This is my one-hundred-sixty-seventh weekly reflection. Here are my takeaways from this week:

• Contract details matter – This week was a reminder that details matter in contracts. It’s worth taking time to understand the details before agreeing to a contract.
• Schedule experiment – I’m a few weeks into my schedule experiment. The schedule change has had positive impacts that I didn’t anticipate. It’s led me to adjust what I read, when I read, how I read, and why I read. I’ll dive into the adjustments in another post; for now, I’ll just say that I’m happy with this new habit. I believe it will turbocharge my ability to acquire and compound wisdom. And I also believe it will increase the frequency with which I uncover insights.
• Back to growth – I’ve been talking with early-stage founders and tracking a few public technology companies. Anecdotally, there’s a trend of companies getting things cleaned up and returning to growth mode or discovering how to enter growth mode for the first time. Sentiment for some company leaders is shifting from negative to optimistic, which is a big shift from six months ago.

Week one hundred sixty-seven was an insightful week. Looking forward to next week!

I caught up with a founder who’s been trying to sell his solution to customers for months. It’s gaining traction—but more slowly than he would like. With his current monthly burn rate and cash on hand, he has less than a year of runway. He realized he likely wouldn’t reach breakeven before his runway ends, and raising more capital from investors is far from certain, so he decided to try something different.

At the end of his pitch, he began asking his prospective customers if they would buy his solution if he repurposed it to address a few pain points they’d mentioned. The response has been overwhelmingly positive. The pitch meetings went from maybe we’ll try this to, yes, we want to buy that. In the same meeting.

It’s early, but the response is night-and-day different, according to the founder. He spent months building a solution that sold slowly. Then he began giving out one-pagers on his new solution, and prospective customers are ready to sign up. He went from begging for follow-up meetings to customers asking for follow-up meetings within three days of the initial meeting (two meetings in one week!). He went from trying to convince customers to pay for a solution to customers offering to pay in advance.

It’s early and a lot could happen or not happen, but this founder has likely hit on the painful problem that could lead to product–market fit. Product–market fit is hard to define, but when you have it or are getting close, your customers will let you know with their wallets.

The prospect of running out of money has been scary for this founder, but it looks like it could have been the spark that led his company to early signs of product–market fit. The team is focused on building what customers want instead of what investors want to hear.  

I chatted with a founder who’s thinking about shifting his business back to growth mode. He’s spent the last year or so fine-tuning processes and people to make the company more efficient. His profit margins have increased by 50%, and he’s ready to start growing again.

He shared that he’s thinking about taking on, as a customer, a larger company that needs the services his company provides. It would give him a steady (but not guaranteed) number of new monthly orders, but at a price reduction and with longer payment terms. He’s considering this because it could get the company back to growth mode quickly.

A few things I pointed out to him:

• Margin compression – This agreement will bring in low-margin revenue, which is different than his current revenue. He’ll have to do more top-line revenue to generate the same gross-margin dollars.
• Concentration – He’ll be heavily reliant on this single entity for a material amount of his revenue. This means he won’t have leverage in that relationship, which could work against him if the relationships frays.
• Operational strain – This is a traditional business that requires people to do the work. The additional orders will necessitate adding more staff. But the lower margins on that revenue could put the founder in a tough spot. He might not be able to afford the caliber of staff he’s used to, which could have an impact on quality and team culture.
• Cash flow – The larger company wants preferential payment terms, meaning it wants longer than average to pay. This could dramatically affect cash flow. The founder must pay employees and cover the costs of materials upfront but wait longer than normal to be paid. Running low on cash will be a greater risk. He can probably cover shortfalls with something like a line of credit, but that would incur interest expense, further reducing his margins.

This founder has put in a lot of work to get his business to a great place with high margins, a great team, and a solid culture. I’m not sure what he’ll decide, but these factors are worth including in his decision-making process. Landing a big customer—a big source of revenue—sounds appealing, but second-order effects should be identified and considered.

A few days ago, I chatted with a founder in the medical field who turned down a private equity offer to acquire his business. Today, a founder of an automotive business reached out to me and shared that someone in private equity inquired about buying his firm. Neither of these founders had their companies up for sale. The private equity firms found them.

These two stories are anecdotal, but they align with what I’ve been hearing from other investors. Large pools of capital have been raised by private equity to buy relatively small, profitable businesses.

Small businesses represent a great investment opportunity. Their size, usually $10m in annual revenue or less, means there’s ample room to grow revenue if their market is big. Their operations may not be very efficient and may rely heavily on the owner, so technology and better processes can enable these businesses to grow while increasing profit margins. Last, because these businesses are small, valuations are low because there are (or were) fewer potential buyers (i.e., less competition).

I’m a big fan of communities. I recently had a conversation with someone about them and was asked what’s been most valuable to me about the communities I’ve been a part of. After reflection, here’s my answer:

Connecting with people trying to solve the same problems I’m trying to solve.

Being around people who have similar interests is okay. But being around people actively trying to solve for the same thing I am is when I’ve received the most from communities and contributed the most to them. In my experience, sharing and learning from one another builds deeper connections.

Communities of people actively trying to solve the same problem have the most passionate members because those members receive immense value from being part of those communities.

I chatted with an entrepreneur in the medical field who has built a business doing seven figures in annual revenue. He built the company from the ground up over the last decade and was recently approached by a private equity firm about acquiring his business.

He wasn’t looking to sell but decided to go through the process of having the private equity firm evaluate his business. In the end, the firm gave him a thorough analysis of his company and an offer to buy the entire company. He would have had to stay on, with a high salary, to continue running the company.

The founder did his own analysis and declined the offer. His business is generating a material annual free-cash flow. He concluded he’d rather own the business for the long haul than sell for a lump sum today because he’s built an asset that’s giving him an above-average return that probably will improve over time. He’d rather own a cash-flowing asset he controls with potential for increasing returns than take a lump sum and find other assets to invest in that will likely pay a lower return.

I enjoyed talking to this founder and hearing his thought process. I like the way he views his company as a cash-flowing asset and how he factored returns of his two options into his decision-making.

Yesterday I was at a social gathering. The topic of markets and investing came up because a few of the people there make relatively small personal investments in their spare time. The gathering included people from various backgrounds, locations, and professions, so I was very curious to hear what everyone had to say. I observed three notable points:

1. Negative sentiment – These people are interested in investing only in traditional cash-flowing businesses. This wasn’t surprising; I’ve heard the same from other investors and entrepreneurs. What stood out was the negative sentiment my friends had about start‑ups, technology companies, and to a lesser degree public equities. Their views applied to all start-ups and technology companies (excluding mega caps such as Google).
2. Historical trends – They expect certain asset classes, including real estate, to continue to perform well even in the current interest-rate environment.
3. Debt – They’re still embracing the use of debt to purchase physical assets.

Here are my thoughts on each point:

1. Sentiment about start-ups and technology companies may have swung from too optimistic to too pessimistic.
2. Understanding why a trend occurred in the first place is important. Then you can assess whether the same conditions still exist and gauge the probability of the trend continuing.
3. Everyone must make the decision that’s appropriate for their personal situation when considering whether to assume debt.

I enjoy going to social events that include people from various backgrounds and perspectives. I get a lot out of conversations at these events. It’s a great opportunity for me to understand how different people think about things.

This is my one-hundred-sixty-sixth weekly reflection. Here are my takeaways from this week:

• May – May went by quickly. We’re now ~40% through 2023. In the first few months of the year, we’ve seen unexpected events like bank failures. I suspect that more surprises await as the year unfolds—hopefully positive ones.
• Successful investing – I listened to a successful investor share why he continues to invest after several decades. He’s doesn’t do it for the money—he’s wealthy. Rather, he likes the fact that to continue being successful he must continuously learn because the investing landscape evolves continuously. The mental stimulation and motivation to stay curious are enjoyable to him.

Week one hundred sixty-six was a productive week. Looking forward to next week!

Over the last year, I’ve watched a number of founders I’m close to go from “what traction do I need to show to raise my next round” to “how can I get to breakeven?” The time it’s taken to make this mental shift has varied, usually based on how much cash they had in the bank. The less cash, the quicker the realization.

I’m a fan of this mindset change. Focusing on reducing cash burn can change a culture in a positive way. The team realizes that resources are scarce and becomes more efficient in using them. People stop throwing money at problems and start coming up with creative, out-of-the-box solutions and ideas. All of this increases the probability that the company will create a solution that customers want and will pay for continually.

One of my closest friends put it best: “I’ve done my best work when running out of money was a real possibility.”

In the last few years, there’s been a push to acquire small retail brands that sell on marketplaces like Amazon. Fueled by the pandemic-induced surge in e-commerce growth, aggregators raised billions of dollars to acquire Amazon.

Aggregators remind me of private equity—but more focused. They build a scalable platform that allows acquired companies to benefit from economies of scale. They acquire a number of tiny retail brands and plug them into their platform. The idea is that these small brands can scale more rapidly as part of a platform. From what I’ve read, many acquisitions are teams of five or fewer people doing $1 to $5 million in annual revenue.

Many aggregators raised billions in debt to fund their acquisitions when interest rates were low in 2020 and 2021. Now, for a variety of reasons, they’re beginning to experience some pain. First, e-commerce growth rates in 2020 and 2021 have not held up. E-commerce is still growing, but at a rate much closer to historical averages because people are shopping in person again. This means that the growth projections of companies acquired in 2020 and 2021 aren’t being met, which in turn means that cash flow projections aren’t being met. Second, inflation has increased costs substantially. Costs for producing, packaging, and shipping physical goods are materially higher. High costs (absent offsetting price increases) translate into lower profit margins and cash flow. Third, interest rates have increased substantially since 2021. The debt service on some of these loans is an issue. When debt needs to be refinanced, it can be hard to demonstrate how you’ll repay the debt—especially when sales, margins, and cash flow aren’t meeting projections.

According to a Bloomberg article earlier this month, the Amazon aggregator industry is in trouble and may begin consolidating. Based on my e-commerce experience, I agree. But where there’s pain, there’s also opportunity. I can see sophisticated investors who are experienced in e‑commerce purchasing some of these assets at very distressed prices, turning operations around, and transforming these brands into assets that generate great returns.