work within particular parameters when they go about their business.
There are a couple of advantages to having a thesis-driven approach as a venture capital firm. It will drive relationships that the firm pursues. This relationship driver applies to how firms source deals from an investment standpoint and choose their limited partners. These relationships with experts in a particular vertical will help portfolio companies with mentorship, independent board seats, and talent sourcing.
A thesis compels VCs to be experts within their particular field. If a firm bases its thesis around FinTech, it will most likely have some expertise in that field. This knowledge will help them understand the marketplace, specific problems a startup is trying to solve and judge founder talent. The firm will also be a thought leader in the space by releasing analysis and reporting trends in the industry. Lastly, the firm's partners will be a better value-add to the companies within their portfolio, paving a quicker path for a startup's growth and success.
Example of a thesis
A16Z, a prominent Silicon Valley firm, has several different areas they invest in, from FinTech to Growth to Consumer focused startups. Below is their investment thesis for their FinTech portfolio:
"Fintech companies are innovating across broad categories — in banking, lending, insurance, real estate, and investing — both on the customer-facing side and in core infrastructure. We believe the combination of mobile, digital money, machine learning, and new data sources offers startups a unique opportunity to leapfrog outdated infrastructure and compete with incumbent financial institutions to reimagine the way we manage our finances." Source
We understand that the firm focuses on startups that use mobile and machine learning to innovate on financial management through this statement. This thesis has helped drive the firm's investments in Stripe (now valued at $36B) and Carta (currently valued at $3.3B).
For an awesome hub of investment thesis examples, check out this link!
How to build an investment thesis
When developing a thesis, there are vital things to keep in mind:
Markets: Start with market sizing to make sure that a particular industry is worth pursuing. We will discuss market sizing strategies in a future post.
Trends: Understand macro trends impacting the markets and industries that you determine are big enough to pursue.
Companies: Break down each company within a market that has upside potential. Look at recent companies that have seen success within your specific industry focus.
Exits: Make sure there is an exciting exit environment for companies in that particular segment. You want your investments to see a return through going public or M&A activity.
Tips on the above:
Things to think about defining in a thesis would be company stage, geography, vertical, or market.
People tend to want a fully-formed thesis right off the bat, but it's an iterative process. The scrum process might be three months, but the full process can take a year before talking about a thesis publicly.
Have a hunch on something that isn't fully formed and then test it out:
Go out and talk to entrepreneurs.
Talk to buyers of the technology.
Form relationships with ecosystem partners.
Incrementally improve your thesis based on feedback and results.
For some more tips and strategies on creating a thesis, check out this informative Medium post.
Final thoughts
The thesis can help you stay focused and is your north star. For startups, it will help them target your firm. For LPs, it will help them judge your conviction and investment strategy. When developing a thesis, think about taking on big problems and big ideas. There are so many significant issues to be solved globally, and we have a golden opportunity to help solve them. Think big, and don't limit yourself only to ideas on making returns for investors, but how to impact the world.
This story is from Sutton Capital contributor Zeb Hastings. For more information on Zeb’s work, please visit his website.