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.

During the last few years, we’ve seen a significant increase in the number of venture capital funds started. I’m happy that more people are deploying capital to founders. I think this is great for founders. But I’m concerned about how efficiently the capital is being matched to high-potential founders—especially those outside venture capital networks.

I’ve investigated and found that many (not all) funds have similar strategies. Sourcing, evaluating, and supporting founders look similar, with small tweaks. A lot of these funds were raised in 2020 and 2021. Those were great years because the start-up market was booming. These new funds benefited from the rising tide. They didn’t find and evaluate nonobvious founders with high potential. Many used VC network consensus to find and evaluate the companies they invested in. More capital was available, and lots of their investments enjoyed markups because of the abundance of capital—not because of traction earned by solving a problem well.

If the current market downturn continues, companies that aren’t focused on solving a problem well enough to reach product–market fit will struggle to raise additional capital. Their runway will shorten. Early-stage funds with unoriginal strategies that invested in these types of consensus start-ups will face hurdles too. If their portfolios aren’t performing well, they’ll have a harder time convincing others to give them more money to deploy in more consensus deals.

I’m curious to see how this pans out. I believe the non-consensus early-stage investors with original strategies will excel.

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A good friend shared his story with me today. His first few years as a founder were tough. He was figuring it out and progressing steadily, but he didn’t know what he didn’t know. That changed once he got the right introduction into the right network. A few conversations with the right people opened his eyes to what he could be doing and helped him understand how to do it.

My friend is doing well and is a success by any measure, but it’s too bad that it took him years to get in the right network. I can’t help but wonder what would have happened if he’d been connected sooner. How much further along would he be now?

Matching is important for early-stage entrepreneurship. The best start-up ecosystems are efficient at matching early founders with the right people and resources. As my friend experienced, that can be a catalyst. Not getting into the right network won’t, by itself, cause you to fail, but it could lead to valuable time passing that you can’t get back.

Today’s conversation has me thinking about ways to improve the matching mechanism for early-stage entrepreneurs—especially given the distributed nature of the world post-pandemic.

I caught up with a founder who described his traction. As he shared his update deck, two things jumped out at me. He’s raised around $100k, and he’s had a team of five or so working for over a year. They’ve made significant progress and have built a product that has early paying customers.

For a team that size, $100k is a small amount of money, so I asked how he’s sustaining things. He said his team agreed to deferred salary. Their salaries are set, but they receive only a portion of them until the product is launched. They’re about to raise a proper round from venture investors. When they do, the deferred salary will be fully paid.

This is an interesting approach to building a company absent sufficient investor capital. It definitely isn’t an option for all founders or their employees, but it’s one to be aware of. This founder has done a lot with a little. I’m confident he’ll be able to raise capital to fulfill his promise to his team and keep building.