Early-stage investing is all about exceptions. Outliers make careers while convention is a path to mediocrity. However, it’s easy to forget this because pattern matching and rules are critical at the outset of a venture career.
As the American philosopher Hubert Dreyfus once said, “Rules are like training wheels...we may need such aids when learning to ride a bicycle, but we must eventually set them aside if we are to become skilled cyclists.”
Just as training wheels can stifle a cyclist from navigating sharp turns, crowded spaces, and novel situations, venture capital conventions and pattern recognition become straitjackets when adhered to without restriction. A few examples:
Ownership targets make VC math work. Yes, but if you’re just starting out and don’t have a track record, it’s okay to have smaller ownership percentages if they give you a better chance at investing in an outlier business. This LP highlights how one of their VCs took this approach: A small $75k investment into a startup turned into $30m of returns. Moreover the ticket came from a $27m fund with 120 portfolio companies because they were open to going small to win big.
Cofounder teams are better than solo founders. Yes, but around 20% of unicorns were founded by solo-founders. Dropbox, Calendly, Amazon, Checkout.com, eBay, and Zoom had solo founders. In fact, solo-founder unicorns achieve their $1bn+ valuation faster than cofounder teams. Solo founders can do better if they recruit well and are exceptionally resourceful. Meanwhile, a lousy cofounder is worse than having one in the first place.
Established and competitive markets are bad. Yes, Peter Thiel is right about competition and monopolies. However, entering a market with established legacy companies means that (a) there’s definitely a market, and (b) there’s less work to do in educating customers about a product. A startup that introduces a new product category and/or business model in an existing market can succeed where a company that attempts to create a new market altogether would fail.
Rules of thumb in venture are helpful shortcuts when reviewing thousands of investment opportunities. You can make decisions quickly with hard-earned intuition and shared wisdom. But as the examples above show, mastery of any domain has to go beyond that. You also need to know when to throw out the ‘rules’ and make intelligent exceptions. Doing this well is hard. Doing it consistently well is a sign of mastery.
🥡 Practical takeaway:
Question every rule or convention you come across in venture capital. Ask why things are a certain way. Always consider exceptions, contradictions, and tensions. This is where the magic happens.