Artiman invests in white space companies that are in large markets with no identifiable competitors.
When I joined Artiman a few years ago, I asked the partners what exactly did that mean. The official answer? White space companies disrupt existing or create new large markets and frequently operate at the intersection of multiple technology disciplines and business models.
Sounds great, but what does that mean in practice? I set out to answer that question. As a failed physicist, I often find myself trying to create formulas to fit things into boxes I can understand. I came up with five rules, each rule associated with a mathematical model to help me figure out both where to look as well as how to recognize a potential white space company when I saw one.
Today, I am going to introduce you to the five rules and their ratios.
1. The Scarcity Rule
The Math: 100:10:1.5
White space companies are hard to find. Each partner receives at least 100 deal referrals per year. Of those, we each seriously vet maybe 10 and hope to find about 1.5 deals we each close. Most teams we see are domain experts who attack existing markets with solid but incremental improvements. White space companies frequently leverage technology/models found elsewhere to disrupt the market.
2. The Equivalency Rule
The Math: 0:1:5:25
White space companies look like “other” companies in the first 4 years. Most business plans I see are all the same. No revenue in year 1, $1 million in year 2, $5 million in year 2 and $25M in year 4. Yes, there is a corollary to this rule, you should add a few zeroes at the beginning if you are working with drugs and semiconductors. The other corollary is most companies claim they only need $5-15M in capital to get to cash flow break even and achieve grandeur. I don’t even look at the numbers provided until I dig into serious due diligence. Yes you need to have this slide, but more importantly you need to understand what early stage investors are looking for: what is the opportunity? (See the Black Tee Rule), how you think about business models and risk as well as what risks go away on this round.
3. The Black Tee Rule
The Math: 10:1:.1
When assessing incoming deals, one thing we always ask: "Is this a company, a product or a feature?” What drives this discussion is the total addressable market (TAM). With a TAM of more than $10 billion you have the chance to build a white space company. If your TAM is closer to $1 billion, you have a chance to build a great product company with a nice M&A potential. If your TAM is $100 million, you are likely a feature that should be developed and quickly flipped to product lines that need you. We play from the black tees (for those who don’t play golf, that’s the tee furthest from the hole). While we may find ourselves in the woods, when we birdie from the blacks it really feels great.
4. The Rule of Lemmings
The Math: 1:3:9
Whenever I see a deal that claims to be unique, chances are there is another team in the world thinking the same way. If I can find a second company, then there are invariably a third doing the same thing. If I can find the third company, then the odds are that this space has attracted nine or more companies all racing up the same hill. If there really is $10 billion of TAM there, you are either in a winner-take-all game or are going to carve up the $10 billion TAM into nine $1.1 billion chunks. History has proven that the spoils of any market aggregate to 2-3 companies. Time to pass if there are 2 companies already ahead of you.
5. The Rule of Patience
The Math: 1:4:7
Feature companies are typically flipped in a year or two. Product companies take longer—four years sounds about right. White space companies take a minimum of seven years to build and exit. To do white space investing, you need deep pockets, like-minded entrepreneurs and co-investors
Finding companies that disrupt either existing industries or create new industries is difficult—they are rare, difficult to identify, tough to build, require significant investment and take a lot of time. There are many strategies to make money. Some firms invest in fast followers, product/feature flips or simply play the odds by spreading their bets over many different companies. All valid strategies, just not ours.
