As an early founder, I’d built a manual operation and was having a hard time growing it while maintaining operational consistency. Our workflow was complex, with many potential points of failure. It was expensive, and it couldn’t scale. I figured technology could help make our processes consistent so we could grow. There were other benefits I didn’t realize.

After we built technology, things got predictable. I began to model growth scenarios, and something jumped out at me: the incremental margin. As revenue increased, our costs went up, but not nearly as quickly as revenue did. With every additional dollar of revenue we earned, a bigger fraction fell to the bottom line. Said differently, the more we grew, the more profitable we became —mainly because of the efficiency gains from the software we’d built. For the first time, I could clearly see the profit potential of the business.

Seeing the impact that the incremental margin could have on the business was a big aha moment. It was as if I could see into the financial future of the company and I just needed to figure out how to grow to get there.  

Side note: I had assumed that customer acquisition costs would stay flat, and that assumption proved incorrect years later because our market wasn’t growing. Nevertheless, thinking in incremental margins is something I do to this day.

I talked with a founder/investor and another investor today, independently, about scaling start-ups. Finding product–market fit is the first hurdle. After that, scaling your solution can be difficult. We discussed various ways to go about it, with markets dominating both conversations.

Markets play an outsize role in a start-up’s ability to scale. I should know. When I was a founder, my team and I realized we were in a big market. At the time, it was $30+ billion. We figured that was more than big enough for us to build a huge company. One percent of $30+ billion would be $300+ million in revenue. We figured that getting 1% market share was more than reasonable. What we didn’t spend enough time on was understanding the trajectory of the market. It was a decades-old market that was flat, meaning it wasn’t growing. We eventually realized we had to steal customers from established competitors. (That didn’t go over well. We upset many people.) We scaled the company to $10+ million. (So much for $300+ million.) There were several reasons for that, and market was a big one. Stealing customers is difficult if your solution isn’t 10X better than the competition (ours wasn’t).

My big takeaway from that experience was that market size matters, but the trajectory of the market matters too. A fast-growing market can be a great opportunity for founders, even if it’s small now. If you find product–market fit, the market’s growth can pull the start-up along, making it easier to find customers and scale the company.

I caught up with a founder friend today. He shared his vision for his next thing. It’s big! It could have a huge impact if he’s successful. I asked him some questions about execution. Without hesitation, he told me they’re important questions and they’ll get answered, but that’s not his strength. He’ll bring on another leader strong in execution and details. He didn’t sugarcoat anything. He owned his weakness and has a plan to address it.

I love how my friend is self-aware. He’s an idea guy, a big-picture thinker who enjoys thinking about the future and what’s possible. He knows this and stays in his lane. He recognizes that a team is required to turn his vision into reality and is eager to partner with someone strong in the areas where he’s weak.

I’m excited to see him start working on this new thing and can’t wait to see the team he assembles. I suspect it will comprise people who complement each other and who will help him do amazing things.

For several months, I’ve been gathering information for a personal project. I wanted help digesting all the information, and I wanted holes poked in what I’ve done so far. So, I spent today in a multi-hour whiteboard session with others. I wasn’t sure what to expect, but I was excited heading into this meeting.

As it turned out, it was very helpful. It was great to get the perspectives of credible outsiders who could look at the problem and the information gathered with fresh eyes. We identified some great insights and are energized about the problem.

Today’s session reminded me of the strategy sessions I had as a start-up founder. There’s a problem to be solved, we believe it can be solved, but the solution isn’t obvious. After debate and a thoughtful exchange of ideas, a solution is formulated.

Today was a reminder that I need to do these sessions more often.

I want to follow up on yesterday’s post about larger VC funds creating a dilemma for established firms. I chatted with an emerging manager recently. Raising his first fund wasn’t easy. After eighteen months, he hadn’t hit his $25 million fundraising goal and stopped at $10 million. That first fund is performing well, and he went out to raise his next fund a few years later. He wanted to raise $50 million but ended up with $60 million because of outsize demand from limited partners who wanted to invest at the ground level of amazing companies.

When we spoke, he was happy the second fund is larger but, at the same time, on the horns of a dilemma: he can’t deploy fund 2 using the same strategy he did with fund 1. He gave me some simple math. (Note that he ignored reserves for follow-on investments and other variables for the sake of getting his point across.)

He wants to invest at the ground level and aims to be the first check or in the first round of capital raised by early companies. From fund 1, he could write a $500k check—5% of his $10 million fund. He could make 20 of these investments, which is achievable, and deploy the full $10 million. The valuations were reasonable, and if one investment performs well, it could return the entire $10 million fund.

With fund 2, though, to write 20 checks each representing 5% of the fund, each check must be for $3 million. But the early companies he targets don’t need $3 million! Their first rounds are usually much smaller.

He now must choose among what he views as not great options: overcapitalize 20 early founders with $3 million at inflated valuations and negatively impact fund returns, stick with $500k checks and find 120 companies, do a hybrid of the two, or invest in 20 slightly later-stage founders (i.e., not at the ground level) at reasonable valuations.

This manager has done a great job of finding, capitalizing, and supporting founders during the earliest part of their business cycle. He’s successfully investing at the ground level of some amazing outlier companies. His strategy worked well for fund 1, which led to fund 2 being larger. He now must adjust his strategy because of the larger fund size, which could hinder him from supporting founders at the ground level. The math (simplified here) demonstrates how raising a larger fund can complicate backing founders at the earliest parts of their journey.

It’s been interesting to watch the last few years of venture capital. The number of firms raising larger funds appears to be increasing. This sounds good until you consider the math of venture capital funds. Most early-stage funds consider an investment a winner if it returns the entire fund or more. If you raise a $500 million fund, you’re looking for an investment in a single company to return $500 million or more. The number of companies capable of such a return is small, so when you find one, you must capitalize on it. If you don’t, a fund is less likely to generate a meaningful return for its investors when the companies that will fail are factored in.

Instagram is a well-known acquisition. It was founded in 2010 and acquired in 2012 by Facebook (now known as Meta) for $1 billion. Andreessen Horowitz invested $250,000 in Instagram’s early seed round and realized $78 million at the time Instagram was sold. That’s a 312x return. The challenge is that Andreessen made the investment from a $1.5 billion fund. Instagram was the investment of a lifetime, but it didn’t return the fund. It returned less than 6% of the fund. That means Andreessen would need to make 19 investments like this one to return its fund. That’s not likely. Do note that Andreessen made decisions specific to this situation that reduced the firm’s return, but this nevertheless illustrates the challenge of large funds investing at the ground level of a company.

The larger the fund, the larger the check the fund needs to write (unless it increases the number of checks) for a single investment to return the fund. When VC firms raise larger funds, many choose to invest at a slightly later stage (think seed instead of pre-seed or series A instead of seed) because the larger check size makes sense given the number of checks they want to write out of that fund. I think this leaves a void to be filled. The question is, what’s the optimal way to fill that void AND still generate a meaningful return?

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

• Tough decisions – This week was a reminder that tough decisions require a balance of IQ and EQ.
• Good people – I spent time connecting with other investors at an event this week. Good high-quality people in a fun environment. This was another reminder that good people know other good people.
• Shower thoughts – I’m thinking more about a particular problem—even in the shower. The last time I thought about a problem this much, I started a company to solve it.‍
• Downtime – I have some downtime coming up. Looking forward to spending time with friends and family.

Week one hundred twenty-three was a busy week. Looking forward to next week.

The rise of no-code tools has made it easier than ever to get early versions of products into the hands of users for validation. What used to take months and a technical leader can now be done in a weekend by almost anyone. No-code tools are a founder’s friend for this part of the journey—but they can’t be relied on much beyond that.

I chatted with a founder who has a few enterprise customers paying to use a solution he built via no-code tools. He’s now looking to raise capital off this validation so he can scale. The challenge is that he doesn’t have a full-time technical leader on his team. I explained to him that his situation carries high execution risk that could hinder his fundraising. He hasn’t shown he can build a technical product. Nor does he have a technical leader with a track record of building products. Investors will give him credit for solving a valid problem because customers are paying, but there will be questions about technical execution. Can he build a technical solution and scale it?

No-code tools are great for validating the problem, but they aren’t the goal. If you’re a founder using or considering using a no-code tool, have a plan to start building your own proprietary product so you can remove concerns around execution and build something scalable.

I chatted with a founder who’s building an impressive software company. He’s bootstrapped his growing—and profitable—company to $2 million in annual recurring revenue. And he’s done it without proximity to success, since he lives in a tier 3 city. He’s been figuring it out as he goes. I could tell he didn’t understand the significance of what he’s built to date. Sure, there are things that need to be cleaned up, but the results are impressive given his resources and environment. He’s thinking about raising capital now and isn’t sure how to go about it or whom to talk with.

I think of him as an outlier founder. He’s outside the purview of traditional start-up and venture capital networks and ecosystems. Yet he’s demonstrated that he has many of the traits that make a great founder, including resilience in a suboptimal environment. If he were surrounded with the right resources and advice, this founder has the potential to build a huge business that customers love.

Outlier founders (and markets) really interest me. They’re solving unique problems that are overlooked by most people. I believe there’s a ton of opportunity to have a huge impact on society by getting resources to outlier founders and markets.

I talked to a friend today who’s in a fortunate position. He’s an executive with start-up experience, and several companies are recruiting him. All the opportunities look good on the surface, and all the founders are trying to move the process along quickly. He’s trying to figure out how to make the best decision for his family. He asked for my thoughts.

I think I know which company he’ll end up with. From the initial pitch, everything sounds promising. The market is big, the product is great, customers love the solution, and the team is strong. My feedback was simple: Don’t fall in love with any opportunity until the deal is signed. Continue to move all the opportunities forward with a focus on diligence to better understand each and gauge for fit. The recruitment process is bidirectional—treat it as such. Understanding the market and the team (especially the culture) and talking to customers are some ways to gain insight. As you dive deeper, you’re bound to uncover things that didn’t make the sales pitch; you’ll have to determine if they’re deal breakers or not.

I’m excited for my friend and can’t wait to see where he lands!