Five things a VC wants you to know about network effects

This is why the DMZ recently jump started its monthly investor series, Capital Catalyst, to help entrepreneurs maneuver through the current fundraising environment. Our first official session was on network effects. Often underutilized or not carefully executed, network effects are a key component in what venture capitalists look for when considering whether to invest.

It’s important for entrepreneurs to fully grasp what network effects are and how to gain them positively, especially from an investor’s standpoint. Network effects are straight forward: increases in usage lead to direct increases in value. And although it may seem like an obvious component in developing a successful company, many entrepreneurs are missing some key details.

This is why we invited Angela Kingyens and Boris Wertz from Version One Ventures -a $35 million fund that backs startups across North America- to break down the layered concept of network effects, how to best utilize them to grow a business and more. We’ve broken down the top five takeaways from the session:

1. Have a strong founding team According to Version One, it’s the combination of domain expertise, talentand passion that makes a strong founding team. As a founder, you need to have the knowledge and experience within the market you’re tackling, have the talent to execute those plans efficiently and of course, exhibit the passion and drive to build and scale your company.
2. Leverage network effects The basic concept behind network effects is that the value of the network increases the more users you gain. As a result, your company is able to build momentum and create shields against new potential entrants into the market, and those larger existing rivals. Companies that sufficiently and positively use network effects to their advantage are what Version One Ventures is looking to invest in According to Version One Ventures, network effects can be unlocked by connecting people and through data at scale. A great example of such effects is Uber: the more drivers they onboard, the more ground they were able to cover, the more pickups they were able to make (simultaneously driving wait times and pricing downwards), leading to faster pickups and increased number of users, which in turn lead to a greater demand for more drivers. As you gain more users and the value of your product/company goes up, you’re then able to build a better market strategy and scale your business in different directions using the data.
3. Use the bottom-up approach The bottom-up network driven approach targets the user base first, as opposed to the traditional approach that targets the larger clients at the top first. This gives your startup a better understanding of the market, validating your product, as well as giving you leverage when targeting the other side of the equation (the larger companies/clients).
4. Target a market that people care about Version One highlighted that they’re ultimately seeking companies that are targeting a market in high demand (and relevant). At minimum, this early-stage fund is looking for a startup that has minimum viable product (MVP) with the potential to grow on a global scale.
5. Solve an important problem in a unique way Last, but definitely not least, Version One (like many other investors) are looking for a startup that is able to stand out from the vast number that flood the tech industry. Therefore, it’s important to provide a one-of-a-kind value proposition and solution.