Over the last year or so, I’ve shared with friends a hypothesis that leverage is causing extreme fluctuations in asset prices. I believe it was a material factor in the 2020–2021 runup and that it’s played a significant role in the declines in 2022. Leverage enables an investor to multiply the potential return on an investment. It can involve using borrowed money to amplify bets or other means to allow an investor to have exposure to an asset without fully owning it. Leverage amplifies movement in both directions, which can cause havoc in markets when things move to the downside.

History doesn’t always repeat itself; sometimes it rhymes. I started looking into the past to understand the present. Specifically, periods when interest rates were increased and financial markets experienced high volatility. I’m still early into this, but I’m looking into the mid 1990s now. It was a period of rate hikes and bond volatility that the Fed couldn’t explain at the time. Rate increases kicked off a sequence of events. We now know that volatility was caused by excessive leverage that most were unaware of at the time. Because the leverage wasn’t public knowledge, the volatility was hard to understand or explain. It’s early, and I still have more reading to do about other periods that fit my criteria, but what I’ve learned so far has been interesting.

I’m no economist, but my gut tells me we have more leverage in financial markets than we’re aware of. It may be amplifying market movements to the downside now.

Outsiders are people who aren’t working in an industry and (usually) don’t have relationships in that industry. They’re on the outside looking in, wondering what it’s like to be on the other side. They don’t understand how the industry works, but they work to fill their knowledge and relationship gaps. Successful outsiders can penetrate the industry through hustle and a bit of luck.

The experience of being an outsider who makes it inside an industry puts these people in a unique position. They’re different from insiders. They’re engaged enough to see and understand the mechanics of how the industry works, but they’re detached enough to question the status quo. They see things from outside and inside the industry simultaneously. This perspective can help them identify a gap that others have ignored and understand the potential in exploiting it. Further, they’re uniquely qualified to come up with the right plan to exploit the gap in a way insiders and those still outside the industry can’t.

I’m a fan of backing outsiders. They’re driven enough to hustle their way in. They’ve likely got a chip on their shoulder from wanting to prove others wrong. And they usually have strong conviction. All these are great founder traits.

While some think outsiders are “out of place,” I view them as scrappy people who can be catalysts for innovation.

Yesterday was Thanksgiving, a holiday I enjoy because I get to spend quality time with family and friends. We’re a few years removed from the beginning of the pandemic, and I’m more intentional about this holiday than I was pre-pandemic. This year I made a point of thinking about and sharing with others all the things I’m thankful for. The year hasn’t gone according to my plan or other people’s plans. At times it’s been frustrating and felt like a stream of bad news. But even with all of 2022’s curveballs, I was able to come up with a long list of people, memories, and things I’m extremely thankful for.

What are you thankful for?

Happy Thanksgiving!

I hope everyone had a safe and healthy holiday!

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I connected with an investor who shared how he evolved from a start-up founder to venture capital investor. He had an idea of what it meant to be a venture investor, but he learned that the reality is quite different. His first year was one of not knowing. He didn’t know what a good company looked like, so everything looked good to him. He didn’t know what his approach to finding great companies was, so he tried a bunch of stuff. The list of what he didn’t know is long. But the big takeaway from his first year was that he could learn by doing. There’s only so much that people can tell you about the craft; you have to get your hands dirty to learn and get better.

Having always been a practical learner, I agree with the learn-by-doing mantra. Action produces information. You learn from the information, improving your decision-making and actions. This was true for me as a founder, and it’s true for me as an investor. Some of my learning has been painful and expensive, but I’m comfortable with that. Instead of being unhappy about the money, time, or energy lost, I consider them the tuition I paid for knowledge.

If I want to learn how to do something, I now think about ways to do it so I can learn (and maybe pay some tuition too).

Thanksgiving week has historically been calm for me. This week, though, hasn’t been as calm as I expected, and the rest of the week will likely be more of the same. I wasn’t sure if it was just me, so I asked a friend who does deal-related work. He’s experiencing something similar: lots of deals and other things he’s trying to get over the finish line. I also know a few founders trying to close rounds, friends trying to close real estate transactions, company leaders navigating layoffs, etc. All anecdotal, sure, but there appears to be more activity on a variety of fronts.

I’ll make sure I spend quality time with friends and family this week, but otherwise, no lounging around for me. The rest of the time, I’ll be working on finishing various projects.

I caught up with a founder thinking through the next steps for his start-up. It grew rapidly during the pandemic and raised venture capital but hasn’t been able to sustain that growth rate. A decent percentage of its customer base was venture-backed companies, so the recent tech layoffs have caused customers to churn.

The founder could stay the course and raise more venture capital. The challenge with that strategy is that the market likely isn’t growing as quickly and competition has increased because the problem is obvious to other companies and founders. This company’s solution is much better from a technical standpoint than competing offerings, but it will need to invest heavily in sales and marketing to attract more customers. That will be a costly effort given the slowing growth rate of the space and influx of competitors.

The other option is to position the company to be acquired by a larger company looking to enter this market. Big companies are trying to play catch-up in this market. They’re evaluating whether they should spend one to two years building a solution from scratch or buy a proven solution. The larger companies are also likely thinking they’ll be able to grow the solution quickly once their existing sales and marketing muscle is applied to this product.

This founder is at a crossroads. I suspect he’ll go the acquisition path and be ready to start another company in two to four years. He isn’t alone. I think 2023 will be bring more acquisitions of small players by larger players looking for quick growth or trying to fill the gaps in their existing solutions.  

I’m a huge fan of automation. My start-up was able to scale because we cracked the code of creating repeatable processes and automating them to gain massive efficiency. I’ve chatted with a few founders recently who also embrace automation—but too early. These companies are still trying to find product–market fit, but they’re automating some or all interactions with the customer. When I hear this, it’s a huge red flag.

In the early stage of a company’s life cycle, you’ve identified a problem and built a solution to it. You don’t really know how good a job you’re doing solving the problem (unless paying user growth is skyrocketing). You usually need to let users play with the solution and get feedback. The feedback usually leads to product improvements. This cycle repeats until your solution is so great you’ve reached product–market fit.

Getting feedback from the customer is a key part of the cycle. Sometimes a customer will casually write something that, when double-clicked on, leads to a eureka moment and critical product improvement. If you automate feedback collection in the early days, you run the risk of missing the opportunity to double-click on seemingly small pieces of feedback. Said differently, you run the risk of missing your eureka moment that leads to product–market fit.

If you’re early in your founder journey, consider deferring automatic feedback collection until later and making time to talk with customers/users. One conversation with a customer/user could change the trajectory of your company!

One of the traits I look for in founders is grit. Building something from scratch is hard. Lots of doors will be closed in your face, and you’ll hear “no” a lot (or nothing at all). Founders need to be able to power through all that and move the needle forward. When things look bleak, that’s when founders separate themselves from others by pushing through and finding a way.

What matters just as much as grit? The why behind it. Founders may have to run through walls. What’s fueling them so they can do it? Where is their passion coming from? When you understand this, you’ve really begun to understand the founder. You understand how they’re wired and why they’re doing what they’re doing.

When I spend time getting to know founders, I learn the why behind their grit when I hear the childhood memories forever etched in their brains. The insecurities (we all have them), fears, and other factors that drive them.

Grit is required, and understanding what’s fueling a founder’s grit is important too.

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

• Truth – This week I thought about truth, which led to my post yesterday. Seeking truth isn’t something that most people do. I believe it’s one of the traits that separate the good from the great. Seeking truth allows you to make better decisions.  
• Networks – I started to think about network nodes. How can you create more nodes to increase the free flow of information at early-stage start-ups and the people who support them? Can creating network nodes increase early-stage network quality?
• Non-consensus  – This week I came across two great founders. They’re not in the right VC/start-up networks, and the problems they’re solving aren’t obvious (but they are painful). These founders are non-consensus and, in my book, great founders to back. They represent an opportunity for non-consensus alpha.
• Thanksgiving – Looking forward to time with family and friends!

Week one hundred thirty-eight was a focused week. Looking forward to next week and the Thanksgiving holiday!