An Incubation Playbook for Venture

Overview: in our Fund I at Predictive, we incubated two businesses, Mural and Verified, from inception through institutional venture funding and initial revenue scale: 

(1) Mural is a global payments platform powered by best-in-class stablecoin and blockchain technologies. Born out of a mission to unlock the world’s most powerful, instant, and cost-efficient payment experience for global businesses, we wrote the first check, I served as CoFounder & CPO, and we raised a $5.7M seed round from top Web3 investors including Galaxy Digital, Digital Currency Group, Firstminute Capital, AlleyCorp, 186 Ventures, and over 10 unicorn founders. Mural is now scaling rapidly across emerging markets and counts a range of multinational companies like Opera (NASDAQ: OPRA) as customers. Hats off to the team on the rapid progress and momentum. 

(2) Verified is an AI cloning platform for Hollywood and entertainment, enabling any creator or public figure to be in complete control of their verified AI likeness in an era of deep fakes. On Verified, creators and their teams can securely plug in their public and private data — including video libraries, journal entries, podcasts, social profiles, and more — and create a “verified” AI identity they can license to leading global brands. We wrote the first check and subsequently raised from top notch institutional investors. Verified was acquired in Q4’ 2023 by a pioneering production company that will harness the technology for modern media that “lives beyond the screen”.  

We approached our first incubations with two hypotheses that we’d gleaned from our reps of building software companies zero-to-one:

Hypothesis 1: Even for serial entrepreneurs, there is often tremendous product iteration risk at the earliest stages; one of the biggest traps is over building prior to intimately understanding target customer workflows, grasping friction points, and validating a precise solution. This risk can be significantly mitigated by harnessing UX research processes and design tools like prototyping to understand customer behavior, test hypotheses, receive live feedback, and validate customer willingness to pay upfront (pre touching code). 

Hypothesis 2: With a zero-to-one product and UX research background, we were uniquely equipped as a firm to partner with top notch domain expert founders and build companies in-house as a full-time cofounder.

Via our first two incubations, we learned many things that worked well and not so well. Through our experiences, we’ve created an incubation playbook at Predictive.  I’ll share a high-level synopsis with you below; this is an ever improving framework – we’ll continue to sharpen our model with each new incubation (the next one is in the works).

Why Incubations: If you’re able to successfully incubate companies in-house, you can maintain maximum investment and operating leverage. A great example of incubations executed at the highest scale is Sutter Hill Ventures, which incubated iconic companies like Snowflake and Pure Storage. Here is a fantastic piece by Kevin Kwok on SHV’s Mike Speiser and his approach to incubations. Sutter Hill owned approximately 20.3% of Snowflake at IPO, at an over $70 billion market cap. Another great example is Atomic, which has incubated companies like Hims & Hers, Bungalow, and Homebound. 

Accelerants to Executing on Incubations: Key accelerants to successful venture incubations include experience running design processes (I highly recommend reading The Mom Test to grasp how to conduct unbiased, informative customer research interviews), Figma journey-mapping and prototyping skills, a rolodex of enterprise stakeholders within your target market, and a network of top notch founder candidates keen to build a category-leading company. 

Process: I’ve sequenced our process below in an approximate order of events. 

(1) Pick a Category of Interest: pick a large industry (significant and growing TAM) and category within that industry with a unique window of opportunity for a “category-defining” company to emerge. For instance, in 2018 through 2020, various macro tailwinds were accelerating demand for remote work and global hiring. A window of opportunity for global payroll – addressing critical pain points in hiring, paying, and managing global teams – was emerging for a category-defining company to be built; Deel moved aggressively to win this category, with Remote and Papaya Global in hot pursuit. It is generally too late, in my opinion, to build a startup in an emerging category where there is an unclear direct path to category-leading (or even second mover) position. 

(2) Select Co-Founder(s): I believe it’s incredibly important to partner with the right co-founding team early in this process – particularly entrepreneurs with a network in and passion for the target industry & category. They, after all, will ultimately be the ones championing the business in the long run; it’s critical they have a deep vested interest in the category and play a leading role in the design process alongside you.

(3) Identify Design Partners: Within your target industry and category, pick the industry brand leaders with dominant market share and credibility. Within these organizations, identify the stakeholders responsible for (1) budget decision-making and (2) largest budget allocated for software. You don’t need to necessarily know which workflows you’re solving for yet, but you do want to identify the organizations and their stakeholders with capacity to pay meaningfully for a new solution. By targeting the highest-regarded organizations with a presence within that category, you establish favorable market signaling and brand credibility. A great example here is Medallion ($85M raised), which landed healthtech pioneer and industry leader Ro ($7BN valuation) as their champion customer and design partner from inception of the business. 

(4) Run a Design Process: With target industry stakeholders lined up, run a design process to understand their current workflows and points of friction: 

• Conduct at least 10 “journey mapping” interviews, outlining step by step their existing daily, weekly, and monthly workflows. What tools do they use? What friction points do they experience? Where are specific opportunities to improve their process? This work accomplishes two key goals: (1) It provides a sufficient breadth of understanding of key customer workflows prior to forming hypotheses about what to build for them; (2) It provides psychological agency for the design partner in the research and development process, incentivizing them to “see a solution through” with you — it's as much their solution as it is yours.

• Cluster friction points and areas for potential value add, and stack rank these by impact and effort to tease out a prioritized list of opportunities. 

• Translate this list of opportunities into a set of hypotheses about a simple potential MVP.

• Create moderate fidelity mocks in Figma that visually illustrate this set of solutions.

• Get these designs in front of your design partners live and collect raw feedback. Establish a feedback cadence and whittle designs into a high fidelity prototype that your target customer will ideally agree to sign an LOI for – all pre touching code. 

• Sign LOIs with clear objectives and key results, ensuring the moment you ship an MVP to these design partners, they’re ready to use it and pay for it. 

(5) Set up an Advisory Board: now that you’ve validated a set of hypotheses and have a clear sense of an optimal MVP, select advisors within your target category. These may include stakeholders you’re working with as early design partners, or senior individuals deeply respected within your target domain that can unlock trusted doors to additional customers. Building a senior advisory board is one of the best hacks I’ve learned as a founder. Grant advisors stock options vesting over 2-3 years. 

(6) Define Unit Economics Upfront: there are different potential routes here depending on involvement, including:

• Leading the first round of funding at favorable terms

• Earning a percentage of founder shares for commensurate full-time work

• Earning advisory shares for a lesser degree of involvement

However, most important is defining economics upfront with co-founders to ensure full transparency, expectations, and alignment from inception. 

(7) Define Time Balance Expectations: in my opinion, serving in a full-time founder role is a key part of this playbook, providing strong operating leverage and true sweat equity value, which can contribute substantially to asymmetric investment upside – particularly if some or all of that equity is allocated to the fund itself. 

Title: I prefer participating in a non-CEO role (such as CPO), which ensures consistency and longevity in culture setting by the founding CEO from inception of the business – particularly important when building out an early team. Generally, the CEO will also have a deep existing familiarity with the target marketing, enabling them to speak the language of their target customer. 

Timeline: I’d suggest defining a period of full-time commitment upfront, ensuring founding team members are aligned in advance. This might look like 1-2 years of full-time operating work, including getting the company to defined milestones like a shipped MVP or recurring revenue, before stepping back and subsequently supporting in an advisory capacity. 

Risks to Watch Out For: the biggest risks, in my opinion, are unclear expectations and time. The former should be directly mitigated by setting clear ownership and accountability expectations upfront amongst the founding team, and the latter should be factored directly into a respective fund’s investment model, personnel, and operating capacity. 

Potentially Innovative Strategies: in an ever-evolving venture capital landscape, incubations present a powerful way for operator led funds to differentiate and generate outsized returns. A few ideas I’ve been mulling include:

(1) Incubating companies directly into Y Combinator, particularly given YC’s new four batch per year strategy. Executing the above playbook paired with YC’s immediate distribution advantage may present a powerful one-two punch for consistent asymmetric returns. 

(2) With a rolodex of corporate partners, lining up an “inception through exit” plan with corporate stakeholders, thereby manufacturing exits from inception by designing solutions integrated tightly with an incumbent corporation’s workflows and tech stack. Biotech venture pioneers like Atlas Ventures and Flagship Pioneering have executed this model with outsized success in tandem with incumbent corporations in the biotech & pharmaceutical sectors. 

We continue to sharpen our incubation playbook at Predictive, and I’d greatly appreciate any feedback you may have. Reach me at [email protected]. 

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DISCLAIMER:

Content contained above is not intended as, and shall not be understood or construed as, financial advice. All views and ideas expressed are my own.