Circle of Competence and the Venture Capital Investment Triangle

  1. Mistakes of commission
  2. Mistakes of omission

Circle of Competence

To define the circle of competence, we begin with Buffett’s original insight. An investment within your circle of competence is one which you understand a product and market well enough to effectively gauge its probability of future success. As an example, if you are a seasoned early-stage software investor, a new early-stage marketing SaaS prospect should be within your circle of competence. A growth-stage biotech deal would not be in your circle of competence, because you know nothing about biotech.

The Innovation/Market Map

645 Ventures’ VC Investment Triangle

There are several key aspects of the framework. First, the most obvious is the lower left area of the graph, where existing markets meet gimmicks and incremental innovation. In traditional areas of finance, this is where one might find an investor’s circle of competence. But venture capital is different. Although companies in the bottom left circle are easy to identify and assess, they are unlikely to generate exponential growth opportunities. Any differentiation that they have is quickly competed away by new entrants, and their innovations are not substantial enough to create large, new markets.

  1. Berkshire Hathaway 1996 Shareholder Letter
  2. Warren Buffett Describes the Circle of Competence, Jack Welch Management Institute
  3. Warren Buffett Speech to the University of Georgia Students Part 1 (Archive 2001)
  4. Understanding Your Circle of Competence, Farnam Street
  5. The Innovation/Market Map was defined by Greg Pass, former CTO of Twitter and Chief Entrepreneurial Officer at Cornell Tech.
  6. Please refer to the book “Play Bigger” for a definition of category kings and their characteristics.
  7. Legendary VC Fred Wilson has written, “Every really good venture fund I have been involved in or have witnessed has had one or more investments that paid off so large that one deal single handedly returned the entire fund.” See “Venture Fund Economics: When One Deal Returns the Fund”, AVC
  8. Howard Marks, “The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor”, Columbia Business School Publishing, at page 71.

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