Matching Makes a Difference

A good friend shared his story with me today. His first few years as a founder were tough. He was figuring it out and progressing steadily, but he didn’t know what he didn’t know. That changed once he got the right introduction into the right network. A few conversations with the right people opened his eyes to what he could be doing and helped him understand how to do it.

My friend is doing well and is a success by any measure, but it’s too bad that it took him years to get in the right network. I can’t help but wonder what would have happened if he’d been connected sooner. How much further along would he be now?

Matching is important for early-stage entrepreneurship. The best start-up ecosystems are efficient at matching early founders with the right people and resources. As my friend experienced, that can be a catalyst. Not getting into the right network won’t, by itself, cause you to fail, but it could lead to valuable time passing that you can’t get back.

Today’s conversation has me thinking about ways to improve the matching mechanism for early-stage entrepreneurs—especially given the distributed nature of the world post-pandemic.

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Deferred Compensation

I caught up with a founder who described his traction. As he shared his update deck, two things jumped out at me. He’s raised around $100k, and he’s had a team of five or so working for over a year. They’ve made significant progress and have built a product that has early paying customers.

For a team that size, $100k is a small amount of money, so I asked how he’s sustaining things. He said his team agreed to deferred salary. Their salaries are set, but they receive only a portion of them until the product is launched. They’re about to raise a proper round from venture investors. When they do, the deferred salary will be fully paid.

This is an interesting approach to building a company absent sufficient investor capital. It definitely isn’t an option for all founders or their employees, but it’s one to be aware of. This founder has done a lot with a little. I’m confident he’ll be able to raise capital to fulfill his promise to his team and keep building.

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Can Venture Capital Handle More Founders and More Capital?

Venture capital is an interesting structure. On one side, you have capital contributed to venture capital funds by limited partners. I’ll call that the supply side. On the other side, you have founders building companies. Founders usually need capital and resources. Let’s call them the demand side. In the middle, you have venture capital making the connections between founders and resources (mainly capital). I guess that makes venture capital a marketplace, albeit one that requires lots of manual intervention.

Many people would argue that this marketplace is inefficient in its current state. I tend to agree, but I think more about its future state. What will happen if the supply of capital increases materially? As public markets continue to swing and inflation lingers, I suspect more capital will come to early-stage venture capital.

What happens if the demand side grows? More people are wanting to control their destiny and seeing entrepreneurship as a way to do it. And if recession-related layoffs increase materially, more people will look for their next thing. The result: many more founders.

All these changes are great, but I’m not sure venture capital could handle them. Would it be able to efficiently increase throughput and efficiently deploy capital? I suspect it could deploy it—but not efficiently. Those close to venture networks would receive more capital, likely creating a bubble.

I believe there’s an opportunity to rethink critical pieces of this marketplace to both improve throughput and reach founders outside traditional venture capital networks.

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Try Fishing Out of a Different Pond

I spent time today talking with a friend and fellow investor. We talked about similarities in various venture capital firms. Many firms are fishing in the same pond, we agreed—they recruit people from the same network and use similar strategies to source and evaluate founders. He said something that resonated with me:

“If everybody follows the same playbook, the returns will reflect this.”

My buddy makes a great point. If a venture firm is making investments similar to those of other firms and generally doing what other firms do, that’s consensus investing. They’re likely investing in consensus founders solving obvious problems. That’s a recipe not for outsize returns but for average or below-average returns.

This truth was masked by the rising market over the last few years since a rising tide lifts all boats. The tide seems to be going out now, and I’m curious to see what changes early-stage firms make to their playbooks.

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The Best Founders and Investments Don’t Fit into Convenient Buckets

I listened to Michael Moritz share his thoughts on venture capital investing. Michael is a former journalist turned venture capitalist at Sequoia Capital (he joined in 1986). He isn’t just an investment partner—he’s been part of the firm’s leadership team for decades. He played an integral role in the firm’s international expansion and expansion into investing beyond venture capital stages. Given his unusual path to venture capital and the firm’s success, I was curious to hear what he had to say.

One of Michael’s insights that jumped out to me was his perspective on classifying founders and ideas:

To me, the best investments are the ones that don’t fit into a convenient bucket.

He cited Airbnb, Yahoo, Uber, and others as examples. The concepts behind those businesses were different than the norm at the time. It’s obvious now that they’ve worked out, but back then, the founders and their niche ideas weren’t obvious winners. Michael and others had to intentionally look past that.

I like Michael’s perspective. Sequoia’s investments in non-consensus ideas and people led to outsize results. Even though those founders and ideas didn’t fit into logical buckets at the time, investors still made the leap of faith to partner with them. This wasn’t just one or two lucky investments. Sequoia has a history of doing this, which implies that it’s core to their strategy and contributes to their success.

It makes sense that nonobvious people, ideas, and problems won’t fit into buckets. If they did, they’d be obvious.

I think other VC investors can learn a lot from Sequoia. The best people and problems can seem odd. But if you look past the surface, ignore the consensus feedback, and take the leap of faith, you could find yourself with a series of outsize returns and lifelong partnerships with founders who change the world.

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Social Proof May Rule Out Exceptional Founders

I had a spirited debate with a founder friend this week. He raised $20+ million in venture capital for his company and sold it for nine figures. Based on his experience, he believes social proof is a critical driver in the fundraising process for founders. If you have a bigger, better network inside VC (investors and founders who have raised from investors), it gives you social proof. The more social proof you have, the more likely you are to get a meeting and get funded.

My friend is right. That is currently how VC works. I don’t think this is good. Venture capital is about finding new problems to solve and taking risks. Risks with ideas. Risks with people. Social proof is often justified as a proxy for what you can expect from a founder. The thinking goes, if you can’t figure out how to get a meeting with a VC investor, how will you get a meeting with a potential customer? Said differently, will this founder hustle to make things happen?

Founders need to have grit and hustle. Those qualities are critical to surviving the inevitable ups and downs. But social proof has evolved into something beyond evaluating hustle. It’s been used to derisk the entrepreneur; that is, it’s a way to evaluate whether this entrepreneur is a quality person worth betting on. If other people in the VC investor’s network know the founder, the investor can derisk the entrepreneur by asking others about them. Unfortunately, the feedback, instead of being about the founder’s abilities, is often based on shared personal characteristics and relatability.

In venture capital, you want to back founders who see the world differently and identify overlooked problems. Said differently, you want nonobvious problems and markets, which are usually identified by people with unique perspectives. These people and the problems they see may not be part of the “in” crowd. They may have different personal characteristics. People may not be able to relate to them or find commonalities, but that doesn’t mean they can’t be amazing founders.

Using social proof to evaluate founders isn’t a great practice. Instead, founders should be judged on their abilities, the severity of the problem they’ve identified, and the potential of the solution they envision. The number of connections they share with a VC investor shouldn’t factor into funding decisions. In fact, social proof as a founder evaluation tool can lead to false negatives on under networked high-potential founders solving nonobvious problems.

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Weekly Reflection: Week One Hundred Thirty

Today marks the end of my one-hundred-thirtieth week of working from home (mostly). Here are my takeaways from week one hundred thirty:

  • Needs more work – You know your pitch still needs work when those closest to you respond with blank stares. I definitely got some blank stares this week. I’ll keep refining until the blank stares turn into excitement.  
  • Complexity – Sorting through complexity isn’t easy. When there’s complexity that others can’t figure out, that’s a big opportunity to create value. I need blocks of uninterrupted time to do this. I carved out time this week, and I’m glad I did.
  • Timing – You can’t control timing, but you need to be aware of it because it can have an outsize impact on outcomes. When the timing is right, you need to recognize it and take advantage of it. This week was a reminder of that.

Week one hundred thirty was calm (meeting-wise) but highly productive. Looking forward to next week.

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Constructing a Winning Pitch – Tips from Sequoia Capital

Knowing how to pitch an idea succinctly is important for founders, especially early founders with no traction. A pitch can be built in many ways. I came across an approach Sequoia Capital created that was used by the Airbnb founders to create their early pitch deck. Given Sequoia’s track record of investing in amazing companies (Apple, Airbnb, Cisco, Google, Figma, Instacart, Stripe, Yahoo, Zoom, etc.) over many decades, this approach has been battle tested and has benefited from compounding experience. A few takeaways:

  • Origin – Sequoia doesn’t include this, but it’s important to articulate how you discovered the problem and why you want to solve it. If you’ve lived the problem, even better. That makes the pitch more personal. I suggest starting with this and then following Sequoia's outline.
  • Simplicity – The approach is simple and straight to the point, and it flows well.
  • Problem – Describing the pain is part of describing the problem, but understanding current solutions and their shortcomings is also important. This approach, if followed, can make explaining a complex problem easier (not easy).
  • Why now – Timing is important. It’s very important to communicate why now is the right time and why it hasn’t been done before.
  • Market – This is critical. You must understand your current market and have an opinion about where it’s going. Creating a new market is a big deal. If that’s your situation, don’t leave that out.
  • Mission/vision – The outline begins with the mission (what you plan to do in the next few years) and ends with the vision (how you’ll transform the world if you achieve your mission). It’s important to communicate both, and I think this approach makes a lot of sense. When you formulate your vision, dream big!

If you want to see the details of Sequoia’s approach to pitching, look here. I think it’s a great guide for founders to follow when they’re constructing their own pitches.

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The Dilemma of Acquiring New Customers via Paid Advertising

Today I listened to a seasoned e-commerce entrepreneur share an interesting insight. He recently sold his company, but he’s still running it. He and his data team have noticed that advertising rates on platforms like Meta (Facebook) and Google have increased sharply this year. This is anecdotal evidence, but it’s not the first time I’ve heard this.

Acquiring customers from paid advertising channels can be part of a customer acquisition strategy, but it can’t be the customer acquisition strategy. Especially for early-stage companies. Relying on paid ads puts the company in a reactionary position—it’s at the mercy of platforms’ rates, so the economics of a nothing-but-paid-advertising strategy can stop working quickly. When this happens, companies are in a difficult position. They can keep paying the higher rates to protect top-line revenue at the expense of margins. Or they can reduce paid advertising, which reduces top-line revenue (and could reduce profitability).

Acquiring new customers is hard, and founders should think thoughtfully about how to best do it.

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Top Start-up Cities Spawn Market Leaders

I listened to an investor share his views on what it takes to become a top city for start-ups. He believes the most important characteristic is the ability to create companies that lead in their markets. Cities creating market-leading companies are the best cities for start-ups and start-up ecosystems. His reasoning is that a market-leading company captures most of the value created in its market (70% or more). Cities that create companies that lead markets will see torrential trickle-down effects from having them.

I agree with this investor. You can have a lot of great companies in your city that do well and even exit. That’s a great city and ecosystem to be a founder in. Such success leads to more success, but likely at the pace of a dribble. But if a city creates a market leader, the effect isn’t a dribble. A tsunami of capital, knowledge, relationships, and energy hits the city’s founders. And it doesn’t lead just to more garden-variety success but also to people wanting to recreate and support what they just saw—a market leader enjoying massive success. The rate of change in such a start-up ecosystem is accelerated, the resources and network available to founders are amazing, and people are thinking big.

Markets matter a lot, and founders should take time to think about the market early in their journey. Fast-growing markets with massive potential are the best (even if they’re small now). Cities that want to be top start-up destinations should think about how to create an environment that creates market-leading companies.

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