Venture capital is an interesting structure. On one side, you have capital contributed to venture capital funds by limited partners. I’ll call that the supply side. On the other side, you have founders building companies. Founders usually need capital and resources. Let’s call them the demand side. In the middle, you have venture capital making the connections between founders and resources (mainly capital). I guess that makes venture capital a marketplace, albeit one that requires lots of manual intervention.

Many people would argue that this marketplace is inefficient in its current state. I tend to agree, but I think more about its future state. What will happen if the supply of capital increases materially? As public markets continue to swing and inflation lingers, I suspect more capital will come to early-stage venture capital.

What happens if the demand side grows? More people are wanting to control their destiny and seeing entrepreneurship as a way to do it. And if recession-related layoffs increase materially, more people will look for their next thing. The result: many more founders.

All these changes are great, but I’m not sure venture capital could handle them. Would it be able to efficiently increase throughput and efficiently deploy capital? I suspect it could deploy it—but not efficiently. Those close to venture networks would receive more capital, likely creating a bubble.

I believe there’s an opportunity to rethink critical pieces of this marketplace to both improve throughput and reach founders outside traditional venture capital networks.

I spent time today talking with a friend and fellow investor. We talked about similarities in various venture capital firms. Many firms are fishing in the same pond, we agreed—they recruit people from the same network and use similar strategies to source and evaluate founders. He said something that resonated with me:

“If everybody follows the same playbook, the returns will reflect this.”

My buddy makes a great point. If a venture firm is making investments similar to those of other firms and generally doing what other firms do, that’s consensus investing. They’re likely investing in consensus founders solving obvious problems. That’s a recipe not for outsize returns but for average or below-average returns.

This truth was masked by the rising market over the last few years since a rising tide lifts all boats. The tide seems to be going out now, and I’m curious to see what changes early-stage firms make to their playbooks.

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I listened to Michael Moritz share his thoughts on venture capital investing. Michael is a former journalist turned venture capitalist at Sequoia Capital (he joined in 1986). He isn’t just an investment partner—he’s been part of the firm’s leadership team for decades. He played an integral role in the firm’s international expansion and expansion into investing beyond venture capital stages. Given his unusual path to venture capital and the firm’s success, I was curious to hear what he had to say.

One of Michael’s insights that jumped out to me was his perspective on classifying founders and ideas:

To me, the best investments are the ones that don’t fit into a convenient bucket.

He cited Airbnb, Yahoo, Uber, and others as examples. The concepts behind those businesses were different than the norm at the time. It’s obvious now that they’ve worked out, but back then, the founders and their niche ideas weren’t obvious winners. Michael and others had to intentionally look past that.

I like Michael’s perspective. Sequoia’s investments in non-consensus ideas and people led to outsize results. Even though those founders and ideas didn’t fit into logical buckets at the time, investors still made the leap of faith to partner with them. This wasn’t just one or two lucky investments. Sequoia has a history of doing this, which implies that it’s core to their strategy and contributes to their success.

It makes sense that nonobvious people, ideas, and problems won’t fit into buckets. If they did, they’d be obvious.

I think other VC investors can learn a lot from Sequoia. The best people and problems can seem odd. But if you look past the surface, ignore the consensus feedback, and take the leap of faith, you could find yourself with a series of outsize returns and lifelong partnerships with founders who change the world.

I had a spirited debate with a founder friend this week. He raised $20+ million in venture capital for his company and sold it for nine figures. Based on his experience, he believes social proof is a critical driver in the fundraising process for founders. If you have a bigger, better network inside VC (investors and founders who have raised from investors), it gives you social proof. The more social proof you have, the more likely you are to get a meeting and get funded.

My friend is right. That is currently how VC works. I don’t think this is good. Venture capital is about finding new problems to solve and taking risks. Risks with ideas. Risks with people. Social proof is often justified as a proxy for what you can expect from a founder. The thinking goes, if you can’t figure out how to get a meeting with a VC investor, how will you get a meeting with a potential customer? Said differently, will this founder hustle to make things happen?

Founders need to have grit and hustle. Those qualities are critical to surviving the inevitable ups and downs. But social proof has evolved into something beyond evaluating hustle. It’s been used to derisk the entrepreneur; that is, it’s a way to evaluate whether this entrepreneur is a quality person worth betting on. If other people in the VC investor’s network know the founder, the investor can derisk the entrepreneur by asking others about them. Unfortunately, the feedback, instead of being about the founder’s abilities, is often based on shared personal characteristics and relatability.

In venture capital, you want to back founders who see the world differently and identify overlooked problems. Said differently, you want nonobvious problems and markets, which are usually identified by people with unique perspectives. These people and the problems they see may not be part of the “in” crowd. They may have different personal characteristics. People may not be able to relate to them or find commonalities, but that doesn’t mean they can’t be amazing founders.

Using social proof to evaluate founders isn’t a great practice. Instead, founders should be judged on their abilities, the severity of the problem they’ve identified, and the potential of the solution they envision. The number of connections they share with a VC investor shouldn’t factor into funding decisions. In fact, social proof as a founder evaluation tool can lead to false negatives on under networked high-potential founders solving nonobvious problems.

Knowing how to pitch an idea succinctly is important for founders, especially early founders with no traction. A pitch can be built in many ways. I came across an approach Sequoia Capital created that was used by the Airbnb founders to create their early pitch deck. Given Sequoia’s track record of investing in amazing companies (Apple, Airbnb, Cisco, Google, Figma, Instacart, Stripe, Yahoo, Zoom, etc.) over many decades, this approach has been battle tested and has benefited from compounding experience. A few takeaways:

• Origin – Sequoia doesn’t include this, but it’s important to articulate how you discovered the problem and why you want to solve it. If you’ve lived the problem, even better. That makes the pitch more personal. I suggest starting with this and then following Sequoia's outline.
• Simplicity – The approach is simple and straight to the point, and it flows well.
• Problem – Describing the pain is part of describing the problem, but understanding current solutions and their shortcomings is also important. This approach, if followed, can make explaining a complex problem easier (not easy).
• Why now – Timing is important. It’s very important to communicate why now is the right time and why it hasn’t been done before.
• Market – This is critical. You must understand your current market and have an opinion about where it’s going. Creating a new market is a big deal. If that’s your situation, don’t leave that out.
• Mission/vision – The outline begins with the mission (what you plan to do in the next few years) and ends with the vision (how you’ll transform the world if you achieve your mission). It’s important to communicate both, and I think this approach makes a lot of sense. When you formulate your vision, dream big!

If you want to see the details of Sequoia’s approach to pitching, look here. I think it’s a great guide for founders to follow when they’re constructing their own pitches.

Today I listened to a seasoned e-commerce entrepreneur share an interesting insight. He recently sold his company, but he’s still running it. He and his data team have noticed that advertising rates on platforms like Meta (Facebook) and Google have increased sharply this year. This is anecdotal evidence, but it’s not the first time I’ve heard this.

Acquiring customers from paid advertising channels can be part of a customer acquisition strategy, but it can’t be the customer acquisition strategy. Especially for early-stage companies. Relying on paid ads puts the company in a reactionary position—it’s at the mercy of platforms’ rates, so the economics of a nothing-but-paid-advertising strategy can stop working quickly. When this happens, companies are in a difficult position. They can keep paying the higher rates to protect top-line revenue at the expense of margins. Or they can reduce paid advertising, which reduces top-line revenue (and could reduce profitability).

Acquiring new customers is hard, and founders should think thoughtfully about how to best do it.

I listened to an investor share his views on what it takes to become a top city for start-ups. He believes the most important characteristic is the ability to create companies that lead in their markets. Cities creating market-leading companies are the best cities for start-ups and start-up ecosystems. His reasoning is that a market-leading company captures most of the value created in its market (70% or more). Cities that create companies that lead markets will see torrential trickle-down effects from having them.

I agree with this investor. You can have a lot of great companies in your city that do well and even exit. That’s a great city and ecosystem to be a founder in. Such success leads to more success, but likely at the pace of a dribble. But if a city creates a market leader, the effect isn’t a dribble. A tsunami of capital, knowledge, relationships, and energy hits the city’s founders. And it doesn’t lead just to more garden-variety success but also to people wanting to recreate and support what they just saw—a market leader enjoying massive success. The rate of change in such a start-up ecosystem is accelerated, the resources and network available to founders are amazing, and people are thinking big.

Markets matter a lot, and founders should take time to think about the market early in their journey. Fast-growing markets with massive potential are the best (even if they’re small now). Cities that want to be top start-up destinations should think about how to create an environment that creates market-leading companies.

Last week, Adobe announced that it will acquire Figma for $20 billion. That’s a massive outcome for founders, employees, and investors. Digging into Figma’s history, I noticed something interesting. The company was founded around 2011, about eleven years ago. But it didn’t launch the product until around 2015. Even then, the product wasn’t readily available—it was launched to a group of private beta users around 2015 and made publicly available around 2016. That means the company spent roughly four years getting things right before putting the solution in customers’ hands.

Speed of execution matters for start-ups. It’s one of the most important characteristics of successful founders. It might appear that Figma wasn’t executing quickly since it went four years without shipping a product. Given the product’s growth post-launch and this acquisition, I’d bet otherwise. I don’t have any direct knowledge of this situation, but I suspect the team was executing quickly—it was just that what they were trying to accomplish was so massive that the hurdles were extraordinarily high. They were trying to displace entrenched tools like Photoshop (which Adobe owns). They likely had to dive deep to understand the component problems with tools like Photoshop and to understand what users needed (not wanted) and then take a first-principles approach to create a new solution. That’s not an easy or quick process.

I’m sure there were lots of mistakes along the way, too, that prolonged things. But in the end, Figma spent four years building a better mousetrap to disrupt Adobe (and others) and ended up getting acquired by the eight-hundred-pound gorilla it disrupted. I’d say things worked out pretty well and the approach was the right one for what they were trying to do.

When you’re trying to accomplish something great by disrupting incumbents in an established industry, speed of execution is crucial, but it might look different (especially to those outside the company). And that’s OK as long as the end result is a solution that’s ten times (at least) better than what’s already available. Figma understood this and ended up with a superior product that customers (and now Adobe) love.

VC funds can have a big influence on start-ups. VC funds get the capital to invest in companies from their limited partners (LPs). LPs can be individuals, families, or organizations (pensions, endowments, corporations, etc.). I connected with someone who knows the LP world well and helps LPs discover and evaluate VC fund managers. One of his points, which is accurate, is that when LPs find a VC fund manager to invest in, they want to back multiple funds managed by that person (i.e., invest for many years). He also said many LPs want to back VC managers who invest early in emerging technologies and markets. Said differently, they want to invest in a VC fund that can help them invest early and for many years in innovative companies.

Early VC investing is done at a nascent time in a company’s life cycle. Founders haven’t found product–market fit (if they’ve even built a product). It’s not surprising for founders to have a problem they’re passionate about and just an idea about how to solve it. This stage is commonly referred to as the pre-seed or seed stage.

Pre-seed and seed stage investing is different than later stages (when product–market fit has been achieved) in various ways. It’s more transient and in a constant state of flux. Let’s dive deeper into this:

• Flux – The rate of change in the world is accelerating. People are constantly discovering new problems, creating new technologies, and thinking of new ways to repurpose existing technologies. And they’re doing this at a faster rate. Some things end up being viable to form a company around, and some don’t. Keeping a finger on the pulse of all this flux and identifying the promising people and problems isn’t easy. It requires constant refreshing of your perspective and relationships, among other things.
• Transient – Companies either succeed or fail, so companies are constantly transitioning into and out of this very early stage. VC fund managers investing at this stage (likely emerging managers) are similar. The managers that fail stop investing. The successful ones raise a larger fund, which usually pushes them to start investing at a later stage ( more on that here and here). When this happens, it can cause misalignment between LPs and VC fund managers (more on that here) and cause VC fund managers to transition out of investing at this stage too.

Some LPs want to invest in cutting-edge companies early and they want to back a VC fund manager who can do this for them for many years. This approach works at later stages (Series A and later), but given the flux and transience at the pre-seed or seed stage, it doesn’t make sense then. These two goals are counter to one another when investing this early. I believe some LPs want to invest in innovative companies as early as possible because of the potential financial upside and societal impact. But backing the same VC fund manager for many years isn’t the right action to support that goal. It would likely have the opposite effect. I suspect LPs want relationship consistency (or something else) for various reasons and think backing the same manager is the answer. They may believe this because it’s all that’s been available to them historically (other than sourcing founders themselves).

There’s a disconnect here. The stated goal and the action being taken to accomplish that goal aren’t aligned, and I’m not sure people realize that. I suspect this is affecting the efficiency of capital and resource deployment to early-stage founders. There’s likely an opportunity to present an alternative solution that embraces the transient and flux nature of this early stage but also addresses LPs’ other concerns (e.g., relationship consistency).

I had a great conversation with a founder who bootstrapped her software company to over $1 million in annual recurring revenue. I got a product demo and learned about the customers she’s signed to date. A big part of her ability to bootstrap was that she got multiyear agreements with a material amount of the price paid up front. She has big growth plans and is evaluating whether she should raise capital to accelerate her growth.

During our chat, she shared her seven-year goal—to reach nine figures in annual recurring revenue—and more of her thoughts about how she wants to get there. She likely isn’t going to tolerate large losses for the sake of growth.  She also isn’t focused on an exit. Instead, she will likely achieve rapid growth in a way that’s authentic for her and her team—measured, calculated growth with an eye to profitability and ownership for the long haul.

This founder has built her business in an intentional way. She’s capitalized it using customer revenue, and that’s served her well. She’s positioned herself to have options so she can build the company in a way that fits her. I’m excited to follow her journey and curious to see how she decides to fund her growth plans.