Show Your Working: Understanding our DD Process
Part 4 - Building an Edge
We all know that venture capital can be a bit of a black box. From opaque processes to complex deal structures to the alphabet soup of acronyms, to, well, our personalities, it is no secret that dealing with investors can be wildly frustrating. So in an effort to lift the veil, we are publishing a multi-part series on our diligence process. Over the course of the series, we will cover customer pain, team, product, competitive positioning, the nuts and bolts, and the overall market. We hope that this will make things easier for founders, help them understand our decision-making, and be better prepared for their own ride on the merry-go-round that is taking investment dollars from a VC.
This time around, we are focusing on competition and moat - how we think about it, why it matters, and how to get (and hold onto) it.
Spoiler: you are not alone
It is pretty easy to lay out the ins and outs of your solution and conclude that no one else is doing what you are doing. While that may technically be true, it is meaningless in the real world. Customers have a problem to solve, and they are choosing between you, a handful of slightly-inferior-but-passable alternatives, an Excel sheet, or just doing nothing. Remember, in most cases, customers are already addressing (if not solving) the problem today in a way that they are used to, and inertia is a powerful force. Plus, you have to rise to the top of the priority pile, and that can be a hard thing to do when a customer has 17 other unrelated fires to put out. That’s why you’ll hear us collectively groan when founders tell us they don’t have competition - it shows us they don’t fully understand the battlefield they are entering, and that is symptomatic of a much bigger problem. What’s more, the landscape isn’t static - new entrants appear, incumbents zig and zag, priorities change, and the battlefield shifts. Today your competition might be a spreadsheet, but tomorrow it could be the latest AI-powered tool to rule them all. That’s just the nature of dynamic and exciting markets. Chris and the team at Waterly impressed us for many reasons, but especially for their ability to clearly explain the realities of their market, from competition as simple as pen and paper to more complex point solutions around utility workflows. It was a sign of entrepreneurial excellence - they knew the players, knew the game, and knew how to win. The point is, your competitor set is almost always wider than you think, and there’s always something. Understanding and articulating that is the first step.
Whatever floats your moat
Strong competitive positioning really comes down to moat. Your moat is your unique advantage, the thing that creates an unbridgeable gap between you and your competition. It is that special value you provide that others can’t and that can’t be replicated. Or at least, not without serious effort. Competitive moats are critical to scaling companies - they are what allow you to keep early momentum going, create resilience to short-term mistakes, and make you unavoidable (to customers, to investors, and to just about everyone else). We also have to be real here - VCs want to see you succeed and knock it out of the park with a killer IPO or acquisition. Defensibility gives you a premium that acquirers and public investors will pay for. And that’s the kind of outcome everybody wants.
It is not enough to build a better mousetrap or compete simply on price (nobody wins in a race to the bottom). Building a great company means strategically and consistently investing in the things that make you impossible to ignore. If you want to dig a moat, you gotta pick up a shovel.
The first line of defense
Patents and trade secrets can be a great way to slow down the competition, and are often the first port of call for water innovators (or anyone else, really). They also raise the stakes in exit conversations - acquirers and partners for hardware companies will expect a robust patent portfolio. But not all patents are created equal. For IP to be the shield you want, it must be relevant, hard to design around, and enforceable. The first one is a given - if your patent isn’t relevant to what you are doing, then what are you doing? Second, competitors are smart. And sometimes they have pretty hefty budgets, too. If someone with time and money can create something just a few inches to the left of what you are doing and get a similar result, then you are in trouble. Finally, your patent is only as strong as your ability to defend it. That means you need to have the time and ability to find copycats, and the budget to litigate - as well as to defend against litigation if a large, deep-pocketed competitor chooses to challenge you. This one is a toughie, but it is so important to remember. Patents are not an impenetrable fortress, they are the first line of defense, and holding the line requires resources and effort. Nobody gets this better than the team at Aqua Membranes, who have done an incredible job of building up a robust IP moat around their printed membrane spacers. The tech is better in just about every way than alternatives, and they have reinforced that performance advantage with an IP fence to rival the best. They are truly holding the fort.
Making the network work
Network effects are the gift that keeps on giving: delight early customers, they tell their friends, and suddenly you have a snowball of (hopefully) excited users clamoring for your product. And the more users you have, the more data you have to improve the product further, and the happier those customers get. That is the power of the positive feedback loop and the core of this type of moat. It is about customer retention and value creation, not just acquisition. And it’s easy to get wrong, especially in water, where word-of-mouth is everything and bad news travels fast. Operators talk. They attend the same conferences. They solve related problems. This is why we love TeamSolve, who have built a wildly sticky product by staying close to the field operators who use their platform and keeping that feedback loop tight. Every new customer makes their AI co-pilot smarter and more useful, and the way they delight their users keeps customers talking about them over beers after a long day of panels.
Brand is the name of the game
Investors can get nervous around brand - it can feel a little amorphous and hard to quantify. But there’s something really powerful about a well-built brand. It creates trust. It gives people a shortcut to a decision, and in a world of too many options, there is real value in that. Decision fatigue is real, y’all. Brand is not just great visuals, though that is one piece of the puzzle, it is satisfying every early customer, having excellent customer support, and building loyalty. HOPE Hydration has done an amazing job of investing in brand early. They are creating consistent, positive customer experiences and turning every new customer into a HOPE evangelist. Now they have built something culturally resonant that people just want to be a part of. And some pretty cool people at that: Nike, Liquid IV, Rivian, and Barry’s, to name a few. Cala Systems is also killing it on the brand front - who knew people could get this excited about home water heating? Answer: they did. They’ve managed to change a boring and utilitarian home appliance into a story about comfort, customization, and living your values as someone sustainable and ahead of the tech curve. And they have a 20,000-strong customer waitlist to prove it. Brand moats are true multipliers, and super powerful if you can get them right.
We’re gonna need a bigger moat
Once products are in market, you can start to build another reinforcing moat - economies of scale. Costs drop, margins expand, and you can reinvest gains to get bigger and better. But this is not just about supersizing and winning the right to spread your fixed costs over more units, this is about carefully designing your business to generate efficiencies at scale. Are you tapping into organic growth so CAC lowers over time? Are you putting in place the systems and processes that make handling more volume a breeze without increasing overhead? You can’t just floor it, you have to design the growth engine in the right way for this to be a true driver of moat. Some folks who have really mastered the mechanics are the team at AquiSense, who are building next-gen disinfection systems using UVC-LED. Their technical lead in the market is phenomenal, but they are also doing all the right things to make scale and efficiency rhyme, including amassing and monitoring an insane amount of data to fine tune production, yields, failure modes in the manufacturing process, and more. This company is already on the road to ‘big’, and we think they can be huge.
Holding on for dear life
Once you have found your moat, maintaining it is the next challenge. The great news here is, the best moats compound. Network effects, strong reputations, excellence in execution - these are all things that build and get stronger over time. But in order to get there, you have to lay the right groundwork. Yes, that flywheel will eventually turn on its own, but it needs persistent, deliberate effort to get it moving. I have harped on this a lot, but this is where great entrepreneurial process, remaining obsessed with the customer, maintaining tight feedback loops, testing and re-testing assumptions, and staying agile are all so important. All of these choices and strategies compound, and allow you to build bigger, wider moats as you grow.
Now, of course, there are many other ways to dig a moat that we don’t have space to unpack here, from process excellence and high switching costs to the power of proprietary data and distribution networks. There are different forms of defensibility - the best strategy is to identify which are going to protect your business and be deliberate in going after them. And if you’re building with an edge, like the ones above or in your own way, we want to hear about it! Get in touch and tell us why you are going to win.