Last week I chatted with a few investors at Venture Atlanta. With one group, the topic of sourcing came up. I’m always curious to hear how others think about identifying the companies they’ll invest in. I noticed that most of these people had a strategy that focused on driving inbound activity. They had different approaches to accomplishing this, but bottom line, they all involved founders reaching out to investors.

Inbound activity is great for investors, but I think it can also be a double-edged sword for early-stage investors. It’s reactive. Because investors are reacting to founders, the markets they end up investing in are limited by the communications from founders they happened to receive.

Markets matter a lot in venture capital investing. It’s hard to make a big impact on the world or realize outsize returns if you’re in the wrong market (one that’s small or hypercompetitive, for example).

Inbound activity is an important part of an investor’s strategy for finding companies, but it can’t be the strategy if you want to invest in the best founders building in the best markets. You’ll likely have to spend time thinking about what markets you want to be in and then go pursue the founders in those markets.

Last week I attended Venture Atlanta and a variety of other events throughout the week. I hadn’t been to Venture Atlanta in person in over two years, so I wasn’t sure what to expect. The events were all great, and I met some amazing people. One of the things that jumped out at me was the number of people who didn’t know each other. Said differently, last week’s events highlighted how little certain networks interact with each other.

Once I realized how many people didn’t know each other, I made a point of trying to connect people who should know each other or could help each other. Hopefully, those connections will be helpful and allow those folks to expand their networks.

I think there’s a big opportunity in early-stage entrepreneurship to connect more networks that don’t interact—locally and nationally. I’m going to spend more time thinking about how to do it.

I listened to someone share an interesting way to think about start-up investments. This person is helping a seed-stage investor rethink their evaluation process, which included considering how big the company could be if things went well. Could this be a billion-dollar company that returns the fund, or would it max out at something smaller? They modified their approach to think about near-term probabilities. Specifically, what’s the probability that the company will raise a Series A? The logic behind this change was that most companies wouldn’t exit for more than $1 billion without raising a Series A, so why not focus on evaluating this?

It’s an interesting approach that got me thinking. The likelihood of a company raising capital from a later-stage investor is something that it’s good to be mindful of. Thinking about the probability of this happening could produce useful insights.

In the last two years, many early-stage companies raised at high valuations by historical standards. I remember seeing a seed-stage company raising at a $100-million-dollar valuation. Given these high valuations early in their life cycle, I’m wondering, what are the probabilities of these companies raising clean Series A rounds?

I had a chat with two friends yesterday about the venture capital (VC) industry. One works in the industry and the other is entering it. We debated the difficulty of breaking in to the industry, the challenge of getting capital if you’re a founder outside the VC network, gender issues, and a few other things.

One of my friends pointed out something that stuck with me. He said VCs that have been successful have accumulated unheard-of amounts of wealth at young ages (relative to historical norms). They’ve achieved this success using a particular playbook. There are certain parts of that playbook that people might not like and that are under fire now. But why change what you’re doing if it’s working so well?

If you look at the history of venture capital, you see that the industry changes when it’s forced to. Said differently, when its economics are threatened, the industry reacts. Masayoshi Son and Chase Coleman are examples of outsiders whose unusual approaches affected industry returns and caused the industry to adapt.

It’s interesting that for all the disruption and innovation VC brings about in other industries, VC itself doesn’t evolve and innovate at a faster pace. The world has changed a lot since March 2020, and I think the VC industry hasn’t innovated enough to keep up with all the changes. I think we’re due to see another wave of changes to the industry caused by outsiders.

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When early-stage founders building high-growth companies think of raising their first bit of capital, they think find a venture capitalist. What they don’t think about is where the venture capitalist gets the money. The people who invest in a venture capital fund are limited partners (LPs). VCs have a responsibility to be good stewards of LPs’ capital—and if they aren’t, they won’t get any more of that capital.

I had breakfast with an out-of-town venture capitalist raising a $100+ million fund that invests in seed-stage (product built, but no product–market fit) companies. They’re not investing at the idea stage, but still early. He worked at a notable fund for years, but this is the first time he’s raised his own fund. We discussed his fundraise and the LP environment. He’s been focused on institutional investors (endowments, pensions, foundations, etc.), given his relationships and experience. He’s gotten good traction with his fundraise, but he’s hearing that many institutions prefer to back a manager at fund three and beyond. They want to get to know you during fund one and two. They want to see the company’s track record and performance and build a relationship with the manager over the first two funds. Once they get comfortable with a manager, they’ll back them over a few funds.

My conversation with this manager reinforced my view that early-stage investing can present a dilemma for LPs because what they’re comfortable with doesn’t align with the flux and transient nature of the early stage.

I walked away from this conversation, and others, feeling like there’s ample capital available from folks who want to invest in early-stage companies. But the current venture capital construct isn’t ideal when it comes to matching capital to founders. I’m wondering, is this an opportunity for an alternative that institutional LPs would like, or will LPs backing early-stage companies forever not be institutions (individuals, family offices, etc.)?

Over the past few years, I’ve connected with lots of investors outside Atlanta interested in learning more about the city’s start-up ecosystem. It isn’t easy to understand, I’ve often heard, and they want to know why. I explain that Atlanta’s ecosystem is composed of mini communities built around similarities. Universities (Georgia Tech, Atlanta University Center, and others), neighborhoods, and coworking spaces all have their own communities. These types of mini communities are a normal part of a healthy start-up ecosystem. The challenge in Atlanta is that they don’t overlap enough. In my explanations, I say that people don’t like to leave their neighborhoods. That’s half joke, half truth. More accurately, people are less inclined to leave their preferred mini community.

Venture Atlanta is this week, and many events are taking place. Yesterday I attended two evening events given by different mini communities. An investor and a founder were tagging along with me. Both were from out of town and interested in learning about the Atlanta start-up ecosystem. As we left the first event and entered the second, one of them commented that the events felt like two different worlds. Both were attending by amazing people from mini communities who want Atlanta to win—people who were noticeably different and only minimally overlapping. As we left the last event, my two guests shared that attending the two events (which were two miles apart) and seeing the mini communities helped them understand the Atlanta ecosystem.

Legendary companies are built when high-potential entrepreneurs are matched with capital, scaling knowledge, and relationships. Atlanta’s mini-community dynamic creates network distance, which fosters inefficient matching.

I see an opportunity to supercharge early-stage entrepreneurship in Atlanta. If the number of conduits between these mini communities were to grow, the free flow of information and relationships in the city would do likewise, thus reducing network distance and increasing matching efficiency.

I’ve shared my views on how short-term valuation changes affect psychology. I was reminded of them recently when I had a great dinner with two established, successful founders, one of whom recently sold his company. The topic of public markets came up, and both shared that their portfolios have lost material amounts of money. The most interesting thing they said was that looking at their portfolios regularly is frustrating. One of them even mentioned that he was nervous about checking it given the recent market trajectory. They’re both considering selling losing positions to stop the bleeding.

Liquidity is a big difference between the public and private markets (i.e., venture capital). Some view the liquid nature of public markets as a benefit. There are benefits to it, but I also see a downside. Because of the liquidity of public markets, investors can constantly check the value of their investments. When valuations fall for macro reasons (i.e., the company is doing fine), some investors may sell their investments with the click of a button. Even though the company is doing fine and could appreciate significantly in value in the future, today’s pain is too much to bear, and people sell prematurely.

Private markets are different. Investors can’t check the current value of an investment. Companies are usually valued at the last round of capital raised. As companies face hurdles or the macro market changes, the valuation is still at the latest round. Resetting the valuation usually means raising a new round or a private party transition between two parties. Neither of these options is easy. If a seller is able to coordinate a transaction with a willing buyer, some companies can have the right to block the transaction. All of this means that investors in private companies are more likely to stick it out with private investments when times get tough.

The illiquid nature of private investments makes it hard for some people to embrace them. I think this illiquidity isn’t necessarily a bad thing. For winners, it forces investors to stick with investments during hard times. As companies get past the hard times, these investors reap returns they likely would have missed out on if they’d been able to sell their investment early.

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!