Last year I had a friendly debate with someone about getting more capital to more early-stage founders. At the time, I believed scale was the way to go. Build larger VC firms (not funds) to increase the number of seats in a historically cottage industry. Make it possible to institutionalize the knowledge of how best to fund and support early-stage founders, which would become more distributed as team members left these larger firms. Build firms, not funds, was mostly my thought process.

I’ve had the opportunity to speak with many emerging and established VC fund managers, their limited partners (LPs), academics, and of course founders since then. These conversations have made me realize my original thesis was incorrect (that’s the power of discovery). Scaling larger VC firms with larger funds isn’t the way to get more capital in the hands of high-potential early-stage founders.

Larger funds create challenges for LPs and VC fund managers (emerging and established) doing early-stage investing:

• Smaller funds are a better fit because they enable fund managers to write a check that’s an appropriate size for an early-stage company.
• Early-stage investors need to suspend disbelief and make nonconsensual investment decisions. Otherwise, investors fund what everybody else is funding. That’s hard to do in a large organization, because decisions tend to lean toward consensus when more people are involved. Smaller teams are more likely to make nonconsensual decisions.
• I also believe in a world where great founders are more geographically dispersed—centralized capital deployment isn’t as effective in reaching high-potential founders. A dispersed model would be more effective because it would help capital meet founders where they are.

It’s been interesting to see my thinking on this topic evolve and realize that the person I was chatting with was more right in his thinking than I was.

I’ve had the privilege of chatting with many emerging VC fund managers this year. One thing I consistently hear about is a goal to raise continually larger funds. For example, a first fund might be $10 million. If it does well, they’re planning for fund two to be $50 million and fund three to exceed $100 million. They’re driven to do this to increase cash flow from management fees, which provide them with more resources.

Most of the emerging managers I’ve chatted with are investing very early. Most aim to invest as close to when the company is created as possible, even if there isn’t a product yet. These emerging managers have unique perspectives and networks they believe position them to find non-consensus and high-potential founders very early. I agree that they’re more likely to find and fund non-consensus founders or markets, and I view them as playing an important role in the early-stage start-up ecosystem. If things go well, these founders, fund managers, and fund limited partners will realize massive outcomes.

Raising larger funds will give emerging managers more resources, but it will also compel them to begin investing at a later stage. The challenge here is that the edge they have investing early might not carry over into a later stage.

The current VC fund fee structure—specifically, the traditional management fee, usually 2%—isn’t ideal for emerging VC fund managers. Successful emerging VC managers want more resources, and rightly so. But they don’t necessarily want bigger funds, because it’s harder to deploy a larger pool of capital. I see an opportunity to provide an alternate structure to emerging managers investing early-stage who exhibit early signs of success. I think this will not only solve the resource problem but also better align emerging managers, their limited partners, and founders. The early-stage startup ecosystem will be the better for it.

Mentoring is important to founders. Good mentors can help you get to your destination faster. They have experience, and they can share with you what they’ve learned from it—that’s a lot of the value of a mentor. You can incorporate their learnings into your decision-making and make better decisions without giving up the time it takes to live those experiences. It’s common for a founder’s trajectory to be changed forever by sitting down with an accomplished entrepreneur for thirty minutes.

Not everyone is fortunate enough to have the right network to get mentoring from an accomplished entrepreneur. The network distance is just too far. Founders shouldn’t let that stop them—learning from others can be accomplished in other ways. I think autobiographies and biographies are a great alternative. Many founders who’ve had a massive impact on society are the subjects of biographies or autobiographies, and their learnings are usually incorporated into these books. That wisdom won’t tell you how to build your business, make a specific decision, or be related to your industry. But these books will share the path these entrepreneurs took, what they learned along the way, and what allowed them to succeed.

If you’re a founder hoping to fill your experience gap through mentorship, consider picking up some books!

I had a great chat about matching with a founder friend today. We agreed that great companies are built when founders are matched with capital, knowledge, and resources. The matching is the important part—and the most difficult part at the early stages. The more inefficient matching is, the less likely it is that resources will reach founders who will use them best.

Matching is network driven. The closer founders’ networks are to the networks of people who have capital and expertise, the more likely effective matching is to occur. The farther away they are, the less likely it is to occur. Said differently, network distance affects how efficient matching of high-potential founders and the resources they need is.

If we want to match capital and resources with high-potential founders, we have to reduce network distance to make the matching process more efficient.

One of the most noticeable changes in the last few years has been geographic diversity. People’s priorities have changed, and where they choose to live has followed suit. The common thought was that you needed to be near a tech hub like San Francisco to be matched with resources to increase your chances of succeeding. Some people still want to be near these traditional tech hubs, but many have opted for other cities more aligned with professional and personal goals.

Geographic density was a big part of what made these tech hubs so powerful. It’s also why many venture capital funds were traditionally located in tech hubs. The closer you are to someone geographically, the more often you’ll interact with them—or at least have a chance to. More frequent interactions increase the flow of resources, knowledge, etc.

Geographic diversity is a big change in the start-up world. I suspect it will lead to big changes in venture capital. We’ll likely see more variety in the structures and operations of venture capital funds.

Venture capital is an industry that changes when it’s forced to, and I think geographic diversity will force big changes.

I met with a successful founder who shared an interesting insight with me: he sold his company for ~$200 million and is happy he wasn’t able to easily raise capital early in his journey. Most founders view insufficient resources as a negative, so my curiosity was sparked.

The founder and his early investors viewed the market they were going after as a $10+ billion opportunity. It was a new market, and his company was at the forefront. Wanting to be the undisputed market leader, he tried to raise a war chest to go after this opportunity. He didn’t raise the $100 million he wanted, but he was able to raise $20 million.

Fast forward a few years. An interesting thing happened. The new market he was going after ended up not being as big as they’d anticipated: $1 or $2 billion instead of $10+ billion. The much smaller market was split among this founder and all his competitors.

As the smaller market size became clearer and investors started getting closer to the end of their fund life cycles (~10 years), they started thinking about the company exit. They decided to run a process to sell the company and got an offer for ~$200 million. It wasn’t the $1+ billion they’d hoped for years earlier, but it was satisfactory given the smaller-than-expected market.

I won’t get into all the math, but since the founder raised ~$20 million total at a fair valuation, the ~$200 million exit gave his investors a satisfactory return. Therefore, the founder and the company’s employees weren’t subject to liquidation preferences. Investors, employees, and the founder were all happy.

Though the ~$20 million this founder raised wasn’t what he hoped for, it ended up being the right amount of capital to build a company appropriate for the size of the market. If he’d raised $100+ million, his outcome would have been materially different. He wouldn’t have been able to sell for ~$200 million because that wouldn’t result in a sufficient return for investors (exiting would have been delayed by years). Or, if he’d sold for ~$200 million, that would have limited or eliminated payouts to himself and his employees because of liquidation preferences.

This founder’s story highlights the importance of founders understanding the potential size of their market (to the extent possible) and seeking resources to build a company appropriate for it.

I regularly have the conversation with founders about what metrics they need to achieve to raise capital. Most commonly, they’re focused on revenue or some derivative of revenue. I remind early-stage founders that revenue isn’t always the best metric to demonstrate the potential of your solution.

Instead of asking about metrics, I like to reframe the question. How can a founder demonstrate the value they’re creating for users or customers? I like this better because revenue is a by-product (or should be) of value creation. If your solution is adding value to others’ lives, they’re likely to pay for that value (now or in the future). Thinking about value creation keeps you aligned with customers and doesn’t force you to turn on monetization prematurely. If value creation can be quantified in other ways (engagement, sign-ups, repeat transactions, etc.), smart investors will give you credit for the absent revenue.

If people have a problem (realized or not) and you solve it, you’re creating value for them. Healthy revenue is the result of value creation. Focus on creating value for people by solving a problem well, and things like fundraising become a lot easier.

I’ve noticed that a number of venture capital firms prefer to hire people with a finance background. Those with investment banking and private equity work experience are thought to be great candidates. In my chats with emerging and established managers, several mentioned they’re seeking junior hires and emphasized a desire for candidates from finance.

I’ve never worked in finance, but I have friends who have. It’s notorious for long hours and hard work. Anyone who’s done time in this world is thought to have a great work ethic, which is likely true. One learns a host of skills in that environment that many think highly of (financial modeling, research, etc.).

A banking background provides a strong skill set and will set people up to succeed in some stages of venture capital, but I don’t think that applies to the early stage. Evaluating companies at the idea stage or before product–market fit requires skills that a finance background likely doesn’t equip you with.

Early-stage investing tilts strongly toward evaluating people and markets to find the nonobvious. Identifying founders’ strengths and weaknesses and what’s possible if they’re surrounded by the right resources and support is key. It’s difficult—more art than science. Many people have a hard time ignoring the unpolished exterior of a founder they can’t relate to and seeing their potential. Evaluating nascent markets can be equally difficult. Recognizing the severity of a pain before others understand it and the market size if the founders can create an ideal solution can require one to suspend disbelief and ignore current reality.

Skills acquired working in finance are great, but I don’t think they make you an ideal early-stage investor.

I’ve spent time with lots of emerging venture capital fund managers recently. These managers are like the founders they invest in. Many of the same qualities required for a start-up’s success are needed for a fund to succeed. Today I met a fund’s founding team that had an interesting dynamic. They reminded of me of the hipster–hacker–hustler concept for creating an ideal team:

• Hipster – The hipster focuses on the product being desirable to customers. They think about things like user experience and product design. They tend to be in tune with what’s trendy and cool. They have a unique customer-driven perspective.
• Hacker – The hacker is a builder. Building new stuff excites them, and they can focus intensely on it. They’re driven by data and logic. They see the world as black and white and may not have much charisma.
• Hustler – The hustler makes sure things get done. They relate well with people and are persuasive. They can hold people accountable to results, sell to customers, and rally people behind their vision.

The team I met today had all three: a hipster, a hacker, and a hustler. The complementary nature of this team shows. They’ve built a fund with a unique perspective and way of doing things in a relatively short time. I think this team will do well in the long term, and I’m excited to follow their journey and the journeys of the founders they support.

The last few weeks, I’ve been focused on solving a complex problem. It’s been iterative and hasn’t always moved as quickly as I’d like. I normally work on it on weekends too. But this weekend, I didn’t. Instead, I attended an event with extended family and friends. I gave myself permission to not think about the problem for a few days, and I’m glad I did.

It was great to be fully present to celebrate with people I care about. It was also nice to reset mentally. Today, when I began to work on the problem a bit more, I had renewed energy and some fresh ideas.

This weekend was a reminder that sometimes it’s best to put something away for a few days and then come back to it with a fresh mind and renewed energy.