Last week, I read a post on X that caught my eye. I shared it with a few folks, which sparked some great dialogue. The post was based on this article. The gist of the post and the article is that the venture capital industry has increasingly focused on coordinating capital across multiple funding rounds for the start-ups it invests in. Therefore, investors focus on fundability—the likelihood they can attract later investors—when making investment decisions. This is a form of consensus seeking. The more capital a company requires from VCs, the more consensus is needed.

For several reasons, it’s harder for smaller VC firms to play and win this game. They need to play a different game if they want to generate alpha (i.e., outsize returns for their investors). Instead of focusing on the fundability of a company, here’s what they should be looking for:

• Companies that are capital efficient and don’t require insane amounts of growth capital to build a great business with a moat. For example, Ho Nam and his firm Altos Ventures invested in Roblox early. He says (see here) that Roblox needed only $10 million total from investors to become cash-flow positive. Roblox has a market cap today, as of this writing, of roughly $50 billion and generated over $1.3 billion in operating cash flow in the last 12 months.
• Companies that don’t need hype or investor consensus to prove they work. With very little capital, they can show in their data that customers demonstrate strong demand for the product because of how well it solves a problem for them.

Interestingly, Ho Nam commented “Agree 100%” below this post.

I’m glad I found this post. It got me thinking about how, going forward, outsize returns can be generated by the smaller funds, especially those that aren’t feeder funds to the big boys.

I tend to still think that founders (and small VC funds that back them) create a lot more optionality for themselves when they focus on providing a good product that customers will pay for (which provides growth capital) instead of on giving the VCs the story they want to invest in. Ironically, if customers love and pay for your product, VCs will love you too. The inverse isn’t always true.