by Incredible Health CEO & Co-Founder Iman Abuzeid
In 2019, NFX company Incredible Health announced a $15 Million Series A led by our friend Jeff Jordan at Andreessen Horowitz. NFX participated in the round, along with Obvious Ventures and Precursor Ventures. Today, CEO & Co-Founder Iman Abuzeid breaks down the complicated (and often convoluted) process of fundraising and makes public her lessons for the Founder community on what it takes to raise venture capital from top-tier VCs.
In September 2019, the company I co-founded, Incredible Health, announced a $15 million Series A round led by A16z. We’d first received seed funding from NFX, and we sought them out because of their expertise in marketplaces and network effects. James Currier introduced us to James Joaquin of Obvious Ventures who led our seed round, and when we were ready to raise our A, James introduced us to Jeff Jordan. We also received Series A term sheets from other top VCs in the world, but had to select only one due to each VC’s ownership requirements.
The biggest lesson Founders should realize is that traction alone is rarely sufficient to raise venture capital from VCs of that caliber. Consider that Incredible Health has a huge vision of a hiring marketplace for hospitals and nurses that solves the U.S. nursing shortage, and aims to be the category-defining, market-leading company in healthcare labor. The hiring gap for nurses is 3x larger than the engineering shortage and recruiting tools and processes have barely changed since the 1980s and 1990s. This has created a multi-billion dollar market opportunity. We also had an impressive roster of customers from brand-name hospitals like Cedars-Sinai Medical Center and Stanford Healthcare. And we had strong traction with these customers who were witnessing real results – cutting the average time to fill permanent nursing jobs from 90 days to 30 days.
All of this indicates a confluence of opportunity that NFX likes to call “fast-moving water”.
But even with all this traction, I’m not sure our fundraise would have been successful without a strong process – something most Founders don’t realize or get access to. This essay lays out what I learned from fundraising and the process that emerged. My focus here is on raising for a Series A, because that’s my experience thus far, but many of the lessons learned likely translate into Series B and beyond.
Do you really want to raise venture capital?
Before you begin raising, consider and understand the pressures and expectations. If you raise money from venture funds, they will expect rapid growth and most likely will want to be heavily involved with the management of your company. Venture backers will also expect you to hire quickly and scale up fast in many or all aspects of your business. Is that what you and your co-founder(s) want? If not, you might want to look to raise another form of financing or simply use your revenue to fuel growth.
There is a wide spectrum of vehicles, from convertible notes, to venture debt, to standard revolving lines of credit, or use your revenue. Venture equity is the most expensive of the bunch, but venture firms increasingly provide their portfolio companies with lots of business help — in hiring, marketing and PR, strategy, and business development. The bank providing you a line of credit will not take those steps. Consider all of these questions before you definitively decide to raise money from venture capitalists.
Fundraising had many surprising learnings for us.
One of the biggest was that traction, even strong traction, is not enough to spur action. Instead, a huge vision and story, and FOMO (fear of missing out) are the strongest forces for accelerating your fundraising process. Once you incite FOMO, it is powerful and you should use it wisely and deliberately. More on that later in the post.
We had so much going for us — traction, product-market fit, a huge TAM. But without treating our raise as a rigorous process, I am not certain we would have achieved nearly as good an outcome – and we may not have been able to raise money at all. We got dozens of rejections, changed our deck dozens of times, and sifted through hundreds of pieces of advice.
Making sure you have the right rationale for fundraising
A16z’s Marc Andreessen listed two reasons to raise venture money: you either have a killer idea that is only partially validated and need capital to get to product-market fit, or you have product-market fit with real customers and real revenue and need capital to grow and expand.
Either is a good answer. If you are seeking product-market fit, you could frame your raise as a seed round. This sets expectations appropriately and allows you room to build your product and seek validation from the market. If you have product-market fit, then aim for a Series A.
However, the distinction between the two has gotten blurry. Companies can raise a “super seed” of $5-10 million, while Series A raises can be anywhere from $6 million to $50 million, depending on various factors. Whatever the case, make sure you understand which of the two rationales you occupy. And if you can’t clearly identify either — if you are post-seed but don’t have product-market fit, for example — then don’t raise.
The Two Components of a Strong Raise
We knew pretty early on we were going to raise. I am an entrepreneur at heart and I wanted to grow a business, fast. I had no interest in building a business that might be lucrative for me personally but did not have the scale to make a difference in the world. With that in mind, let’s separate the fundraising process into two parts: the process, and the pitch.
In my experience, the proper breakdown of effort and time spent is 30% process, 70% pitch.
Here’s why: If your pitch is not going to knock their socks off, if you cannot communicate a big vision, then even if you build out the smartest, most thoughtful process of chasing fundraising you will fail.
In reality, though, you have to be amazing at both. Failing to create a strong process limits the pool of potential investors who will hear about you and also reduces your chances of landing with a top-tier fund and a partner that you really want to work with.
The Fundraising Process
There were two key ingredients in our fundraising process: timing our raise, and identifying the right investors.
Timing your raise
When you decide that you want to raise, you should have a reality check to make sure that you are positioned to do so, or have strong reasons to want money.
Fundraising is too much of a time sink to pursue if your probability of successfully fundraising is low. Some key triggers that I thought about, and that CEO friends who have raised mentioned to me, as good indications that it’s time to raise include:
- You want to expand nationally or internationally due to market demand and because your product is working and churn is low.
- You want to expand your engineering team to accelerate product development, and to build features and integrations users are asking for.
- You want to expand marketing efforts because you have a repeatable sales cycle and need more in the top of the funnel to fuel sales growth.
- Your revenues are steadily rising month over month, or quarter over quarter.
Some indications that it might not be the right time to raise include:
- You just missed two quarters of growth or sales numbers. This is a red flag to investors.
- Your growth rate is flattening out.
- Your space just cooled off. You know this because two competitors raised less than the market expected.
These are just a few of the triggers to look for. Above all, be very intentional about the timing of when you raise, because you want the fundraising to happen quickly and successfully. To do that, you need to have all the right ingredients in place, and strong momentum in your business. With so many startups fundraising at any one time, any question marks will slow down a fundraising process.
Identifying the right investors
Here is the process we followed for identifying investors. We built a spreadsheet for this, as you probably would want to do, with some simple data on how well they fit with our ideal VC funding candidate.
Step 1: Filter based on the criteria that matter to you
Just like a sales team identifying the right potential customers who fit the profile of your product, you want to identify the right potential investors. We considered a number of criteria as important in our screen including:
- Location – we wanted investors in the Bay Area
- Check size – we wanted to be able to raise a decent-sized series A to reduce the need for follow-on funding
- Sector expertise – we wanted experts at building marketplaces so we could benefit from their experience, connections, and talent network
- Fund size – we wanted a lead investor from a large fund so we could have confidence they would be able to easily write checks in follow-on rounds (equally important here is whether the fund is planning to raise another fund for not. You may want that additional fund for follow-on funding).
- Track record – we wanted a lead investor with a solid track record because that signals it’s a good fund with good capabilities, which also would reflect well on Incredible Health.
You may decide other factors are important in your screen, like specific technical expertise (if you are an AI company or a data company, for example) or ability to help with business development (some funds have detailed ongoing programs to introduce their portfolio companies to prospective customers).
Or you may also want a fund that is well-known for being hands-off. Anything that you think is important should go into your screen. We went with the above criteria as our primary screens.
Step 2: Build your fund wish list with tech tools and human recommendations
Once we selected the criteria that were important for us, we used some tools to build our list.
- Signal (built by NFX) is an investor database with lots of screens. It helped us narrow down our options very quickly.
- Crunchbase has information on different funds and the deals they had invested in.
- Pitchbook has the most detailed deal data and valuation info. Both deal data and valuation data were important for helping us screen investors, and later for building out models around how much we should try to raise and at what valuation.
While databases are nice, we also found that human filters gave us some of the best recommendations.
We asked all of our CEO friends and our early investors who they recommended we talk to about raising money. This can be powerful for a number of reasons. You may be connected with unexpected opportunities or learn about things that may not be in the databases yet (for example, if a prominent partner is about to break out and do their own fund).
These human filters can also help warn you off working with funds or VCs that may be difficult to deal with, or simply are unlikely to be a good fit for your needs. Your CEO friends often have a great handle on which VC fund, and which partner, might be the best match.
I’d recommend you build a list of 40 to 50 funds because you should expect a rejection rate well above 90%. Trust me. I’ve lived it.
Also, you will likely be working on getting an introduction into multiple funds at once so you want many irons in the fire. You are not in full control of timing in this step of the process so it’s best to cast a relatively wide net. However, after the introduction is made, you are back in control and can determine when you meet the investor, because they often connect you with their assistant.
Granted, if you have very strict criteria then you may want to narrow it down more. But that also carries the risk of not raising a round. We were fortunate enough to get both the fund we wanted and the valuation and round-size we sought. Not every founder will be so lucky and sometimes you may need to accept a less than perfect scenario.
Step 3: Identify the right partners at each fund
For each fund, you now need to identify who would be the best partner for your to seek an introduction.
This is super important. There are complicated and usually hidden power dynamics inside most funds. You can’t judge whether a partner is a good fit for you just from the website or even from news articles about them.
Some partners have more clout to push a deal through than others. Some partners may not be seeking more investments because they are at their deal quota and sit on more boards than they can handle. Some funds have specific ways of performing due diligence that more senior partners can influence but junior partners cannot. With all of this in mind, we considered all of the following angles:
- Is this partner powerful enough to get our deal through the full partnership vote? Or is this a weaker partner?
- Which of the partners adds the most value / adds real value? Which ones might actually be disruptive and demanding?
- What is the communication style of the partner? Does it match ours?
- Does the partner have strong or weak expertise in our business area?
- Can the partner help us build a strong board of advisors?
- Will the partner actually help you bring in customers or partners by tapping their Rolodex?
- What is the particular expertise of the partner? Marketing? Operations? Engineering? What types of expertise map the best to your company’s needs?
- What do they care about? For example, some investors care a lot about network effects. Others are more into robotics or crypto. Do their interests match what your company does or what you need?
Getting this type of intel about individual partners is time-consuming and challenging. But it is absolutely critical, because otherwise you will be walking into a fund blind, and potentially picking a partner that has a lower probability of getting you funded or making you successful down the road.
Another key part of this due diligence process is to start figuring out who can give you a meaningful warm intro to the partner. Venture capitalists are extremely busy. They are bombarded with requests for their time and meetings. Getting a warm intro from a strong connection is invaluable both for getting in the door and also for the halo effect it gives you walking into that first meeting.
Frankly, we didn’t even consider cold-contacting venture capitalists. Our friends and early-stage investors told us it was not a good use of our time.
That lays out the process we developed and ran during our raise. Now, on to the pitch.
The Fundraising Pitch
During the entire course of your raise, our pitch was a work in progress. We changed it dozens of times, which was healthy because we were responding to feedback and learning and iterating.
If you aren’t constantly tweaking your pitch, then you are probably not listening to feedback enough. During our rounds, we customized our pitch deck for each meeting, catering to what we thought would resonate the best with each set of potential investors.
There were core themes and slides that remained the same. But we believed that personalizing was crucial to showing we had taken the time to think about pitching to them as a person.
What to put in your pitch
The pitch model we followed (that worked) is straightforward:
- Discuss the market
- Demonstrate the size of the market
- Cover what the problems are that customers are facing in the market
- Introduce your product and how it solves those customer problems
- Explain how you plan to bring your product to market and scale your company
Within this framework, here are some additional guidelines that we picked up in our journey.
Pitch Guideline 1: Highlight the differentiation of your product
Good UX or clever marketing is not sufficient. VCs are looking for technical or really measurable differentiation. Some examples along these lines might be:
- Unique algorithms
- Data network effects / data gravity
- Superior or unique product capabilities that might take a while for competitors to replicate
Pitch Guideline 2: Use good metrics
Ideally, you will have specific metrics that show your traction and strength. The best metrics are:
- Industry appropriate: You should assume that whomever you are pitching will know (or soon find out ) what the right metrics to look at are for your space and expect you to know them, too.
- Demonstrating stickiness: DAU, MAU, time spent in-app, repeat customers, churn rate, NPS, and CSAT are just a few examples of this. Product stickiness and happy customers or users are the best indications you are doing something right.
The Importance of Go-To-Market And Winning Big
GTM is a major buzzword. We were asked about it often during our raise. You should expect this, as well. The more detailed you can be about your GTM, the better. A strong, detailed plan for GTM demonstrates you have thought about how to grow and that you really understand your space.
Now, about winning big. This is probably not news but it’s important to underscore because we got called on this in some of our meetings. A few VCs said we were too “capital efficient.” This means they didn’t see us as having a reason to spend their money or a clear path in our minds and in our presentation to rapid growth.
Never forget that VCs are looking for huge returns. If you can’t show them a path to a billion-dollar exit, they are not interested. For many VCs, they are looking at hundreds of opportunities per month. Few of them will ever get a billion-dollar exit. One billion-dollar exit can literally make their career. So you have to make sure they understand that you are trying to give them that billion-dollar exit.
How To Build Pitch Decks
We used decks as the key prop for our narrative, the visual support for our story. You can do it without them, but it’s hard if you want to tell a compelling story, backed by data and frameworks.
Step 1: Put a relevant number on every slide
We learned an excellent lesson from the NFX team early on: make sure to have a relevant number on every slide, supporting every assertion you make.
Putting something like “We are seeing strong demand for our product” on a slide was not good enough. Instead, we would say “We have seen a 50% MoM increase in inbound leads from hospitals.” Adding the number gives investors confidence that you have done your homework and demonstrates in a more tangible way the assertion you are making.
Step 2: Work hard on your talk track, too
You will convey a lot more information in what you say than what’s in the deck.
In particular, how you explain your product is crucial. I worked on that a ton and got a lot of feedback. I had to hone that ability extensively before we started to make real headway and get investor interest.
Step 3: Rehearse, Rehearse, Rehearse
Practice your pitch with your deck on friendlies. Do this many times.
CEO friends who had recently raised were the most valuable to me. Their advice was the most useful in upleveling our deck and we benefited from what they had learned along their journey. Existing investors are also excellent for practice pitches with a soft crowd.
Use spreadsheets to build a robust financial model
Our second pitch vehicle was our financial model – both P&L and balance sheet – in a spreadsheet. For any financial modeling, this is essential. If you try to do something different, investors will look at you funny.
If you are not good at financial modeling, have someone help you. Any MBA should have the ability to create a decent financial model in a spreadsheet. It shows you are serious about finance and the money side of things and understand the underlying assumptions that drive your business and growth.
You need to have a robust financial model with forecasts going at least three years out, and include your historical financials too. No one expects the forecasts will be accurate. But these forecasts demonstrate what you think the potential of your business is and they also demonstrate basic financial competence.
Be prepared to defend your forecast calculations; know them inside and out. Also, make sure all the accounting terms you use are correct, and that your model passes the sniff test with CFO-types. If you don’t have a CFO or someone that can build a solid financial model (and you aren’t an MBA), it’s worthwhile to hire someone to do this.
Assume you will need to adjust your model over time with feedback. As I mentioned earlier, in our first few pitch meetings, VCs told us we were too capital efficient. “What are you going to do with all the money we give you? Your model doesn’t show that,” they said.
We adjusted our model to demonstrate how we could effectively use all the money we were asking and to have a more ambitious growth-oriented plan. You also want to be very realistic in all your assumptions. Do not put down a $100k salary for an engineer in San Francisco, for example. Unrealistic assumptions will be challenged.
Getting ready to pitch
We had built out a list of VCs we wanted to meet and prioritized them on our criteria. We had worked hard to create a pitch and a deck that we thought would resonate. And we had a financial model. Now it was time to take some meetings. In this section, I’ll cover what we learned in the process of pitching and make some recommendations on the best approaches.
Part 1: The Warm-Up
We warmed up by pitching first to two or three investors that were very low on our priority list. I viewed this as almost like a dry run for job interviews starting with jobs you don’t really want that badly.
There is little risk to you in these pitches. It was helpful to get me in the right mental space for doing pitches. It also helped me hone both my pitch and other skills I learned for pitch meetings.
Part 2: Gathering Feedback
Each VC will have feedback. Some of it may be insanely useful. Other feedback, less so. Gather that feedback closely and use it to iterate and improve your deck and your pitch.
Incorporate language they use that you like. Absorb like a sponge. Sometimes we got feedback that was hard to interpret. In those cases, I talked about it with others on my team and with other CEOs to better understand what the VC wanted or was trying to communicate.
Feedback is not just verbal or via email. In meetings study everyone’s body language with laser focus. Keep track of which slide makes them sit up, when they smile, when their eyes go wide open. Also keep track of negative signals like slumping, looking down, or appearing bored.
Make sure you closely associate these signals with the part of your deck or pitch you were covering at that instant. We took careful notes on this after every meeting. It helped us identify what parts of our pitch and what slides were the most and least effective.
Part 3: Going beyond the KPIs
We had very solid traction, strong revenue growth, excellent customers and a product that both sides of our marketplace raved about.
We quickly realized that traction alone was not going to get us term sheets, let alone partner meetings.
Investors want a really big vision for the future, something they can bet on and something that shows you are trying to build something huge and amazing — a legendary company where the VC is part of that legacy. Traction is required but not sufficient, but having a big vision and a plan to get there is required.
When investors could not see that part of our story easily and clearly, they lost interest. So I can’t restate enough – telling a really big story and having a big vision is essential to raising a healthy round.
Part 4: Using FOMO to drive to the finish line
There were a couple of Tier-1 investors that think independently and made the decision to give us a term sheet independent of the rest of the market. We had heard about FOMO but didn’t understand its power until late in our fundraising process. In the blink of an eye, we saw a rapid increase in Incredible Health from Tier-1 funds. The reality is, we realized, that competition for good deals among Tier-1 funds is just as intense as the competition to raise capital.
Once you are marked as a highly promising startup and the holder of primo term sheets, then you will probably get interest from other VCs who are afraid of missing out on a deal that could make their fund a success.
Once you have it, you can use FOMO to drive a higher valuation, more capital, or lower dilution for your round. But be careful with FOMO.
- Don’t fake FOMO. If you don’t have a term sheet from a top-tier VC, then don’t claim to. If you are called out, you are done.
- Don’t tell investors which VCs have given you a term sheet. You want to keep them in the dark to prevent them from colluding (illegal but does happen)
Once you feel FOMO building, accelerate your process and use it to your advantage. Your goal should be to raise as quickly as possible once you feel FOMO. You can time-box your raise to drive faster decisions, for example. Investors will move quickly when they see something they want. Use the way people respond to FOMO as a filter, as well. You may elect to go with a smaller round and a lower valuation if the partner you want the most made an initial offer and then gets FOMO’d by other funds that you are less interested in for one reason or another.
Don’t Reinvent the Wheel. Enjoy the Ride
I laid out most of what I learned in my fundraising here, which I hope readers find useful.
My sincere wish is to help CEOs and founders save time and effort in building out their fundraising process, in part by leveraging what I learned. This is not rocket science and there is no need to reinvent the wheel.
While fundraising is grueling, it can also be exhilarating and rewarding. You are selling a story and a vision to some of the smartest people in the world. They will ask excellent questions and you will learn from them.
Your network will expand and your storytelling skills will improve. Fundraising is a growth opportunity in more than just one way. It is all part of the journey toward building something that changes the world.
Announcing Mammoth Biosciences’ $45M Series B
Mammoth is now the bio-platform for next-generation CRISPR products across therapeutics and diagnostics.
NFX portfolio company Mammoth Biosciences today announced a $45M Series B, led by Decheng Capital, with participation from Alphabet’s Verily Life Sciences and Brook Byers of Kleiner Perkins, among others. Additionally, Mammoth Dr. Min Cui, Ph.D., of Decheng, Jeff Huber the founding CEO of GRAIL will be joining the board. Lloyd Minor, the dean of Stanford Medical School, will be joining the company’s advisory board.
In addition to raising a new round, Mammoth is also announcing a collaboration with UCSF to explore the feasibility of a rapid coronavirus diagnostic test through Charles Chu, who is a member of Mammoth’s scientific advisory board.
NFX led the pre-seed and seed rounds of Mammoth, and participated heavily in the Series A, and now the Series B.
Mammoth has recently signed a large deal with Horizon Discovery to collaborate on bringing select new Mammoth gene-editing product offerings to the bioproduction market.
This is significant because it highlights the bio-platform approach of Mammoth which builds network effects over time. Mammoth has created a platform across therapeutic and diagnostic applications and now allows partners, like Horizon, to plug in to develop new products and services that wouldn’t be possible without Mammoth.
Mammoth’s platform combines two forms of IP that make the business defensible: 1) “wet” IP of CRISPR Cas proteins, and 2) “dry” IP on the data and AI side. Mammoth is the #1 holder of CRISPR IP now. Over time, working deeply and closely with partners, Mammoth will build up a data set that will speed the development of new products in both gene-editing and diagnostics.
Mammoth’s aim is to change how biology is programmed over the next 30 years, playing a similar role to Microsoft over the last 40 years when they married an operating system to the microchip in 1976, creating a new 2-sided platform for personal computing.
It’s All About the People
The Founders and team of Mammoth are very unique and extraordinarily talented people, including Mammoth CEO Trevor Martin, Janice Chen, Lucas Harrington, and Jennifer Doudna. The company also recently announced that two other industry titans have joined the company. Peter Nell, the new Chief Business Officer in charge of therapeutics, from co-founding Casebia Therapeutics and many years at Bayer and Ted Tisch, the new COO, previously COO at Synthego and many years at Bio-Rad prior to that.
We’re all lucky to have such a talented team assembled.
by Pete Flint (@PeteFlint). Pete is a General Partner at NFX, a seed-stage venture firm based in San Francisco.
Behind every iconic company is a radical, risk-laden idea. But as the startup ecosystem has grown, we’ve seen a decreasing appetite for risk & an increased emphasis on predictability and familiarity. Yet if you carefully study the most successful technology companies of our time, you’ll find something curious – not only are they born from risk, but they’ve survived and thrived because they knew how to evaluate risk itself.
To build iconic companies, Founders must take more risks, not less. But they also need to understand how to classify and assess the types of risk they will encounter. Trulia would have never become one of the most prolific PropTech companies had I not quickly learned how to do this.
I fear the pendulum has swung too far in the wrong direction to produce the kind of companies that technology promises – the kind of companies Founders dream of building. So today, I am sharing a framework for all Founders to evaluate startup risk.
2 Types of (Necessary) Startup Risk
To take risks strategically we must first understand them. We have to be sure that the biggest risks we are taking are necessary, so we can have the conviction to take them. We also have to be able to identify and avoid unnecessary risks so that, if our companies fail, it won’t be because we took avoidable risks.
As we’ve written about recently, two types of risk Founders trade off between are market risk and execution risk. Market risk is the risk that people may not want what you’re building. Execution risk is the risk that you might not be able to execute your idea better than the competition. Or as one memorable aphorism puts it, “vision without execution is just hallucination”.
When we introduced this framework, we pointed out that startup ideas with higher market risk are usually the best option for first-time entrepreneurs looking to avoid incumbents and competitors. By contrast, experienced entrepreneurs will often choose to take on more execution risk because they have more confidence in their ability to execute.
But to help Founders truly calculate how they should assess the risks involved with their startups, let’s take a deeper dive into what these two types of risk mean and where they really come from.
Sources of Market Risk
Market risks are outside of your direct control as a startup. But if you understand the sources of market risk, you can make better decisions upfront as a Founder on whether to start a startup in a given market category.
1. Product Risk — Do people want your product?
Founders often decide to start companies with a founding insight. This is usually an observation or realization of a commonly experienced problem that has become solvable through technological innovation.
For example, when I founded Trulia, my founding insight was that home buyers looking to make the biggest financial transaction of their lives would increasingly want to start their search online — and that there didn’t yet exist a good online resource for this purpose.
Once you have a founding insight, you can iterate on a product until you get to product-market fit and deliver a solution on the founding insight.
Not achieving product-market fit is possibly the biggest risk of all for first-time Founders starting companies with high market risk. In other words, your product risk comes down to how certain you can be about the accuracy of your founding insight. To properly assess it, ask yourself what evidence you have even from an early stage:
- Is your founding insight addressing a clear pain point?
- How big of a problem are you solving?
- Do you have evidence that people are willing to pay money for a solution?
The more data and information you have to corroborate that there’s a real need for your product — and that you will produce real value for your users — the lower this risk.
Early on as a Founder, it’s best to take whatever steps you can to minimize market risk before you start a company and raise capital. The longer it takes you to get to product-market fit, the harder everything else with your startup will become.
The best evidence of low market risk is obviously the existence of thriving businesses that already exist and provide a similar product. But, as we’ll discuss further below, the less market risk you can perceive because of the presence of competition, the more execution risk you tend to take on.
The best market-risk companies have strong evidence that there will be demand for their product and low to non-existent competition.
2. Scale Risk — Is there a big enough market?
The size of the market for your product is (mostly) outside of your control, but one of the biggest avoidable risks I see Founders take is starting companies where the potential market is too small for the economics of a venture-backed company.
There are many good, profitable businesses that can be built in smaller market categories, but these are not usually VC-backable. The real problem is that a small addressable market means that any company, no matter how well-run, cannot achieve the necessary scale to profitably build a breakthrough product with transformative impact and venture scale returns.
Startups that raise VC money must have the ability to (profitably) scale in order for them to be successful. It’s not always obvious what the size of the market for a product is or will be, but sometimes even a cursory glance at the market research will make it evident that the TAM is too small to ever support a potential billion-dollar company.
The exception to this is if you are building a new market like Lyft was doing in the early days. They essentially invented the ride-sharing market category, and so existing data around the size of the taxi industry was not a good indicator of market size. Lyft isn’t just going after the “taxi” problem. They are going after something much bigger — the problem of transportation.
While the size of a potential market for your startup isn’t identical to the size of the problem you’re tackling, there’s usually some correlation. If you’re looking to create a transformative company, it’s important to tackle a big problem.
Not all companies that end up having a huge market size know it at first. Companies like Slack and Instagram stumbled upon huge markets after seeing early traction with a particular feature of their products and looking to rapidly scale in that direction. The strategy is to double down on a market and scale up your ambition once you see early evidence of traction, and this can be one smart way to attenuate market risk.
3. Competitive Risk — What is the competitive landscape?
Another market-related risk to consider is the risk of competition. Big ideas with high market risk usually have limited direct competition, but sizable indirect competition from adjacent market categories.
As we’ve written about in the past, defensibility is the biggest factor in how valuable a company eventually becomes, and network effects are the best form of defensibility. 70% of the market capitalization in tech over the last 20+ years comes from companies with strong enough network effects to heavily mitigate competitive risk.
So as a Founder, it’s important to ask what the competitive landscape looks like. Are there already entrenched incumbents with strong defensibility within or adjacent to your market category? Are there a lot of other competing startups?
While it is possible to compete and win in hypercompetitive markets, as I’ve written about before, facing heavy competition creates significant risk.
Whether or not there’s already a lot of existing competition in any given market category, you can bet that eventually there will be. That’s why one of the most important risks to limit early on is the risk of later entrants eating into your market share by developing a sound defensibility strategy and ideally, building network effects into your product.
4. Timing Risk — Is this the right time?
The last significant risk outside of your direct control is timing.
In my essay, Why Startup Timing Is Everything, I break down the three preconditions that you should look for in a market to know if the timing is right to start a startup: economic impetus, enabling technologies, and cultural acceptance.
When a market reaches a critical mass of these three preconditions, there is an inflection point in the available market size so large that it can determine the success or failure of a given company.
Companies founded before this inflection point, despite having similar or identical products to later success companies in the same market, often fail for this reason alone (poor timing).
By contrast, companies that are too late to a market frequently find a lot of difficulty gaining traction because of entrenched competition. They often fail also.
Understand the current state of the market you’re getting into. The closer you can time your startup to the critical mass inflection point, the lower your risk.
5. Legal Risk — What is the regulatory environment?
Most iconic companies in tech end up having to navigate the obstacle of regulation. When they first got going, Uber had to deal with transport regulations, Airbnb had to deal with housing authority, and Youtube was dealing with copyright issues.
Usually, the regulatory environment surrounding an industry lags behind fast-moving technological innovation seen in startups. But it’s important to know that, just as with all the examples above, if you’re providing sufficient value to the key members of the ecosystem, you’re not breaking laws, and you are able to thoughtfully navigate the marketplace, then it is often a risk worth taking.
The fact that you might face regulatory hurdles doesn’t mean it’s a bad business. Fully self-driving cars are currently illegal, but most of the major transportation businesses in the world are developing autonomous vehicles.
If you face regulatory risk, you just need to be thoughtful about how you approach it. YouTube, for example, abided by takedown notices to protect copyright early on, but they continued to offer their core service which provided a lot of value to both content producers and consumers, and ultimately led to a $1.6 B acquisition by Google.
The continued presence of unauthorized material on YouTube after the Google acquisition led to a number of lawsuits that Google was able to bankroll, which brings up another point. If you’re operating in an environment of high regulatory uncertainty, you need to have the patience and the bankroll to sustain heightened legal and regulatory costs.
The lessons is that if your business is providing value and the legal environment was designed for an outdated technological era, there’s sometimes a path to building a meaningful business, and you shouldn’t be intimidated by regulatory uncertainty.
However, this varies on a case-by-case basis and it’s really a question of magnitude, and you should certainly be careful about overreaching or breaking any laws. It’s also important to be cognizant of societal impact. Ultimately, a lot of the decision around regulatory risk is around the downstream implications of pushing the envelope — a failed medical diagnosis or an erroneous self-driving car is a lot more damaging than disrupting legacy media platforms with online comedy videos.
Sources of Execution Risk
Execution risks are more in your direct control than market risks, so taking on execution risk is betting on your own ability to execute in 3 basic areas: recruiting a world-class team, having the technical capacity to build the product itself, and fundraising aptitude.
1. Team Risk — Can you recruit world-class talent?
As a Founder, you’re likely to have a lot of confidence in the quality and abilities of your own founding team, but early hires can be just as important for startups.
To assess team risk, take a look at your existing professional network and those of your co-Founders. Do you have access to networks in centers of excellence, like a top-performing company or university? Are you geographically located in an ecosystem with an abundance of available talent? As you scale, will you be able to attract top candidates for your VP of Sales or Finance?
One of the big reasons why second-time Founders choose to adopt execution risk is because they can limit that risk with well-developed professional networks which give them more confidence that they can recruit the top people to help them make their vision a reality in the face of technical or competitive obstacles.
Assess which professional network clusters you have access to for early hires before you start a startup, and, if necessary, do the work of developing ties with potential future sources of talent.
In building a strong team, it’s also important to realize that having just raw talent won’t be enough. Equally crucial is the need to have the right mix of complementary team DNA so that the team is able to work together in an ambiguous, pressure-filled startup environment and build a great culture and organization.
2. Product Execution Risk — Can you build it?
Can you actually build the product you want to build?
One of the reasons early-stage investors often look for technical co-Founders is to mitigate this risk.
The more control you as a Founder have over your ability to execute on the product, the less your execution risk. Relying on early hires to build out your concept carries costs with it, because no matter what, you will probably always be the most motivated person at the company to make the business work.
The more you or your co-Founder can guide and influence the execution of the product itself, the lower your product risk.
3. Fundraising Risk — Can you fundraise?
Fundraising is a completely different skillset from leading an organization, technical execution, and business strategy. But for a venture-backed startup, it is equally crucial in the success of your company.
While fundraising is something you can learn and develop (see our essays on 16 Non-Obvious Fundraising Lessons on Pitching, The Fundraising Checklist, and The Ladder of Proof), it’s often best if at least one Founder is comfortable with sales and pitching because it’s a core area of competency required for a Founder to succeed.
How Investors View Risk
In addition to being able to calculate and manage risk as a Founder, you should also understand how investors see risk so that you can be more successful in your fundraising process.
From an investor’s perspective, not all risks are created equal. Investors tend to be biased toward companies with high market risk, but low execution risk.
Why? Because the early-stage VC model is built on high variance investments. Most Funds are made by taking big risks for the chance of getting a huge outcome.
The math looks something like this: if I invest in a market risk company, it might have a 10% chance of having a huge $1B+ outcome, vs. investing in an execution risk company with a 30% chance of a 200M outcome.
Companies with massive defensibilities, i.e. network effects, have the most potential to become huge, iconic companies. But these companies usually have a lot of market risk and are doing something non-obvious that no one else is doing.
Most companies with low market risk are in industries that are very competitive. A lot of people go after it because it’s somewhat obvious. For that reason, it’s tougher to create breakthrough companies with large market share and high defensibility (and therefore high margins).
VCs, however, will sometimes invest in startups going into proven markets with lots of competition if the execution risk is relatively low — either if the startup has an exceptional team or product and strong Founder-Market Fit, or if there is an opportunity for meaningful technology-driven disruption in the market, e.g. a platform shift.
Another thing to be aware of is that investors are also less prone to taking team risk, but more prone to taking technical risk. If you have an amazing team but it’s unclear whether what you’re proposing can actually be done, investors might still back you, as we see with companies like Magic Leap.
This is because investors see team risk as binary — either it’s a high-quality team with the capacity to attract other top performers from centers of excellence or its not. Technical risk is not seen the same way, as in tech there’s a strong belief that given enough time and money you will always figure out a technical solution.
As a result, I encourage Founders to think big and take more technical risk. Investors tend to believe that everything is possible given enough time, money, and the right people. You should have the same outlook. Personally, as a VC, I would love to see more companies taking big, bold technical risks.
Living in the future
One method to come up with a big, bold, radical idea is to implant yourself in the future and think about how people’s lives and needs might be different. Anticipating the needs of tomorrow is one of the best ways to come up with startup ideas today.
One underrated way to do this is by turning to science fiction. Many of our iconic technologies today were predicted or portrayed by imaginative science fiction of previous generations. Think of the self-driving cars in Isaac Azimov’s “I, Robot”, or voice-activated computers depicted in Star Trek long before they had become a household commodity with Alexa.
Another way to do it is by extrapolating big trends in underlying economics (such as changes in costs of computation, storage, genomic sequencing, photovoltaic cells, etc.), penetration of enabling technologies (like increasing smartphone adoption, enterprise cloud computing), or cultural change to anticipate new sources of demand or new enabling technologies.
In addition, given that many of the most interesting trends are compounding or exponential in nature, you can see orders of magnitude difference in just a few years. We tend to think intuitively in a linear fashion, so superlinear trends can catch us by surprise and can rapidly create new market opportunities.
The Varian Rule can also be used to extrapolate future trends in consumer business. Named for Google’s chief economist Hal Varian, this rule holds that “a simple way to forecast the future is to look at what rich people have today; middle-income people will have something equivalent in 10 years, and poor people will have it in an additional decade”.
In other words, The luxury goods of today are often the necessities of tomorrow. Some examples of services which were, until recently, inaccessible to anyone except the very wealthy:
- Personal shopping (Instacart)
- Personal driver (Uber/Lyft)
- Personal stylist (StitchFix).
Whatever method you use to come up with your founding insight, creating an iconic company comes down to tackling a big, important problem with a radical idea. Understand and be strategic about the risks you take on, but don’t shy away from taking them. Risk is, at the end of the day, innate to being an entrepreneur and the lifeblood of the startup ecosystem. Founders, investors, and everyone else in the ecosystem should recognize this and embrace risk-taking as part of our identity.
Why Risk Is Critical
One of the things that drew me to Silicon Valley over fifteen years ago from the UK was the spirit of innovation and risk-taking. It’s that same spirit that continues to draw innovators and technical talent to the startup ecosystem from all over the globe.
The tech and startup ecosystem has long represented an oasis from the drudgery of traditional industry. With its culture of bucking the norms, trying the unproven, and pursuing innovation for its own sake, it was a magnet for people with radical ideas who were crazy enough to pursue them.
Today, the costs of starting a startup are lower than ever, which is an amazing thing. But a growing backdrop of fear and caution means the startup system is more filled with unambitious and unexciting ideas. While there has been a (healthy) education about the importance of taking calculated risks with business models, too often this has been accompanied by an unwillingness to think big enough and to tackle truly important problems.
I believe the startup ecosystem has the continued potential to deliver on our highest aspirations for the future. But we can’t lose our willingness to take big risks. Today I want to look at how risk can be strategically managed by avoiding the unnecessary and embracing necessary risk. Hopefully, this will empower Founders to take more of it.
Revealing the Unseen Forces That Guide Your Life
by James Currier (@JamesCurrier). James is a General Partner at NFX, a seed-stage venture firm headquartered in San Francisco.
What city you live in. Who you date or marry. Which job you choose. What clothes you wear.
We all think we make these choices ourselves. It certainly feels like we’re in full control. But it turns out that our choices — both in our startups and in our lives — are more constrained than we think.
The unseen hand in them all is the networks that surround us and the powerful math they exert on us.
Working with network effects in our 100+ companies makes it impossible not to notice how the same mechanisms and math that create near-destiny for companies also create near-destiny for us as individuals. It’s mind-blowing once you see it.
These constraints are highly determinative of how your life will turn out, guiding us inexorably down one path or another in ways that are both quite predictable. Yet these forces are typically unnoticed.
This article outlines how we see network effects impacting nearly every aspect of your life. With that lens, it lays out a perspective on how to make the 7 most important decisions of your life. It will hopefully help you make decisions that are more true to the kind of life you want to lead.
Network Force: The Unseen Hand
Adam Smith published The Wealth of Nations in 1776. In it, he envisioned markets with thousands of individuals pursuing their own independent self-interest as creating an “invisible hand” that unintentionally promoted the good of society. This “free-market model” allowed him to point out the math and mechanisms behind the emergence of large-scale social order.
Here we want to do the reverse — to use a “network model” to characterize the large scale human social orders and explain how they impact each of us with an often unseen hand.
In short, the networks of human connections in your life create a force that guides you down a path not always fully of your intention, through the mechanism of 100s of small interactions.
Further, this “network force” compounds over time. The longer your relationships, cliques, and communities persist, the more they shape your destiny.
Sociologists regard the evolution of our lives as resulting from a combination of our own choices and preference and the force of our surrounding social network structure.
Observing our own lives, and watching as 100s of founders move through their own journeys, we would go even further in the belief that it’s network forces that influence the majority of how our lives turn out. And 90% of those network forces are established in just 7 crossroads or pivotal life events.
Given the power of network forces on your life, they should be the primary consideration when making decisions at these crossroads. Although it may feel like a complex decision in the moment, they become simplified when seen primarily through the lens of joining and forming new networks and changing the network topology of your life.
The world seems chaotic. But it’s not. Underlying all this apparent complexity is some wonderfully simple math. Follow the math to your destination.
Understanding the primacy of networks will give you a superpower to see what others do not and navigate life’s big decisions more effectively.
Seeing the Math at Work in Your Life
Math underlies elements of the social sphere in ways we don’t always see. In spooky ways.
Here are a few examples of how math drives the large and small scale social orders we experience every day. After that, we’ll get to how the network force should guide your decision making in the 7 crossroads of your life.
Zipf’s Law and You
Did you know the frequency of the words you use are determined by an underlying mathematical pattern?
What’s stranger is that same mathematical pattern seems to determine the sizes of cities within a country, income distributions of people within an economy, income distribution among companies, how much traffic goes to different websites on the Internet, how often last names are used in a society, the number of phone calls people receive, the number of people who die in wars.
This mathematical pattern is a power law known as Zipf’s Law. It was first noticed as a principle of language. About 100 years ago, physicists and linguists discovered that the second most commonly used word in English is used one half as much as the most used word. The third most used word is used one third as much as the most used word, so forth down through all the words in a given language.
This law turns out to hold not just in languages, but in many other cases. The world looks complex or chaotic on the surface, particularly in social matters and perhaps your own life, but underlying what we see are simple rules of math.
The underlying mechanism for Zipf’s law is not yet agreed on but the main hypothesis is that it’s an outgrowth of the Principle of Least Effort. In short, systems that survive and operate at steady state optimize for efficiency. When they do, things tend to look like Zipf distributions.
Related to your life, an even stranger implication of Zipf’s Law is that unconscious network forces will act on anyone or any company that gets to be an outlier in one or more of these distributions. Bringing you back in line — or bringing another person or company back in line to make room for your new numbers — will happen without any conscious or intentional force at play.
This is a bit spooky. It means that the number of inhabitants of NYC constrains and influences the number of inhabitants of LA, Seattle, Chatanooga and all American cities in some unseen way because they are all part of the network of US cities. Even though we are each making what feel like independent decisions about where to live, it seems that we are part of this network unconsciously influencing people to keep American cities on the Zipf distribution line. I am one of those people being pushed around. And so are you.
That also implies that my income is somehow influenced by other incomes that surround me as my income fits into the Zipf Law curve. And my country’s GDP is influenced by other countries’ GDPs.
If math is underlying all this, what else in my life is being affected by the larger social order?
Your Body and Cities Have Predictable Mathematical Patterns
Systemic efficiency also drives other mathematical laws that govern how our lives look. Another example is the ¾ scaling law that shows up everywhere in the world as pointed out by Geoffrey West in his 2017 book Scale. The cells and energy systems of living things scale up in predictable patterns. A mammal that is 200% the size of another will only consume 150% of the energy. That’s because our cells and capillaries have evolved to be the most efficient fractal network transport system for conveying energy and nutrients to a 3D body. Those same underlying mechanisms drive the math of when you’ll die and why you stop growing taller.
This biological fractal network is very similar to the fractal network of a city that has evolved to provide energy and transportation to keep the city alive. The empirically measured numbers for cities are 17/20 scaling, still pretty remarkable energy gains for the city based on its network effect, and still consistent across nearly all cities.
It’s remarkable to think that city planners could actively try to violate the 17/20 scaling rule for cities, and the network would actively work against them in unseen ways to pull the city back to 17/20.
How do nodes on a human network work?
Nodes, which in this case are people, exchange a host of things. Sometimes consciously if I pay you from my bank account, sometimes unconsciously like when you overhear me at dinner telling someone about how I coach founders during walks and you decide to try it with your employees.
The things they exchange are… well… nearly everything. The most important ones for our discussions here are ideas, capital, connections, jobs, status, aspirations, language, requests, standards, expectations, affirmation, criticism, belonging, and physical space.
The nodes exchange more of these things when the friction is low due to physical proximity, interaction frequency, tribal trust, similarity, etc. The nodes also exchange more when the benefit is high due to resources gain, status gain, tribal trust gain, etc.
In Networks, The Rich Nodes Get Richer
Most things that happen in society are multi-turn and repetitive. These are called preferential attachment processes which happen when something (such as money, status, fame, punishment) is distributed based on how much is already possessed. Most social processes are preferential attachment. For example, if two Founders each tweet out the same great idea at the same time, the one with more status will be given credit for the idea.
What’s fascinating is that this is because of math. Nodes that are “ahead” get picked more often by the other nodes because they are ahead and thus offer the nodes choosing them less friction and more benefit. When this gets repeated many times, it systematically directs more resources to the nodes that already have relatively more.
This pattern has been so prevalent for so long, and has been so annoying to the majority of people, who, by definition are not in the lead, that it’s mentioned in one form or another at least five times in the Bible, most famously in Matthew: “For to everyone who has will more be given…” Now called Matthew Effect.
The math behind why dinner parties behave the way they do
If you want to have one conversation at a dinner table, 6 people is about the right number. Maybe 8, max. While that seems like a social decision you made yourself, the reasons behind it are mathematical. That number is similar for all of us because it’s based on how many possible two-way conversations (links) can exist between people (nodes) in a group. The formula (derived from Scale, pg. 317), it turns out, is:
N * (N-1) / 2
Where N is the number of people. If you have a group of six people, that’s 6 * 5 / 2 = 15 potential two-way conversations, which means that to focus on one conversation, you have to suppress 14 others. That’s possible without being too rude, but if you add just one more person to the group, the formula becomes 7 * 6 / 2 = 21. That’s an additional 6 conversations to suppress. That stretches our social skills to control.
The larger point here is that when groups get larger, it’s an exponential change, not a linear one, and that affects social experience you have, how you interact, and ultimately how you feel. Whether it’s a dinner party, the size of your extended family, school, college, workplace, or a city, with networks, the math behind them puts impactful forces on how we all behave.
How Networks Form
In theory, the people who inhabit each “layer” of your life’s network map could be anyone. All humanity is, after all, connected. As Stanley Milgram famously showed as far back as 1967, there are a maximum of 6 degrees of separation between you and any other person in the US. With the advent of the internet and global social networks like Facebook, that number may be even lower — as low as three and a half degrees according to a study conducted by Facebook in 2016.
But in practice, relationships don’t form at random. 5 conditions contribute to the depth and speed at which they form:
- A context for frequent, repeated interaction with a new group of people (e.g. a new school, job, church, club, dorm, living situation, etc.).
- A high degree of overlap between relationships in the new group.
- A transition period where people are open to changing or evolving their identity.
- A high density of people in geographic and network proximity.
- Go through something hard and perhaps fear-inducing together.
So you can see why high school, college and your first job are such important life stages. All 5 of these conditions are present.
What Does Your Network Want from You?
You are not just the recipient of value from your network. The people and nodes in your network want and expect an exchange from you, too. They want you to validate them and support them. You are in a dialogue with the network force. As Obi-Wan says about The Force in the original Star Wars movie:
Kenobi: A Jedi can feel the Force flowing through him.
Luke Skywalker: You mean it controls your actions?
Kenobi: Partially, but it also obeys your commands.
The network force is similar. You don’t always see it, but it is exerting itself on you.
It wants something from you. Your network force proactively guides you down a path. So be careful which sub-networks and people you add into your network.
When you start to see that dialogue between you and your network, the push-pull, you see it everywhere. The chaos of the world diminishes a bit and becomes more understandable and predictable. And you understand more why things are the way they are and why they stay that way. Hopefully, it will also give you insights as to where you can push to change things that should be changed, not just about you, but about your company, your city, and your world.
Your Life’s Crossroads
Let’s look with new “network force” eyes at the crossroads each of us face. This list of crossroads is intuitive, but few of us explicitly understand the math that guides our choices and the gravitational force our networks exert on our lives.
And further, like asteroids colliding in space to form larger asteroids, at each crossroads we pick up greater “network mass”, increasing our network gravity and exponentially heightening the energy costs of changing course.
The conclusion is that the compounding, nonlinear math of networks means that they should be the primary consideration in our big life decisions.
The Network Topology of Your Life
There are three levels of networks you’re a part of.
Within the “People Network”, you are a member of many networks. Your family, your high school classmates, college alumni, company alumni, the people from an activity you do like a soccer team or volunteering, the people who work in your building, the people who live on your street, the people at the gym you go to.
The intensity of each of the links between you and the other nodes in your networks, it turns out, will follow Dunbar’s law, which appears to be based on the fundamental structure of your brain. We each tend to have 5 people who are like family, 15 intimates, 50 acquaintances, and 150 total familiars that we can interact with on a regular basis. Beyond these approximate limits, humans don’t do so well.
You are a node in each of the networks to which you belong. The other nodes – people – give you your ideas, your words and phrases, your assumptions, your desires, your fears and your beliefs. They give you your belonging, your affection, your shame, your fear, and your hopes.
To make an analogy, imagine that the things that these nodes all give you show up on your life dashboard as you navigate life. They appear with a lot of numbers. Probabilities, rewards, costs, frictions. You make your decisions reading this dashboard and what the network presents to you there. You have agency and free will in making your decisions. You look at the math of each decision and make the best decision you can at every point.
The mathematically obvious path will feel like “the right decision.” But note that what even shows up on your life dashboard is put there by your network. And the math associated with each option — the rewards and frictions and probabilities — are determined by your unique network. And your network is the result of the network decisions you made during the few crossroads moments in your life.
What that means is that the little decisions you make daily, the ones you fret over, are orders of magnitude less important than the crossroads decisions you make. This is true because those decisions have been placed in front of you by your network and are mostly a function of your network, and they don’t typically bridge you into whole new networks and new ideas and options.
Crossroad #1 – What Family You’re Born Into
You don’t get to choose this one. For better or worse, your family is the fundamental layer of your network topology. Seeing your family through the lens of the network forces model can reveal the hidden depth of that influence.
Network clusters influence us in proportion to how frequently we interact with them, how early we adopt them, how strong and reciprocal our ties are with the other members, how much they are reinforced by overlapping shared connections, and how long we expect them to last.
In all of these measures, few of our other networks in life can rival family:
- Since you usually live in the same house with your family for a large part of your life, geographical proximity makes frequency of interaction extremely high and friction to interact low.
- Your individual relationship with one family member — usually a strong tie — is reinforced by all the other family members you share in common.
- We expect family relationships to persist throughout our entire lives, an expectation formalized in most human cultures as a deeply-embedded social norm. There’s a long “shadow of the future” with our family members. We know they’ll always be there, so we’re willing to invest and sacrifice for our family relationships more than for non-family.
- Family ties have higher bandwidth than others because we see labels like “mother” or “son” as identity-defining. Family relationships straddle the line between who you know and who you are.
- Future relationships outside the family network, e.g. friends, dates, etc., will be impacted and reinforced by your family. The closer you get to someone, the more they interact with your family, and the more likely it becomes that they develop their own ties with your family members.
- All of the powerful factors above are superimposed by, and reinforced with, our biological drive to connect with others who share our genes.
Now that we can see how families are uniquely influential relative to other networks, it’s clearer why we so often adopt our cosmological, religious views, linguistic dialect, political leanings, dietary preferences, and worldviews from them — despite such things not being genetically heritable.
You go through life thinking such things are innately “you”. But you didn’t adopt your identity in a vacuum. Had you been raised by a different family, you would likely be a very different “you” — Your religion, linguistics, political orientation, favorite foods, worldview would probably be very different despite such things not being genetically heritable.
Our family network impacts what networks we are exposed to and which ones we are constrained from. Family nodes have preferences, and push links to other networks on us in the form of introductions to schools, places to live, jobs, and spouses. There are also prohibitions on fraternizing with the “wrong” nodes in certain networks.
Your family is a low-friction, high-impact network. Because of that underlying math, when making life decisions most people will choose the options that most align with their core family network. Be aware of this if you want to be more conscious in directing where your life path will lead.
Your family network is the one you don’t get to choose, and in that sense, it’s not fair. But it’s not destiny. Think of it as another network force — albeit a very powerful one — that puts data on your dashboard.
Crossroad #2 – High School Network
High school networks are especially important because they are influential when we are forming our identities and worldviews as young adults. High school networks are also correlated with academic achievement, work habits, and even college admission — defining access to future networks and building a vibrant life of your choosing.
Like family, where you go to high school isn’t usually a choice. But if you do have this option still ahead of you, or if you have children and can choose for them, don’t underestimate its importance.
High schools are typically the first peer networks we join that are large enough to have a diverse array of subgroups — better known as high school cliques. As such, they present us with our first significant network-based decision: who to associate with in high school.
The importance high-schoolers place on “popularity” — their status in the social hierarchy of their peers — shows that we intuitively understand the importance of networks even at an early age. In seeking status or popularity, we are, in part, looking to maximize our options in terms of which cliques we can elect to join or form. For most teenagers, that optionality matters deeply.
How does status work? Why does status give you options? Because status lights up the network. It’s a pure shot of preferential attachment we mentioned earlier. Sure, nodes on the network with money attract more money. Nodes with more access attract more access. Nodes with more attention attract more attention. But nodes with status attract all of the above. Nodes of all types want to associate with high-status nodes because it will improve their own status.
Winning status becomes the singular focus of life for many teens, and not a few adults persist in that goal. Adult parents of a high school teen may see it as melodramatic or irrational how much their kids care about their status, reputation, and friends at that stage in life — especially compared with more “important” things like academic accomplishment.
But from the vantage point of a teenager, social obsession is quite rational. Teens intuitively understand that their high school destiny depends on their network of friends. And though it’s easy to dismiss teenage behavior as irrational and hormonally driven, there are serious consequences to the networks we join early in life.
For example, academic achievement in high school has been shown to be directly influenced by friends. “High-achieving students strive for high-achieving friends, low-achievers strive for low-achieving friends … [and] the differences in achievement between the high and low achievers will be exacerbated by the friends they make.
According to one 2011 Harvard study, all kinds of traits, from body weight to happiness, are heavily influenced by network clusters. Throughout your life, your “clique” helps define you. The same study also found that the presence of friends in class has a positive and significant effect on test scores.
Moreover, as your first peer-based network you form after you’ve come of age, your high school friends have a particular influence on your lifelong identity — from your tastes in music, to your work ethic, your fashion sense, and your life aspirations — which is only rivaled by family, and in some cases even surpasses it.
It’s not just during high school that high school networks matter. Those who go to college and build a career in the same cosmopolitan area as their high school are likely to retain some parts of their teenage cliques throughout their lifetime, usually forming a core part of their network.
All this network force taken into account, which high school you go to matters a lot. Imagine the impact of moving a kid from, for instance, Taiwan or Spain to the US, or vice versa, for high school. How much of a difference would that make to the trajectory of a person? The networks presented to them? The ideas, the sports, the foods, the language, the friends, etc. Imagine moving from Arkansas to, for instance, Phillips Exeter Academy in New Hampshire for high school. Intuitively, we know this will make a difference. But we see the mechanics of that difference more clearly when we see it through the lens of network forces.
When navigating the question of which high school to attend or — if you don’t have a choice — who to make friends with as a high school student (or which kinds of people to encourage your kids to befriend if you’re a parent, although good luck with getting them to listen), ask yourself the following questions:
- How big is the high school? The bigger the high school, the bigger the alumni network, which may influence your ability to choose future networks like college, spouse, and jobs.
- How diverse is the school so you can find nodes and sub-networks that fit you best? With more options, there is a higher probability you can find a high achieving sub-network in an area you can be ambitious and high achieving.
- How strong is the affinity of school graduates? Higher affinity indicates stronger network links between nodes in the network, that the network is more valuable to the graduates. How much do they brag that they went to that high school? How often do they come back for reunions? How passionate are they about the brand of the school? Do they use it as a strong identity peg or are they indifferent? Those would indicate stronger network links between nodes in the network.
- How important is academic success to high-status students in this high school? The more that popularity / status positively correlates with academic success, the more that short-term social incentives will be aligned with achievements that will serve you or your kids in the long term.
Parents and ambitious teens often mistake high school for a competition to get into a good college, either through academic achievement or sports. By focusing on the sound and fury of competing for grades and spots on the varsity team, they miss the higher importance of the network dynamics at stake. In high school, putting yourself in a position to form a large number of strong relationships with the right network nodes can make all the difference, not to “get ahead” but to create a vibrant, amazing life of your choosing.
Crossroad #3 – College Network
You should choose your college based on its network of students and the geographic network they inhabit more than course of study or sports teams. If you choose the right people to be around in college, they will open up ideas, relationships, jobs, aspirations, attitudes and resources that fit with you and a virtuous cycle will be set in motion. Your network will ask you to be your best self and live your best life, like a trainer at the gym. In this way, your college network will have an exponential impact on your life.
College networks have many characteristics that make them powerful
- Geographic density creates frequent interactions between the nodes, giving network bonds a chance to form and strengthen.
- There’s a long duration of network formation. 4 years is a long time. A lot happens in 4 years.
- A closed, selective network. This is powerful for three reasons. A) Your reputation matters. People are more likely to have heard about you via a third party, and treat you differently according to your reputation. B) If you meet another student, the chances of them knowing someone you know is much higher than someone you meet outside of the closed network. There is a high degree of network overlap between you and other students, and as network theory predicts, shared connections between two people vastly heighten the chances of them forming a strong bond. C) The likelihood of repeat interaction between students is very high.
- Like with family, these networks cross from who you know to who you are. Identity formation takes place at this age and are thus likely to last longer.
- When you choose a college, you are also choosing a geography. People tend to end up working and living in the same geographical proximity as their college, keeping them close to their college friends.
- People tend to end up working in the same industries as the people in their college network.
- It’s considered a social norm that you should build and value your network in college, so others are more receptive to building new and strong bonds.
- Given your biological age, it’s a good time to look for a partner. The network upshot of this is that many people will find their spouse at college, or at least find someone who they think likely to be their spouse in the future, which impacts big life decisions such as where to live after college. As we’ll see, this is actually a huge decision — and letting your dating life dictate where you live isn’t usually a wise choice.
- College teaches you the idea that you will know these people the rest of your life, so like family, there is a powerful shadow of the future that makes the bonds stronger and more numerous.
- All of the above elements reinforce each other.
To see what this means in practice, consider the following scenario:
As a freshman, you meet someone in class. Let’s call that person Sally. You and Sally have some things in common, and you get along fine. If you were asked to rate your affinity for Sally, it would be a 6 out of 10. Since you share a class together, you’ll see each other maybe twice a week for at least six months.
You’ll interact regularly and frequently — and even after this semester, there’s a high likelihood that you’ll see Sally around campus, share friends with her who might invite you both to the same parties or get-togethers, or participate in the same extracurricular activities. All of this is the result of you being members of the same closed network and sharing the same geographical and institutional circumstances.
Now suppose that, the same day when you first meet Sally, after class you go to a party off campus where you meet Bob. Bob doesn’t go to your school, doesn’t have any shared connections with you, and doesn’t live near you. But he does have a lot in common with you, and you spend all night at the party hanging out because you share so many interests and have so much chemistry. If you were asked to rate your affinity with Bob, it would be a 10 out of 10.
4 years later when you graduate, which friendship is most likely to have survived? How much does the math of network formation matter compared to your own preferences and agency?
Mutual affinity isn’t the only thing that matters in choosing friends. It’s not even the biggest factor. Network force swamps other factors. Taking it into account, the model for relationship development doesn’t just include mutual affinity. Instead, it looks more like this:
Likelihood of forming a relationship = Mutual affinity * frequency of interaction * duration of interaction * geographical proximity * network proximity * number of shared connections * etc…
Bob might be a 10 in that first factor of mutual affinity, but in all the others he’s a 1.
Sally, on the other hand, may be a 6/10 in terms of personal affinity, but she’s a 10/10 in all the other ways, each of which serves as a multiplier on the likelihood of you interacting and developing a lasting relationship with her.
Another way of looking at it is that the friction of hanging out with Sally is much lower than hanging out with Bob — it takes 10X less effort to hang out with Sally. So over time, the math of inhabiting a shared network — the network gravity — makes it hundreds of times more likely to become lasting friends with her than with Bob.
This is a rough illustration of the mathematical power of networks in shaping behavior. As we see, networks impose real constraints on how you make decisions, not only in who you are likely to end up befriending, but the career opportunities, dating choices, beliefs, and information that you’ll end up sticking with.
Network proximity makes some options more appealing than they would be in a vacuum, while network distance can impose a high friction on other options — like being friends with Bob, or choosing to adopt a belief system, a fashion sense, or industry job too different from those of the other people in your proximal network.
So if you are choosing between colleges, or know someone who is, consider the following questions:
- Where do most of the alumni of this college end up living? When you choose a college you are also choosing a regional network. If you go to school in California, for example, your friends and job offers will end up being mostly in that region. I don’t recruit at my alma mater Princeton anymore because it’s so low probability to pull a Princeton grad out of the NYC-DC-Boston orbit. I tried for four years, and each of the people I was recruiting did the math on their own life dashboards, saw the numbers put there by their networks, felt the network gravity, and each made the rational decision to stay on the East Coast. One candidate stayed in NYC to move into an apartment with their college friends and work at Goldman Sachs who recruited heavily on campus, one hour from their office in Manhattan (low friction due to geographic network). Another moved back to Boston to be near to their girlfriend who was finishing up at Brown, and their parents in the suburbs. They each “really wanted” to join a startup, but network gravity and network math were too much.
- Now think about how the math continues to cascade through the network. Princeton hopes that I continue to be an active recruiting node on the network, providing the students with great employment options. But my cost/reward math doesn’t work. The denominator is zero. So Princeton lost a recruiter node in their network for now. Further, now those student nodes back on campus don’t hear from me. I and people like me don’t add our numbers to their life dashboards saying “work for a startup in SF.” So the math for other ideas like Goldman Sachs and McKinsey gets stronger over the years. The strong get stronger. Again, preferential attachment in the network. Students look at the network math on their life dashboards and they choose the mathematically correct choice.
- What kind of career or industry do alumni of this college typically work in? Here’s an example of how this works. My 23-year-old nephew went to Trinity College in Connecticut. Most of the students from that college end up working in finance in NYC or Boston. Guess what my nephew now does? He works in finance in Boston. He followed the least resistance path, leading him to the highest paying, highest status outcome similar to his network. Is his choice of job about his own unique abilities and interests? No. It’s the math of the networks. He made the correct choice based on the options presented on his life dashboard by his networks.
- Do you relate to the other students naturally? Will they relate to you? Do the students represent the type of aspirations, lifestyle, and interests you want for yourself? There’s no point in joining a network where you won’t actually bond with the other nodes, no matter how prestigious that network is.
- How big is the college? The bigger the college, the bigger the alumni network. The bigger the alumni network, the more weak ties you have, which are great for career, marriage, and a host of other life attributes. Harvard Business School has figured this out and has classes of 900 compared to Stanford and MIT Sloan of 400.
- How strong is the affinity between graduates? Like with high school, how much do alumni brag they went to that college? How much do they come back for reunions? How passionate are they about the brand of the school? Do they use it as a strong identity marker or are they indifferent?
- Is it clear what it says about the graduates that they went to that college? A clear, strong brand lights up other networks because external nodes know what to expect from you if you’re a member.
In addition to that, and I suspect this will be controversial, you should probably de-emphasize questions like:
- Where does the college rank in US News & World Report college prestige list that dates back to 1981
- Are the classes amazing?
- Is there a sports team I’m keen to play on?
- Is there a particular professor I want to work with or a particular major I want to pursue? Only 27% of college grads end up with a job closely related to their major.
College is possibly best seen as a place for network formation, and creating the network topology you want. The network you join will lead you to a geography, a type of work, certain ideas about life, and a group of dating/marriage options that will all have a big influence on your life. All that network force will be pushing on you to then take the mathematically obvious path from there, one which will feel like the “right decision”.
Crossroad #4 – First Job
The professional relationships you form during your first job are the seed of your professional network which influences the arc of your career — from how you think about work, to how you’re known, to the geography where you have advantaged job access for a long time.
In working life, you see your coworkers every day of the week for 8 or more hours per day. The frequency of interaction with coworkers, at this stage in life, may be even higher than what you have with your family.
Prevailing wisdom says you should pick your first job based on the highest income, or the one that you’re most passionate about, or the skills you’ll learn, or where the day to day will be the most energizing for you.
All of this is flat wrong. In your first job, go work with people whose career path you want to emulate. Optimize for network.
The early professional relationships you form will have a bigger influence on your skillset, your lifetime earning potential, and the mastery of your craft than the particulars of your job description, the income, the company perks, or the brand name on your resume.
In almost every field — from theoretical physics to growth marketing — top performers were mentored, influenced by, or otherwise connected to other top performers.
There are a couple of reasons for this. First, as we saw in the high school section, high achievement is communicable. Surround yourselves with high achievers, and probability is on your side, you will become like them.
Second, innovation is contagious. If your first job is at a place that’s a breeding ground of innovation, the chances are a lot higher that you’ll come across some really good ideas — especially if you want to start a company one day.
The PayPal Mafia was no coincidence. Network clusters are capable of producing multiple future billionaires. There is no upper price, in terms of effort, difference in income, or even cost of living, that can even close to compare to the upside of being part of a network of high achievers in your first or second or third job.
So, when making a decision about where you want to work, instead of asking:
- Will this give me the work I want to do daily?
- Is this the best offer I got in terms of income?
- Does this company look good on my resume?
- Does this company let me take as much vacation as I want, have free catered lunches, and a fancy office?
Do yourself a favor and ignore all of it. Focus on these questions instead:
- Is this job in the right city? The city I want to live in long term?
- Will I like and respect my co-workers? Will they like and respect me?
- Do I want to be like my bosses someday?
- Do my co-workers career aspirations match mine?
- Am I going to be working with the best?
- Is there a strong culture and camaraderie?
- Will I have opportunities to prove myself to others at my company to build my network bonds?
- Are employees proud of their company and their brand? Do they enthusiastically recruit? Do they seek each other out when outside of work? This indicates strong network bonds are forming.
- Are there politics in the office that could threaten the building of strong network bonds?
- Lastly, because top performers tend to congregate in rising companies, if it’s a startup, ask if it has strong potential defensibility against competitors, especially network effects, and whether it has the 9 habits of world-class startups.
Crossroad #5 – Marriage/Choosing a Life Partner
Marriage, or choosing a life partner, is one of the most important decisions you make in life. It could be the source of your greatest joy and/or your greatest suffering at a very personal level. In terms of the network model, it’s powerful because you are choosing someone else’s full network to add to yours. This person will also share the very center of your network hierarchy with you.
In many cases, this person will produce your children with you. Not only will parenthood be a focus of a lot of your life’s energies, but in addition, your children’s full networks will be added to yours for the rest of your life.
Children are shaped by how you nurture them as parents, and as we’ve seen earlier in the discussion of family, they are shaped by the networks brought to them by their parents. Your children are brought into, and partially inherit, the networks of both parents.
For 60% of people, how you meet their significant other is determined mostly by who you know and who you get introduced to, although that’s changing with the “digital people network” layer beginning to break down geographic networks and other closed networks. In 2017, 39% of all US marriages originated by meeting online.
“It is one of the most profound changes in life in the US” and the best example of what we’ve been hoping the Internet might do for a long time — moving from unchosen network forces constraining options to a global, digital network empowering your own preferences and agency.
I ran the largest self-assessment testing and matchmaking company in the world. We had 150M users and 10s of personality tests written by my staff of 5 PhDs to help people connect better. We also ran a matchmaking site with 30 million users that took advantage of those tests to match people. What my team told me at the time was that the most successful marriages were ones where 1) the two people were the most similar, and 2) they had shared network connections.
What this means is that when you’re dating someone, you’re not just dating them. You’re dating their networks — their friends, family, and colleagues. And vice versa.
Compatibility between two people in terms of their individual characteristics is sometimes much less important than the compatibility between their networks. This is one possible reason why there is a surprisingly low divorce rate amongst arranged matches made solely on the basis of compatibility between kin networks.
Although online dating is gaining ground, meeting through friends is still the most common way to meet someone. Further, what the statistics don’t yet show is how many of the 39% who met online had strong affinity networks already in place before meeting online, but just needed to shortcut the longer, in person, process with the tech layer to find each other.
So how do you find a spouse?
This is where Mark Granovetter’s famous work on The Strength of Weak Ties becomes relevant:
“The stronger the tie between [two individuals], the larger the proportion of individuals to whom they will both be tied.” – Mark Granovetter
Given this, everyone in your “inner circle” probably already knows each other. The closest friendships you have, because of the structure of social network clusters, will have close to a 100% degree of network overlap with you.
So what this means is that your closest friends are usually poor nodes in your network to pursue romantic interests. There are two possibilities if you go this route:
- (More likely) Your closest friends won’t be able to introduce you to anyone new.
- (More unlikely) Your close friends introduce you to a close friend of theirs that you didn’t previously know. You end up dating, and in the high percentage of cases where things don’t work out, the blowback from the ruined relationship wreaks havoc in your network cluster, forcing your friends to choose.
That’s not to say that it’s impossible for people to become friends and then later become romantically involved. But for the purposes of meeting someone new, friends of the inner circle of your network map are not the place to start.
This is where your acquaintances — the weak ties at the outer layer of your network map — become vital. As we know from the work of Duncan Watts and Steven Strogatz, acquaintances serve as vital “bridges” between tightly knit network clusters. For people looking to be exposed to new dating prospects, job leads, ideas, beliefs, or lifestyles that differ from what they’re used to, there’s no better way to do it than through an acquaintance.
Smart questions to ask yourself when you’re single and looking to meet someone:
- Which acquaintance is most likely to know a lot of people that you’re compatible with? Not all people have equally large networks, and some people you know may be “hubs” that have a large number of connections. If you can find someone like this, they are usually quite helpful in meeting new people. “Hubs” frequently have weak ties to a lot of different cliques, groups, and sub-networks. They’re usually happy to make introductions.
- Do you get along with their friends? Do your friends get along with them? If you’re serious about the relationship, consider whether you’d be willing to bring those people into your life. If so, it’s a lot more likely that your relationship will last in the long haul.
- Do you get along with their family? The importance of in-laws isn’t to be underestimated. It’s easy to dismiss this in a culture that preaches that true love is all you need, but network theory tells us differently. Your in-laws are the core network of the person you’ll be closest with in life. What may seem like minor issues at first can grow into powerful problems over the long course of a lifetime.
- Are you in the same geographic network? When a couple is geographically challenged, it puts a real strain on their relationship.
- Could there be blowback if it doesn’t work out? Everyone knows why it’s a bad idea to date a coworker or someone else who you might see on a regular basis if you break up. Network forces are why. The same applies if you share a lot of mutual friends — especially if you ever get divorced. You put your friends in a position where they have to choose, and you risk losing some of the relationships you’ve built up over a lifetime. Don’t underestimate this risk.
Crossroad #6 – Where You Live
Where to live powerfully impacts the relationships and direction of your life, in ways you may not even realize. When coming out of college, this is even more important to your life than your choice of job.
As mentioned previously, physical proximity is predictive of network formation. Cities, from a network perspective, are like scaled-up colleges. Network density, frequency, similarity, and status accumulation all drive urban network formation. Cities do a great job of helping us form our networks because they are networks themselves, both physical and social.
Where you live largely determines who you know. Who you know largely determines the richness of your life and your access to wealth and information. Your network is a form of wealth. It brings you friends, career opportunities, or a spouse.
Committing to a geography and developing a network increases your access to all the experiences and resources you might want.
As the great Saar Gur — Partner at CRV and investor in Doordash, Classpass, Patreon, Bird and many other well-known companies — said to me recently, “Staying in the SF Bay Area after business school was the most impactful decision I’ve ever made. Everything else was noise.”
It’s certainly the most common life advice I give to people. Pick your city first. Everything flows from that. Your job, spouse, friends, income, and other opportunities flow from that core choice. The reason is network forces.
It’s important to note that your “choice” of city may be greatly influenced by the network force from the earlier networks you’ve accumulated. Take note of that and steel yourself to have the courage to make what sociologists call a “major move” if you decide that move makes sense. (Hint: it most likely does).
Making a clean break to move to the place that would facilitate your best life is hard. Network forces keep you on your path. The network wants something from you. Your boyfriend, a parent, high school friends, college friends, your weekend sports team, your roommate, your comfortable job.
This is true for those of us lucky enough to have a lot of resources and equally true for those with far fewer resources. In this article in the New Yorker, Malcolm Gladwell reported on research done by sociologist Corina Graif on people at the lower end of the socioeconomic spectrum who were forced to undertake a “major move” out of New Orleans by hurricane Katrina to growing cities like Houston.
Interestingly, their standard of living ended up rising significantly just as a consequence of the move — even though they were forced to do it by disastrous circumstances. It turned out to be a positive move, but they would never have undertaken it if they hadn’t been forced to by a natural disaster. As Gladwell points out, it gave “them a chance to rethink what they do.” But more importantly, it gave them a new network-geographic context. New network forces. New resources, ideas, jobs, and commonly accepted standards.
It could be that this dependence on location-based networks is changing thanks to the internet and telecommunications in general, since it’s now easier to maintain and form networks in spite of geographical distance. But we’re just 25 years into the digital world, and that process will take 50-75 more years to play out.
Some people are able to use the internet to find, build, and maintain human networks — usually around a niche or interest like gaming, cars, or fashion. For most, the Internet simply reinforces or super-imposes upon the networks they build in real life. For everyone who doesn’t do most of their networking online, physical location matters.
The network math of cities underlies their attractiveness, and helps explain why the planet is rapidly urbanizing. In short, because of a city’s network properties, as it gets bigger, it gives its citizens 15% more of what they want in terms of income, ideas, speed, and stimulation, and it costs 15% less to give it to them in the form of roads, electricity, water, gas lines, gas stations and safety services. That 30% gap is significant and is driven by a city’s network effects.
The higher rate of social interactions in a city has important consequences for your ongoing network topology. Larger cities mean more access to network clusters, leading to a greater diversity of talent, ideas, and backgrounds versus smaller cities. It also means meeting new people will be easier, but forging strong bonds could possibly be harder.
With all this in mind, when deciding where to live, here are some questions to ask yourself:
- Are the people in this city like me? Each city has a vibe that may or may not fit with you. Each city calls ambitious people to improve in some area. NYC calls you to earn more money. Seattle and Portland call you to recreate more. DC calls you to be more connected. SF calls you to create more, invent more. It’s the garage where the crazy uncle is inventing crazy inventions. If you can find a city that drives you in the way you want to be driven, then you’re in luck and you should settle down and build your network and your life with your people. If one city doesn’t call to you, find a sub-network of people that call to you in a city you don’t mind.
- How long can you see yourself staying there? The networks you build when living somewhere atrophy when you move somewhere else. Your networks are a form of wealth, and every time you move, you’re resetting your bank account.
- How important is your career to you? Because GDP scales nonlinearly with population size in cities, your career earnings will grow faster in a city than elsewhere. More importantly, the opportunity to build out your professional network and meet top talent in your industry will be higher in bigger cities.
- How much do you enjoy a fast pace of life? In a big city, everything moves faster. People walk faster, opportunities arise more frequently, you meet new people and encounter new ideas more often. It’s all an inevitable consequence of greater network size and density.
- How much do you enjoy or value meeting new people? If you are looking to build out the middle and outer layers of your network hierarchy, cities are a great place to do it.
- Are the core parts of your network topology filled in? Do you have close relationships that you’re happy with and can rely on? If not, a smaller city may be a better place for you than a big one.
Crossroad #7 – Reassessments
At any point, you can choose to reassess the course you’re on.
The network gravity has been building up since your birth and gets stronger over time. Each network adding and integrating with the others, changing the math on your dashboard until it’s near destiny. But you can decide to ignore that network math and forcibly make a change. This actually gets easier for older people who are done with their “shoulds.” When they’ve raised their kids, built their careers, earned some money. That’s why you see mid-life crises. The network force has been guiding someone for their whole lives, and then it stops exerting so much pressure and the person can consider their own innate interests and agency.
The most lasting and effective way to change your life is to change who you’re surrounded by. Since networks so powerfully shape who we are and what we do, the best way to change ourselves is to change our networks.
This is a big limitation at the way we look at self-development and self-transformation. We think we can just roll out of bed one day, make a few new year’s resolutions, and become a new person. But this approach ignores the biggest part in the equation of who you are and what defines your life — the network force.
This isn’t to absolve us of responsibility for our actions and to shift the blame to others. Rather, it’s to underline the fact that we are powerfully constrained by our network contexts. So the smartest use of energy for those of us looking to make a change can often be to carefully reassess the networks we’re a part of, and find ways to join new ones that are better suited to the life path we want to be on.
On the flip side, if life is going well and you’re happy, understand how important networks are. Double down on your relationships. Cherish the people in your life and be aware of the value of their relationships and the networks you’re a part of.
Our networks are our most valuable resource. They are the way our lives express themselves. Those networks are made up of all the people you care about, the people you, inspire, move, and help to live their best lives.
by James Currier (@JamesCurrier). James is a General Partner at NFX, a seed-stage venture firm headquartered in San Francisco.
Most of the discussions around “Founder-Market Fit” tend to focus on the more tangible concept of industry expertise. In my years as a Founder and investor, I’ve found that there’s a lot more to it. We see four dimensions that contribute to Founder-Market Fit:
- Founder Story
Let’s break it down.
I often tell Founders “don’t start a company unless you can’t not do it… unless you can’t sleep at night and your brain is exploding with the idea.” Founder-Market Fit means you would choose to work on the idea in your free time. It means you can work effortlessly on your product and customer issues. It’s the kind of thing where you don’t notice the time passing. There’s nothing you’d rather be doing. It’s something you need to see out there in the world, and you’re going to will it into existence.
World-class, iconic companies are almost always founded by Founders with that level of obsession because it equips them to endure for the long haul that it takes to build a company without burning out or losing faith.
If you have this kind of obsession, you become a Founder not because you want to move to Silicon Valley and be an entrepreneur and live the lifestyle but because you are compelled by something deep inside. Something creative that resonates in an inexplicable way with the market.
One sign of this healthy obsession is knowledge.
I’m often surprised and disappointed by otherwise competent Founders who haven’t taken the time to go deep in their market and know everything about former attempts to build similar businesses, their current competitors, and future potential competitors.
Studying a market from a distance is not to be underestimated. Founders should talk to 10-30 practitioners and experts who have done something related to what they are targeting. Founders should create an extensive competitive map, researching and studying everything online about competing companies including failed companies in your market. This helps build a deeper idea maze quickly and more fully.
A lack of such attention to detail typically conveys to me that a Founder doesn’t love their market enough to have real Founder-Market Fit. Founders should be obsessed and go deep enough to clear this bar.
Willful naïveté gives you courage, which is good, but shouldn’t ever be an excuse for superficiality.
If you’re building a company in a market which doesn’t exist yet, it might be harder to study up on others, but not impossible. Every significant company had direct antecedents.
Further, in these cases of brand new markets, Founder-Market Fit may reveal itself in the rich process of mapping out the decision trees and probabilities that Founders anticipate the market might manifest. Mapping this “idea maze” and being able to discuss it succinctly indicates a Founder is sufficiently aligned with their market.
Lack of obsession for — and knowledge of — the market is almost always a bad sign.
2. Founder Story
Customers care a lot more about who the company Founder is than most Founders realize. The Founder has to fit with the market, i.e. the customer, and vice versa. Customers have to identify with the Founder’s story and believe that there’s a compelling “why” inside the Founder — that there’s a human behind the company.
For evidence of how influential founders’ stories can be, note Steve Jobs. Apple customers famously identified with Steve Jobs, his garage story, and his reason for “why.” It defined how the customers related to Apple products on an emotional level. Apple users identified with his story as a creative genius and ascribed similar aspirations to themselves.
Facebook’s acceptability on all college campuses was influenced by Mark Zuckerberg’s origin story as a Harvard student. Like Facebook’s early users, Zuck was simply a college student who wanted to use technology to help improve the thing that matters most to college students — their social lives.
LinkedIn carried more credibility because Reid Hoffman was part of the PayPal mafia as well as high-status Silicon Valley insider.
Imagine a company founded by someone in a suit who’s story was nothing more than “I saw a market opportunity.” The story wouldn’t likely be compelling to users, and the company would be less likely overall to gain traction as a result. A compelling narrative signals to both customers and investors that the Founder has a mission and is in it for the long haul and for the right reasons. This is so true that even though Pierre Omidyar founded eBay because it was a good idea, he and his PR team made up a story about his fiancé collecting Pez dispensers as a way of humanizing the Founder story and the “why” of the company.
Markets tend to attract people with similar personalities. Are you the kind of personality that can fit in and make connections with your peers in your market? If so, it’s a positive indicator. The personality profiles — dress, norms, behaviors, passions, interests, recreational preferences, common lingo — tend to coalesce within clusters of professionals.
Having peers that you can connect with, that can bring positive energy, practical advice, and constructive feedback, is essential. Creative genius does not last long in isolation. Most innovation happens as a result of people forming networks with a high density of ambitious, competent people in a similar field or market. This particular kind of network effect is the main reason why Silicon Valley stubbornly remains the dominant force in tech startups to this day, and why Los Angeles does the same with entertainment.
Another example of how personality can fit with the market or product is Mark Zuckerberg. Time Magazine suggested that Mark was the perfect person to build Facebook because his personality lead him to be desperate to automate human interaction. He was obsessed with it and had unique intuition into the problem due to his personal daily experience. Hard to say, but perhaps that rings true with those who know him best.
As mentioned earlier, experience is often overrated when it comes to Founder-Market Fit. If you look closely you’ll understand a lot of nuance is required to properly evaluate how experience influences Founder-Market Fit.
First, too much experience is not always a good thing. Certainly, we do look for Founders who have enough industry experience that they understand the market. But not so much experience that they don’t have any disruption left in them. At some point, if you stay in a sector too long, you get the curse of too much knowledge, and you stop being able to see fresh or new ways of doing things. The angle for innovation becomes harder.
Ignorance is an opportunity for one out of fifty. Knowledge is an opportunity for one out of five. Too much knowledge is a blocker to innovation.
Second, the type of business you’re building matters. There’s a difference between the optimal amount of experience in B2B vs. B2C vs. bio/health.
We know from our own experience that the typical way to invest in B2B/enterprise is to find people who did it before and are doing it again in the same space. Experience is more important in the B2B space, where the complexity of the industry raises the threshold of how much domain knowledge a Founder needs before they’re going to get it right. The more regulated and enterprise-facing the space is, the more you need a ton of experience and credibility to have a shot.
It’s skewed even further in healthcare and biotech, where closer to 80% of founding CEOs have directly relevant experience.
Experience seems to matter the least in consumer.
This disruption/experience curve isn’t definitive, it’s just a guide towards how to think about it. As with any general framework, there are exceptions.
Third, a further insight that few talk about is the difference required by the CEO and a VP of Sales / CMO / CTO or whoever is second in command. We’ve noticed that the number two ranked person at a startup tends to be technical, but industry experience is less important for them as it is for the Founder/CEO.
As a Founder, if you don’t fit neatly into any of these frameworks, it doesn’t mean you don’t have Founder-Market Fit. It’s just one out of multiple indicators. There is usually a correlation, but not always.
The benefits of Founder-Market Fit
Having Founder-Market Fit improves your chances of building a transformative company:
- You have a higher chance of getting a critical insight
- It keeps you 100% focused on the problem with an obsessive, almost maniacal commitment because it resonates so deeply.
- You’ll resonate with other people in the sector you’re in, and the more people you have on your side, both in the company and in related companies, the greater your chance of success
- You will actually be able to pull off nuances in the product experience and product language that make your product best-in-class.
What investors look for
As a seed-stage investor, we look at many things when evaluating whether to invest in a company. See the Ladder of Proof for an overview or NFX Managing Partner Gigi Levy-Weiss on How VCs See Your KPIs for a breakdown of how we look at traction metrics. But the quality of the founding team is paramount.
With Founders, we look for speed, grit, intelligence, and yes, Founder-Market Fit as we’ve broadly defined.
Ask yourself if you have Founder-Market Fit. It allows you to see yourself from an outside point of view and form a realistic estimate about how you will do in terms of having a real disruptive insight, executing on that insight, and raising capital.
If you have it, you’ll know it… and we will too.
by James Currier (@JamesCurrier). James is a General Partner at NFX, a seed-stage venture firm headquartered in San Francisco.
While network effects are often referred to as a singular phenomenon, we’ve done a lot of work to dispel this myth. In 2017 we published the NFX Manual where we laid out 13 different types of network effects we had identified over the prior 15 years. At the time, we said there were “13 and counting”, knowing that more would show up as we work with 100s of businesses with network effects.
Today, we’re sharing the newest network effect we’ve identified: a 14th type that we call Expertise Network Effects (nfx).
Products which can develop “expertise” network effects are typically tools used by professionals to do their job — the instruments with which they ply their craft. As professionals become more skilled in their jobs, they also level up their expertise in tools required to do their jobs. If the tools are sophisticated enough, the tools require particular expertise of their own.
Employers often require proficiency in such tools when hiring, and so professionals have a strong incentive to develop expertise in tools with wide adoption that they can list on their resume and use as selling points on the labor market.
Companies likewise become more likely to employ the tools with the widest adoption by professionals because a) they want their employees to be able to interface to other companies in the industry, and b) they want to be able to attract the top talent who likely will want to use the most popular tool, and c) they know they can more easily replace the professional with someone else trained on the most popular tool.
And this is where the network effects kick in — for every new person in the labor market that develops expertise in a given product, the more valuable that product becomes to all players using or integrating that tool; i.e. all the other skilled users of the product (see the Appendix at the end of the article for a more detailed explanation of the mechanics of this network effect).
Here are some examples of industries and products where you see strong expertise nfx:
- Accounting Software (Quickbooks)
- CRMs (Salesforce, Hubspot)
- Analytics (Google Analytics, MixPanel)
- Computer Languages (Python, React)
- Spreadsheets (Microsoft Excel)
- Architecture (Revit, Autocad)
- CMS platforms (WordPress)
- Design software (Adobe, Figma, Invision)
- Video editing (Adobe, Final Cut, Avid)
- Mechanical Engineering (SolidWorks, CAD, Avid)
The two key distinctions of expertise nfx from other types of nfx is that a) they arise from the know-how required of a person to use a particular tool and b) the value transfer mechanism takes place through labor markets.
Expertise nfx can be seen as a form of individual embedding that aggregates into a network effect because the switching costs compound as a function of the collective effort it would take the entire industry to learn a new standard tool or protocol.
It follows that the strength of any tool’s expertise network effect grows as a tool reaches a critical mass point in the labor market and becomes the industry standard. You wouldn’t be wrong to point out that when becoming an industry standard, an expertise nfx has the flavor of protocol nfx.
It’s also true that the strength of a tool’s expertise nfx scales with the level of product-specific expertise required to use it. Sometimes called “groove in,” the more effort to learn a tool, the more resistance there can be to switch to an alternative. This helps to prevent multi-tenanting where an employee could use two tools equally well.
For example, if you spend months learning how to use Excel with its various shortcuts and interfaces, you’re likely to resist switching over to an alternative tool like Numbers. You’ve already developed a level of comfort and know-how that won’t all translate.
Our recognition of expertise nfx began during a conversation I had with Intuit Founder Scott Cook two years ago in Palo Alto. We were discussing different nfx and feedback loops to explore if there were ideas that could be used within Intuit, and he described how bookkeepers using Quickbooks as their system were more likely to get clients because other bookkeepers were also using Quickbooks. I came to realize that the phenomenon he was describing was a whole new type of network effect that didn’t fit into the 13 types we’d already identified.
Scott is one of the top minds I’ve ever met on the subject of network effects. We recently revisited this same conversation about Quickbooks and the power of network effects on the NFX podcast. Take a listen for a more detailed case study of Intuit’s expertise nfx.
Learnings for Founders
The implication of expertise nfx for Founders is perhaps hidden— if you’re a Founder competing with a professional tool like QuickBooks or Salesforce, you have to realize you’re not just competing with the direct product utility. You’re also competing with the ease of hiring people proficient in the industry standard — hiring managers who know to look for bookkeepers that know Quickbook, for example — versus your alternative with a smaller number of users.
With professional tools, you typically see the labor market coalesce around the industry standard. Salespeople are trained to use Salesforce, so even if you make a much better or easier-to-user alternative, you’re competing against the switching costs of learning something new compounded across the entire labor pool.
So even if your product is 10x better or easier to use, it won’t necessarily matter if it’s too different from the industry standard and requires too much additional time and effort to learn. This is why you often see professional tools cloning or mirroring features of the industry standard. Numbers and Google Sheets, for example, are a pretty close ripoff of Excel. They are still finding it difficult to displace Excel because of the strong expertise nfx Excel has accrued over the years.
It’s interesting to note that if you’re a Founder building a professional tool in a category with no clear incumbents, making your product easier to use will make it easier to spread but perhaps less defensible in the end. The easier it is to learn how to use one tool, and the more skill with your product translates to others, the lower the costs are to switching to an alternative.
If you’re a Founder building a tool for professionals, ask yourself which side you’re on. Are you competing against an industry standard with an expertise network effect, or are you operating in a white-space category?
If you are competing against an industry standard, have you done everything you can to minimize the switching costs, or find new use cases in order to avoid or complement the incumbent? If you’re in a white space, have you done all you can to foster expertise nfx in the labor market and between companies?
Expertise nfx can be a powerful foe or ally.
Appendix: the mechanics of expertise nfx
Expertise nfx are one of the more complicated types we’ve written about in terms of the underlying mechanism, so we’ve added this appendix to explain how they work at a more technical level.
Expertise nfx are 2-sided, so the cross-side network effects of increased supply (the experts) makes the product more valuable for employers or product-builders (demand) because they’ll have an easier time hiring different professionals who are skilled in the use of the same tools.
The indirect same-side network effects for supply come into play when, as demand for the expertise in a tool grows, all the existing experts in the tool gain more value from their expertise in that particular tool. In addition, there are also direct same-side network effects because professionals can exchange information and work together more easily if they’re using a standard tool.
This fulfills the purest definition of a network effect — showing how a product with expertise nfx grows in value as the network of users grows. As with other 2-sided network effects, there are multiple types of network effects — indirect and direct, cross-side and same-side, operating together all at once.
The expertise network itself is similar to a marketplace in structure. It consists of experts as supply-side nodes, product builders and end-users as demand-side nodes, and the tool itself as a common link between the two sides of the network.
However, the expertise network effect looks more like protocol nfx than 2-sided marketplace nfx. Just as the ethernet standard became the dominant protocol after it had reached a critical mass of adoption by early local computer networks, so too a product with expertise nfx will become the dominant industry standard when it reaches a critical mass of adoption by professionals. And it will be difficult to replace for the same reasons it is hard to replace a protocol (like fax, which is still in use) — the switching costs are too high.
The NFX Manual notes about protocol nfx that:
The success of such an adoption strategy is often less about technology and more about marketing, social engineering, and choice of market niche. That’s why VHS beat Betamax, even though Betamax was arguably a better standard.
Similarly, products with expertise nfx and wide enough adoption will have an advantage over technically more advanced products with less users. Once a standard is established, a technically “better” alternative rarely sees much traction.
by Pete Flint (@PeteFlint). Pete is a General Partner at NFX, a seed-stage venture firm based in San Francisco.
Marketplaces are a balancing act that never stops.
When I first started building Trulia I quickly learned that, for marketplace startups, it’s a race against time to achieve liquidity in the marketplace before competitors or incumbents do — and your resources are very limited. So it’s key early on to identify the few fundamental lessons of marketplace leverage and have a laser focus on those fundamentals.
I recently had a conversation with Thumbtack Co-Founder and CEO Marco Zappocosta and discussed one big question – what are the highest leverage lessons you wish you’d known earlier about building marketplaces?
Here are the key takeaways:
1. Create “network-independent value” to solve the chicken-or-egg problem
In our essay 19 Tactics to Solve the Chicken-or-Egg Problem, we wrote about tactics you can use to help overcome the paradox of starting a 2-sided marketplace: how do you attract supply-side users without any demand, and vice versa?
When I asked Marco how he solved the chicken-or-egg problem for Thumbtack, he said that he asked himself this question:
How can we create network-independent value? How can we create value for our Pros, the supply side, before we had any network of customers? (2:47)
Thumbtack’s solution was number 7 in our list of 19 tactics — build a SaaS tool.
What we built was a very easy tool for them to create a Thumbtack profile, and then with one click republish that onto Craigslist, importing all the pictures and reviews and metadata with a great sort of HTML layout, which they weren’t either interested or capable of doing themselves and was instantly valuable to them. (3:19)
Thumbtack built this tool to attract supply-side users. They knew that if they could get a critical mass of professionals, demand would follow on its own, similar to what OpenTable did (for example) to bootstrap their network, in their case creating a SaaS reservation software for restaurants.
Creating a free tool like this lets you offer a single-player product with “network-independent value” to supply-side users. Also, by publishing to Craigslist, Thumbtack was leveraging the classic growth technique of finding a scale destination and figuring out a way to help add supply so that they could later siphon off demand.
2. Understand the risks of horizontal vs. vertical marketplaces
One of the themes Marco and I discussed was the challenges of maintaining a horizontal platform against disruption by vertical competitors.
The benefit of being horizontal is that you’re leveraging a single product experience across a large customer set or audience, and you’re able to make that single experience really, really good. The generalized experience combined with the ability to cross-promote traffic can be a better experience than a vertically-focused marketplace can provide with a lack of brand awareness and low traffic/liquidity resulting from a smaller network size or network density.
But on the other hand, if you’re building a marketplace going after a highly monetizable vertical, you can spend enough money on customer acquisition to acquire that network density, and this can be a problem for horizontal players.
For Craigslist, all the high-value categories are being picked off one by one, and what remains are things like resale furniture, free stuff, apartment rentals, etc. They lost the home sale category very early on but were able to retain rentals for a longer period of time because it’s much harder to monetize as a vertical.
The lesson to draw from this is that the lowest-hanging fruit for vertical players to disrupt will be those that are easier to monetize or are more effectively monetized via an alternative business model or product experience. NFX portfolio company Incredible Health, a verticalized recruiting marketplace for healthcare, is a good example of this because healthcare is an industry with sufficient complexity as to merit a differentiated product experience for recruiting.
And as Marco shared, continuing to innovate and push forward on the overall product experience as a horizontal platform is the best way to stay ahead of vertical competitors.
3. Strike the right balance between short-term vs. long-term goals
Between going after short-term goals and long-term, it’s a constant balance as a marketplace startup.
The reason to not ignore the short term is that you have to walk before you can run, and sometimes you have to do things that don’t scale. The MVP mindset of building a skateboard, then a bike, then finally a car applies to goal-setting.
The best form of financing as a startup is revenue. Even if it’s not going to be optimal in the long-term, to survive you may have to do things that don’t scale in order to get revenue or acquire users so that you can fight another day. Furthermore, if you’re able to get customers to pay, it demonstrates you may have some degree of product-market fit.
The other thing is that you don’t always know what the optimal long term goal is. If it’s too far off, you don’t necessarily know what you’re trying to build. You may have an idea of what a car should look like, but you don’t try and built that car on day one. You take baby steps.
On the other hand, it’s important to have goals and metrics for the long term especially with things that compound. As Marco mentioned during our conversation, he regretted not focusing on PR enough early on because it has a compounding effect so it’s harder to make up for early negligence of it later on. Marco shared that he thought Thumbtack lost out on a lot of brand-building opportunities because of that early lack of focus on PR, and brand in particular something that compounds tremendously over time, so focusing on it early can be a key competitive advantage.
Introduction: This is Christen O’Brien, Managing Editor at NFX, and you’re listening to the NFX Podcast. We’re talking about how to build a $ billion marketplace in this episode with Marco Zappacosta and Pete Flint. Pete is a partner at NFX and the founder and former CEO of Trulia, the real estate marketplace that merged with Zillow in a $3.2 billion transaction. And Marco is the co-founder and CEO of Thumbtack, a marketplace that matches customers with local professionals now valued at more than $1.7 billion. Today we’re at the NFX headquarters in San Francisco, California to uncover what it takes to build an iconic marketplace.
Pete Flint: Today we’re talking about marketplaces, we’re talking about Thumbtack. Maybe just as a way to introduce the story. Why don’t you tell us about Thumbtack and really the origin. How did you get going? How did you solve that critical cold star problem from zero to something?
Marco Zappacosta: So, all the way back.
Pete Flint: All the way back.
Marco Zappacosta: So, in many ways we did what you’re not supposed to do at the beginning, and decide to start a business and then go hunting for an idea. I’m happy to speak to the merits of that approach, which I think is undersold in Silicon Valley. But really the heuristic we took was, what is the biggest problem that we can think of that will inevitably be solved? And the observation that led to the last 10 years of work was why is it so hard to hire a plumber? We weren’t homeowners at the time, we were still in college.
Marco Zappacosta: But when we sort of realized this and started thinking, and it’s not just home services, it’s really all local services. It’s very rare for you to have to work so hard to spend money. All of capitalism is about enabling sort of your laziness to get what you want easily. And yet here was a category where people had the budget, had the desire, had the intent, and struggled to spend their money. And as we dug into that, it wasn’t because there was a lack of labor or lack of supply. There are millions of great professionals out there who would love to find that work and do a great job for you. It was a marketplace failure. It was a matching problem.
Pete Flint: So, how did you kickstart that? Because obviously the business today makes sense. But small company, no customers, no demands on their supply side. What was the sort of… Typically there’s a technique you employ to get going.
Marco Zappacosta: So, we actually went very broad, and in fact that was something that focused our thinking because it forced us to find solutions to drive liquidity that we’re sort of category independent and geographically independent. And you know this super dorky phrase that we told ourselves early on was: how can we create network-independent value? How can we create value for our pros, the supply side, before we had any network of customers that would ultimately be the the draw, and they want, you just don’t have that. So, that sort of hack or sort of a growth tactic that early on let us get going was we looked for where these pros were and where they were already hunting for customers. And at the time, 2009, 2010, that was Craigslist.
Marco Zappacosta: And so what we built was a very easy tool for them to create a Thumbtack profile, and then with one click to republish that onto Craigslist, importing all the pictures and reviews and metadata with a great sort of HTML layout, which they weren’t either interested or capable of doing themselves and was instantly valuable to them. Because we could say, “Hey, you’re on Craigslist or it looks like you want to be on Craigslist. We have this great tool. Just come fill out a profile.”
Pete Flint: A free tool?
Marco Zappacosta: Free tool.
Pete Flint: Yeah.
Marco Zappacosta: And what that did was attract pros who were motivated to use the internet to find customers. It was exactly who we needed. And two, it also gave us a relationship with them from the get-go. So unlike a typical directory, which has a ton of content about millions and millions of entities that has no relationship with, Thumbtack from the very beginning and still to this day has a relationship with every pro that you find on our marketplace.
Marco Zappacosta: Because we want to connect you with a person, with a pro, not simply with information about a pro. So, that was the early sort of growth tactic that got it all going.
Pete Flint: So, sort of classic growth technique of finding a scale destination that is attracting a similar level of demand and supply and then figuring out a way to add value to that to the sort of… On the positive side is symbiotic relationship on the negative side is sort of siphon off that demand.
Marco Zappacosta: Well, there was only an opportunity because they weren’t doing a better job.
Pete Flint: And it’s very hard as a horizontal platform to really excel in these vertical domains.
Marco Zappacosta: They are very unique. Craigslist could be this incredible juggernaut and it chose not to be and that left the door open to Thumbtack, Airbnb, all the personal sites could have been them. It’s incredible that they could have built that but chose not to.
Pete Flint: And then there was I imagine a fair amount of SEO work as well. I know, from my experience, we similarly employed kind of SEO in the early days. Back in 2009 and 2010 it was a viable strategy to kind of scale.
Marco Zappacosta: And we used that as well. And the benefit we had was because pros were coming to create profiles that they were going to use to represent themselves on other platforms like Craigslist, they’re very motivated to create a great looking profile and to give it a lot of unique content. And for a long time early on and even today we have shockingly little overlap with the other platforms that are out there. So, think of a Google of Facebook, a Yelp, this is a very long tail category that is very fragmented, that is still very opaque to sort of the internet writ large.
Marco Zappacosta: And our approach not only got us sort of high quality intentful relationships, but gave us sort of content that nobody else has, which for SEO is gold and is what it takes.
Pete Flint: I’m curious your experiences. Often what we see in startups is growth is a series of S-curves.
Marco Zappacosta: Yep.
Pete Flint: And that you sort of capture one opportunity and you leverage that. And then you’ve really, it’s sort of surfing a wave of kind of various different S-curves and finding distribution opportunities, and the bigger you are often the more opportunities open up. Over the last 10 years, how have those sort of S-curves evolved and perhaps how do you think also about platform risk? Obviously building a company off Craigslist. Craigslist end up shutting down a lot those kind of widgets.
Marco Zappacosta: Sure.
Pete Flint: How do you think about platform risk alongside that?
Marco Zappacosta: Well, day one you don’t, because you have nothing to risk and so you’re very happy to leverage some other platform to get going. And even with SEO early on our thinking was, oh man, this is a zero marginal cost platform to attract customers looking for exactly what we offer, which in our case was uniquely well-suited because we are a search engine at the end of the day. We are a place to find and hire pros, which is a search problem. So, it was a phenomenal fit in terms of channel. Now, there was no doubt that there was risk to it, which we are very well aware of, but the ultimate hedge against that is to create something that has the stickiness, that has the retention and the repeat usage such that even if sort of one channel in the early days is the dominant source of new customers, as you built up your base of existing customers over time that overtakes and becomes the dominant channel.
Marco Zappacosta: And that’s true for us. And I think that’s why we are at this point don’t fear that problem. But it took years and years to get there. But they won, that’s okay. And now we build our own direct relationship with these customers and word of mouth and that becomes the most important channel that we have to be able to keep growing.
Pete Flint: And it’s been fascinating to watch Craigslist, ’cause that has been a kind of a source of many, many startups. But it’s also a sort of classic kind of innovators dilemma for kind of want of a better phrase. They’ve been driven by the community, but that they failed their community because they’ve really been a slave to that and haven’t really innovated on top of that. And we’ll touch on this, but how do you not fall into that trap that many companies don’t? And we’ll talk about reinventing Thumbtack. But what have you learned from watching Craigslist all these years about what they haven’t done?
Marco Zappacosta: Well, I’ll speak to my own category, which is the one I know best. And I think the one important positive takeaway, which I think is not sort of emphasized enough is the value of liquidity. It’s absolutely mind boggling how big and important Craigslist, even to this day it still is. For a long time Uber and Lyft were getting the vast majority of their drivers off of Craigslist. The biggest sort of margin, accretive player in the gig economy space was Craigslist. And that’s incredible. And why were they going? It’s not ’cause it’s safe. It’s not ’cause it’s easy to use. It’s not ’cause it’s beautiful and well-designed. It’s because it has liquidity and it just shows how critical that is for a marketplace to both succeed and thrive.
Marco Zappacosta: And that was very clear to us. Look, at the end of the day we’re a matchmaker and if you can’t come and get matched with the right pro each and every time, you’re going to go elsewhere. And that has been the sort of overriding objective function to basically everything we’ve done. That said, and this is sort of what we think about ourselves, you can’t get trapped in a current way of doing things if you want to expect to survive sort of for the long term, especially in the consumer arena where sort of preferences are evolving and sort of the tools available to both sides are sort of always getting better and better. You have to keep pushing that ball forward. And I think it’s something I’m very proud of that Thumbtack has done sort of multiple times and sort of very critically over the last few years. But you can’t stand still, you got to keep running.
Pete Flint: The experience that I’ve seen from Craigslist in seeing on the housing side intimately, they lost the for sale category very early on and retained the for rent category for a long period of time. And now it appears they’ve lost it, at least the recent data I’ve seen, but it is truly remarkable.
Marco Zappacosta: But it lasted what, 20 plus years?
Pete Flint: Exactly. It’s truly remarkable that the liquidity has been there and particularly the fragmentation facilitates that liquidity rather than sort of professionally managed property managed marketing in terms of real estate versus more long-tail landlords is that that liquidity is highly persistent. There’s network effects are very, very hard to break, and once you have them, you’re in a very strong position.
Marco Zappacosta: I think our category was very well suited to be disrupted because when you think about what does well in a medium where the inventory is sort of expiring, it’s perishable inventory.
Marco Zappacosta: So, rental markets being a perfect example of that. Service professionals though are not that. A plumber is a plumber today and tomorrow and next week. And in fact, by denying them a permanent presence, you’re denying them the ability to accrue reputation and through that compete, not just on costs but on quality. And that’s the number one thing that pros hate about Craigslist. They say, “Hey, I love being able to access customers but I don’t want to have to compete just on price.” And that makes sense when you’re selling your table, fine, you care about price and that’s it. But when you’re selling your time and your labor and you are a true craftsperson, you want to be able to showcase that craft. And we really think of our pros as skilled professionals. They’re making on average almost $70 an hour in aggregate across the platform because they’re providing a sort of quality, unique custom service.
Marco Zappacosta: And that’s exciting. But what they don’t want is have to waste their time on marketing, and online marketing in particular, which is new and ever changing and sort of very technically demanding and increasingly this sort of like back office. So, our ambition for these pros is to let them focus on what they do best, serving their clients, plying their trade, and abstracting away the rest such that we can empower them to turn their time and talent into money.
Pete Flint: So, looking back, what would you have done differently? Going back nine years ago, what advice would you give your former self back in the formative years?
Marco Zappacosta: So, I have a tactical answer and then a more philosophical answer. My tactical one is I would’ve focused on PR earlier, and that seems narrow and trite, but the point here is that it is a channel that can compound that you have to invest in. And that takes deliberate effort just like any other marketing channel that you have. And I didn’t appreciate that and I underinvested in it for too long, early on. And I think TaskRabbit took the opposite approach, did a great job of investing in that and I think became the sort of labor story in the sharing economy. That could have and should have been us, and that is something that I think we neglected and lost out on a lot of brand building opportunities because of that. And I just thought about it wrong, so it was just a regret that I have.
Marco Zappacosta: The more philosophical answer is we didn’t understand the relative prioritization of what our customers and pros needed deeply enough such that we truly focused our development efforts. We had this vision early on that we had to obviously make the introduction, but then facilitate scheduling and payments and all the steps between sort of not knowing who to hire and a job well done. And look, those are absolutely the right things to have on the roadmap, but you don’t need to do all of them day one.
Marco Zappacosta: And in fact the reason that we were not focused deeply enough on the matchmaking is just we didn’t appreciate that was the core need. So far and above everything else, that’s where we should have focused longer and harder earlier. And I think we probably could have accelerated our path by a year or two had we had that clarity early on.
Pete Flint: Interest in the matchmaking because often in the sort of the quality matching might mean deterioration in short term metrics, but ultimately you’ll see it in retention metrics further down the line.
Marco Zappacosta: That’s absolutely the case.
Pete Flint: When you’re studying the kind of metrics on a day to day basis, you’re just focused on making the numbers go up today or next week, but you’re not necessarily thinking about a year or six months time when they’re looking at it as a second transaction.
Marco Zappacosta: And this is something that I think we came to appreciate and then ultimately bet the company on.
Marco Zappacosta: So, now there’s sort of three areas of Thumbtack. The first area was when we were really just trying to find initial product market fit and early marketplace liquidity, building efforts. That’s from ’09 to sort of ’12 into ’13. Then starting in ’13, we really had something that we were able to scale very aggressively and from ’13 sort of into ’17 we were in that just scale, scale, scale, hold on. But by the sort of early ’17 we came to appreciate that the request for quote model that had powered our early years was not going to generate the experience necessary to build Thumbtack into the branded destination for hiring pros for whatever you need done for the simple reason that it wasn’t fast enough, which at this point in time everybody expected their online experiences to be immediate and instantaneous. Nor was it able to generate enough liquidity, enough supply.
Marco Zappacosta: And that was because to power request for quote experience, pros had to read and respond to every request as it came in, which was incredibly valuable for customers because they didn’t have to go out and search themselves and call down a list of numbers. They could simply wait for pros to send them responses, which they knew would be intentful, qualified, available, with a specific price. Basically everything that you need to evaluate whether that pro is right for you. But in asking the pro to read and respond to everyone, that’s a lot of burden. It’s a lot of effort. And so, in early ’17 we took the bet of saying, hey, the only way we make Thumbtack into this sort of amazing experience it needs to be to become a sort of world dominant brand is if we automate this part of the flow for pros.
Marco Zappacosta: Now keep in mind that we cover 500 different occupations and these vary from everything from a plumber to a wedding officiant to a math tutor. And we need to be able to generate estimates as well as pros generate them themselves, sort of programmatically. And it’s a very compelling thing to say and to put in a pitch deck and sell, it’s a much harder thing to build, harder than even we anticipated. But over the last couple of years pulled it off, which feels really, really good.
Pete Flint: So, this has been the big transition then for the company over the last, what, two years? Transitioning. So, just to clarify that, so moving from a lead generation marketplace to being really more of a transactional marketplace where you’re going to sort of almost instant booking.
Marco Zappacosta: Correct. But I don’t actually like the lead gen word. I think it’s a very misused word. And the reason I react that way is Google and Facebook are lead gen companies too, but they’re typically not thought of as lead gen. I think the traditional association with lead gen is that you’re a pass through, that you are an affiliate, that you buy low and sell high and have no enduring relationship with either side. Thumbtack is all about having a longterm enduring relationship with both sides. It’s true, we monetize customer contacts or introductions, which you could call a lead I think quite fairly. Like Google and Facebook, we think that’s the right point to introduce our monetization that actually makes the experience for both sides better. That doesn’t mean that a pure transactional model would somehow make this a marketplace in a way that we today are not.
Pete Flint: Yeah, it’s like saying Match.com is a lead generation service. You’re not going to perform the transaction.
Marco Zappacosta: You got it. That’s-
Pete Flint: Say, online…
Marco Zappacosta: That’s a great comparison.
Pete Flint: You’re providing a huge amount of value to facilitate an offline interaction initiated online.
Marco Zappacosta: Putting that payment friction makes the match better.
Pete Flint: Yeah.
Marco Zappacosta: Because…
Pete Flint: Increases the quality, and that sort of…
Marco Zappacosta: Exactly. Exactly right.
Pete Flint: … how serious someone is.
Marco Zappacosta: The thing that changed is, instead of Thumbtack being a asynchronous experience where you had to wait for responses, we made it instantaneous. Yet, we did that by working very, very hard to retain the same quality. That same intent that our matches had before. We have a sort of metric to track this, and we’re very proud of how far. We feel like we are now able to generate these sort of machine matches that have the same revealed appreciation by our customers, as well as humans these human pros were able to do it. It shows us that we were right, and that this was possible. Man, it’s a real grind.
Pete Flint: We’ll get into that, how you figured that out. Seen historically from speaking people at Airbnb, and eBay, that sort of addition of this instant booking, or buy it now that those sort of product enhancements offer preexisting service have made…
Marco Zappacosta: Enormous.
Pete Flint: … enormous benefits off a relatively simple on the surface, but always complex behind the scenes, and that sort of consumer desire for confidence, and convenience is overwhelming.
Marco Zappacosta: Evergreen. Even if I don’t know anything about your marketplace or your business, if it’s a consumer business I can almost always say something to the effect of, “Hey, if you make it easier and better for your customers, you will drive more engagement, and more retention.” In our case, it didn’t take a marketing genius to say, “Hey, customers want faster responses, and they want more responses that are equal or better quality.”
Pete Flint: Yeah.
Marco Zappacosta: A very simple point of view. It’s executing on it, and making it really happen, especially in our case. Some of the examples you cite, like eBay and AirBnB, where you have a hyper fragmented small business base. Think about what we had to change for these pros. We had to move from a request for quote world where they could read, and then deliberately choose to pay to respond to each and every request. They had total discretion, there were no minimums, they could just pay for what they wanted. Now, they’d give us their sort of targeting preferences; where they travel, what they do, how much they charge. We generate those estimates for them, and they pay when a customer contacts them back. Now, they have to trust us to represent them as well as they would themselves, and we are charging them for that. It was an enormous leap, enormous transition that required a big, big change in the amount of trust they had in us.
Pete Flint: I’d be interested in the transition. I’ve seen personally that evolution at Trulia, and then through the merger with Zillow there was several business models behind the scenes, on the back end, innovations that consumers don’t really see it. The pricing model changed a couple of times while I was running the company. Then, within Zillow it’s changed a couple of times again in big ways. These are, they are incredibly challenging to pull off in a kind of execution, but necessary because your consumers typically move on.
Pete Flint: Your supply side typically has different expectations. If you are not enhanced in the consumer experience, then you’re inherently going to fail. Someone else is going to come up. I think we’ve seen, I guess particularly in your area, how there’s been probably a number of vertical specialists that are hoping perhaps to pick off, just in the way that companies picked off Craigslist back in the day.
Marco Zappacosta: Good luck.
Pete Flint: In certain verticals, they’re trying to pick off-
Marco Zappacosta: I would venture to say, having seen a lot of these verticalized companies, that particularly the ones that would call themselves a managed marketplace where the labor is often contracted, or subcontracted directly, that they will struggle to get to scale. Have not seen it work really at all in any vertical. We’ve talked to a lot of these folks. We think that we have more liquidity in any one of these categories than they do, and through that provide a better customer experience, even if the depth of the product experience does not match.
Marco Zappacosta: At the end of the day, the number one feature is, do you have a great pro available for me when I want it, for roughly the price that I’m willing to pay? That’s a very, very hard problem that we are able, with our scale, to solve more effectively than these tailored, verticalized companies. I think a lot of people over applied the Uber experience to this category thinking, “Oh wow, if I just abstract that away and make it a one-click experience, it’ll just be magical in the same way that ride sharing was.” I think they mis-appreciated how much nuance is in these local service categories, whereby ride sharing is really a commodity where you don’t care so that UX is appropriate.
Marco Zappacosta: When you’re talking about spending hundreds or thousands of dollars, when you’re talking about your home, or your wedding, or your child, there is a real need to be able to express your unique preference. Through that you need to reveal the true total availability of this marketplace. You can’t simply just dispatch whoever is at the top of the list.
Pete Flint: Yeah, I can of imagine that certainly it’s more challenging to facilitate liquidity in 2019, because the Craigslist, or SEO or the Facebook, the distribution channels are more challenging. At the same time I guess the product experiences are, from a consumer perspective, the part of the experience, your expectations have increased substantially over the last 10 years.
Marco Zappacosta: bsolutely.
Pete Flint: How do you think about facilitating a horizontal platform, which obviously has the benefits of scale across sending fitness trainers, to dog walkers, to other people at that scale? That’s clearly a kind of asset to the company, but trying to create vertically specific product experiences that over-deliver in those use cases. It must be an enormous challenge.
Marco Zappacosta: It’s a big prioritization challenge. While we are horizontal, we have to customize, and develop things that work for the specific occupations and categories that we do serve. Similarly, we want to push the envelope on our own experience. Basically, we typically have multiple things going on at once, where the vast majority of our effort is on moving the horizontal platform forward, releasing features that apply, if not to all categories, to most. At the same time, have a more hypothesis-driven, more experimental set of initiatives that we’re trying to push it forward for a much smaller subset of categories.
Marco Zappacosta: You’ll see that, and you’ll see us continue to do that. Now that we have this instant match ability, you can see us start to get to instant book. Then, through that, the ability to be relevant. Not just at the point of introduction and booking, but throughout the life cycle of that job. The dream is for us to be the end-to-end experience for all of these categories. I think we will get there faster than starting with one vertical all the way deep, and then trying to line up other verticals alongside of it. I don’t think you see any evidence of that working at all, rather than being able to layer in this functionality as we develop a deeper, and deeper understanding of how to pull it off.
Pete Flint: Again, thinking of your back in the early days, would you have done anything different? I think a thing about this in my own experience of going through these business model pivots, almost several times, that it’s hard to imagine doing something that different. You sort of need to put one foot in front of the other. You have finite capital, you have finite users, you need to how-
Marco Zappacosta: Finite knowledge.
Pete Flint: Finite knowledge. You need to start by solving a discrete problem, and then using that as a starting point to make the transition. Almost the only piece of knowledge or wish I had was, change is a constant, and if you’re not-
Marco Zappacosta: Buckle up.
Pete Flint: If you’re not innovating on your product experience, then you are almost failing because your consumer expectations have moved on during the period of two, three years since you’ve been [inaudible] their business. If your part of the experience has not moved on, and if you’re not able to innovate on that, there’s a degree of almost which these hard transitions are very painful for companies. Whereas, in the organization, if there is an expectation of incremental transition, or consistent transition, then you don’t have to almost rip the engine out as you’re flying. You’re just fixing the propeller, you’re fixing one wing, you’re fixing another wing as you’re flying.
Pete Flint: Tell me about, perhaps as you, as a CEO and founder, how have you managed that transition? Tell me, what are some of the lessons from that?
Marco Zappacosta: When I look back on this transition and think about the things I would do differently, they’re all about how we set expectations internally. Not necessarily the order in which we build things, or specific features that I wish we did or did not do, but much more about expectation setting. Which what you realize is the key to maintaining confidence, trust.
Marco Zappacosta: I think we should have been more honest with ourselves, first and foremost. Then, through that, the whole team about how big of a change this was. Through that, how much uncertainty, and speak to the steps that we knew were next and the mark of success of being through that. Then, when we had more visibility, add that in. It’s hard to know. In some ways it was a benefit knowing… Being naive early on, because it was like, “Well yeah, of course this is the right direction, so let’s go do it.” Then, you get into the muck and you’re like, “Oh my God,” but you’ve burned the bridges behind you so there’s only one direction to go. That’s helpful, but I think we could have communicated the magnitude, and through that the uncertainty more clearly. I think it’s a really hard thing to do as a leadership team, a leader. It’s hard being vulnerable with that uncertainty. I think the partners that you want on the journey, and the smart, thoughtful people, they’re going to see through it if you don’t own it. It’s better to just share that, and engage with it, and help people come to terms with it collectively than try and minimize it. That was a big learning.
Pete Flint: Maybe shifting gears a bit to the future of marketplaces. You’ve been in this industry for 10 years, and I’d love to get a sense of where you see marketplaces heading. There’s obviously enormous fertile ground here at NFX. We have our own kind of perspectives on that. We have a board, a thesis on so-called FinTech enabled marketplaces we’re starting to add a lot more traditional financial services, or FinTech component into that in addition, increase consumer experiences. What do you see as the next wave of interesting marketplace businesses?
Marco Zappacosta: One dimension that I think is not apparent to most folks is how much human capital is out there, and how hard it still is to find that and hire. Obviously, this speaks to Thumbtack’s category, but I would say it more broadly. We don’t touch education, or healthcare, or international remote work. If you look at the trend over the last 10 years in the sharing economy, really what you’ve seen is a capital assets, homes and cars being brought into marketplaces, and through that been able to offer enormous consumer surplus and value. These are capital assets. These are things. What we really have not seen at scale is the same for human capital. For the time, and talent that we all have that I think is ultimately the biggest resource this world has, and certainly this country has, and still the category that is most opaque.
Marco Zappacosta: I think we are in the very, very early days of labor, or service, or human capital marketplaces, however you want to think about it, to dramatically increasing the efficiency through which the two sides of that transaction can find each other. Through that, for human capital to find a market for itself, and bring itself to market. There is so much latent potential, and this gets to the broader view of tech as a force for good, just as much as it can be a force for bad. I think it’s a reflection of people’s narrow view of tech as a substitute for labor. While I think it can also be a compliment to labor.
Marco Zappacosta: What Thumbtack really does, and there are other platforms, we’re certainly not the only one, is it enables the amazing diversity of human talent that’s out there to find a broader audience for itself. Through that, earn more money and reach its own aspirations,` and also help all these end customers paint their homes, and cater their weddings, and tutor their kids. I think we are in day one, minute two of that. It is still so, so early, and I think people under-appreciate how big that’s going to be.
Pete Flint: It’s all just now about making the transition, and managing that transition and your own kind of vulnerability as a founder CEO, making that. Talk to other founders about how the benefit of vulnerability as a leader, and sharing the challenges that you face as an individual, and the and the challenges you face as a leader in the organization, and how you manage through that.
Marco Zappacosta: Yeah, so I think the tension comes about because, in many ways you are cheerleader in chief. When you sell new employees, when you retain current employees, when you’re selling investors, when you’re talking to the press, you are by definition out there selling, and putting out the story of the business and why it’s so great. Then, there are moments where that is not the mood that you have to be in. Instead, you have to be real-talk in chief. The fear, certainly my fear is, how do you do that? How do you balance those two things in the right way? The end goal is to have complete, and utter confidence that you will succeed, but admit every potential flaw, or thing that might get in your way and own it in a truly humble and intellectually honest way. That’s the ideal.
Pete Flint: Yeah, yeah.
Marco Zappacosta: Total confidence, and we are going to win no matter what, but holy shit, if we don’t fix these 11 things, we are screwed. I think leadership is ultimately an exercise in self-awareness, and coming to recognize yourself better, and through that, how you can then put yourself out into the world. One of my things that I’ve learned is, when I’m scared that’s usually actually a sign that I should lean into that, and share. If I’m scared then so are a ton of other people. Even if I’m not visibly scared, the thought that someone may think I am scared is something that will scare them, and worry them. Those are the exact moments to acknowledge that fear, and then unpack it for people like, “Hey, I am scared that this might not work. What we’re trying to do has never been done before. In our early experiments, we saw some clear opportunities for making this work, but also some challenges that are going to be really hard to surmount. But what gives me confidence is X, Y and Z, and that is scary and hard to do.
Pete Flint: Yeah, it is. Echoes a lot of my experience, and vividly, I’m kind of recalling back an experience in 2008. During the midst of the global financial collapse, there was running an online real estate company. It was like no one believed that we would survive, and the employers were kind of enthusiastic. And I was scared shitless, literally, and you feel you need to maintain the motivation, enthusiasm. But everyone is kind of in the headlines, and everyone knows what the [crosstalk 00:36:56]-
Marco Zappacosta: And they’re smart and thoughtful people.
Pete Flint: And they’re smart. And so if you are sort of hiding anything from them, then you will lose their trust and lose their respect. Frankly, a lightning bolt moment for me was when ended up having a very sort of candid conversation around the changes, the business, what we needed to achieve, and having faith in the team to live on that. And then seeing in a matter of weeks how the team had risen to the occasion, and started sort of creating incredible product plans and ideas and execution, which was… Realize that old adage of kind of problem shared is sometimes a problem halved, that the team was kind of bracing these things. It was truly a turning point for me as a leader, how that helped to turn things around. And I think you’re sort of respect as a leader is also magnified within the organization as well.
Marco Zappacosta: And I think another thing that I was certainly hung up on is, well, I know that there’s people who are worried. I don’t want this to push them the wrong way and have them say, “Hey, you know what? I don’t want to be part of this.” But actually in retrospect, I wish I had. First off, the vast majority of people were excited and did believe. And look, for those who didn’t, they deserve a handshake and a hug and a goodbye. We don’t need that around. We need believers. We need people with conviction. And these pivotal moments by definition are ones that not everybody’s going to agree to, and actually revealing that is a very powerful and cleansing thing for the organization, because those detractors are going to continue to detract in just more subtle ways. In the comments they leave in docs, or the questions they ask, or the way they push and prod. And some of that is healthy. You have to be intellectually honest with what’s not working. But if you’re truly not a believer, well then you should find somebody else.
Pete Flint: Yeah, move on. Yeah. I mean, there’s plenty of opportunities in Silicon Valley, and these sort of refounding events almost kind of create a sort of emotional commitment, which is critical for the next wave of execution and innovation. We talked a little bit about kind of internally, I’d love to get your perspective on fundraising, and kind of also board management, and obviously your private company, but managing the other constituents. And then any advice for founders who are fundraising right now. What are some of the lessons that you’ve learned?
Marco Zappacosta: I think the biggest lesson that I wish I knew early on, in my first sort of professional round that I went out to raise my Series A, was that you have to be very clear, not on just what this next investor is looking for, but the one after that. Because that’s what they have in mind, and they’re thinking of this investment as one that gets you to the proof points, to the de-risking events, to the numerical targets that then entice the next round investors. And really working backwards from that, such that the current round has confidence that, sure, you have to execute, but if you do and you deliver on the things that you say are going to deliver on, then they’re confident that the next round’s investors will see that as well and have confidence. And basically every round is a bridge round, and you have to recognize that and talk about and internalize what that next set of objectives is.
Marco Zappacosta: And I didn’t know that the first time around, and that made it harder than it needed to be.
Pete Flint: Being transparent post or during a fundraising event, being explicit around this capital will achieve these particular metrics or milestones to achieve what you think is going to be sufficient to kind of raise the next capital.
Marco Zappacosta: Yeah. Correct. Let’s make it more explicit. You’re raising your Series A, which is effectively your first growth round today, which is-
Pete Flint: It’s true, yeah.
Marco Zappacosta: It’s how it should be thought of. You guys are in the venture business. Everybody else is in the growth business. And so you don’t have product market fit yet. You probably don’t have much business model risk, though you probably have some. But it’s still sort of TBD how quickly and effectively you can scale. Knowing that your Series B at that point then really becomes a pure growth equity investment, you have to be able to tell the story to your Series A investor about, “Here are the key milestones and the things that I’m going to de-risk and accomplish. And if I do those, I know I will be set up to raise a Series B in 18 or 24 months.” The use of proceeds, the sort of goals, should map to what that Series B investor’s ultimately going to look for. And I don’t think you need to be explicit about it, and in fact I think it’s better if you’re not, but that Series A investor will certainly appreciate that.
Marco Zappacosta: And my version of that is public markets. In thinking about what people today need to see to have confidence that their investment will have a good a return is that we are set up to ultimately go public successfully, and the things that are required for that. And they need to see me speak to that to have the confidence that we’ve internalized that and our plans are going to reflect that.
Pete Flint: As you think about the market you’re in, as you think about the wave of competition, you’ve shared the belief that some of the vertical specialists are going to struggle. How do you think competition more broadly… Perhaps against the huge incumbents, Facebooks, Googles, which sort of seemingly permeating kind of almost every aspect of digital business these days.
Marco Zappacosta: Interestingly, you did not name our biggest competitor, which in my mind is word of mouth. The vast majority of these transactions are still sourced by you texting your neighbor, or knocking on somebody’s door, or asking a friend. Now, it’s true that some of that is now mediated through Facebook or through Nextdoor, but the search paradigm is via your social network. That’s ultimately what I’m competing with. 90, 95-plus percent of the GMV is transacted through social networks, not through a sort of marketplace like ours. And that’s really something I think a lot about, which is how can I be better than word of mouth? Well, one, I can be broader. I can give you more selection. Your neighbors have hired zero or one plumbers in the last few years, and the odds that their plumber is right for you is very, very low, but you go to them because of trust.
Marco Zappacosta: Can I accomplish the same sort of level of trust and confidence that this person is going to do a good job while giving you dramatically more selection? That’s, I think, my biggest motivation, because when I think about the defensibility that we have, it’s really the relationship with these hundreds of thousands of small business owners across the country in 500 different occupations. And not simply that we know each other, but that they’ve integrated with Thumbtack. They’ve told us all of their preferences and sort of targeting criteria, and I know they’ve done it more deeply with us than any other platform.
Pete Flint: I hear you. I think the sort of offline sort of non-digital component, the opportunity or market share is sort of de minimus versus the opportunity. But I’m going to push back a bit, because I think there’s… You’re a sophisticated CEO. You’re probably kind of running kind of half a dozen different analysis every time, looking at kind of different competitors in the space who have a similarly or smaller kind of market share. As a CEO running a company then, how much do you think about competition, and how much are you kind of monitoring activities from other people? And I think you’re probably acutely aware of what everyone’s doing at one time.
Marco Zappacosta: Certainly. And I care a lot about being acutely aware. Now, interestingly, historically and certainly at the start, it was driven from a fear, like somebody’s going to beat us and, “Oh my god. Who else is out there? What are they doing?” Now it’s from, “What can I learn? How can that sharpen my own point of view?” And to speak specifically to sort of the competitive set that you, I think, were actually asking about, you do have the giant internet companies, Facebook, Amazon, Google. Facebook was trying to do this inside of Marketplace and shut it down. They obviously could come back to it, but I think they have the tyranny of being so global and so broad, and local services is so market-specific that I struggle to believe it will be very high on their list to generate the type of return that they need to see over the near-term.
Marco Zappacosta: Google, I think this does not play well with their DNA in the same way that they did not win in e-commerce, because they don’t have the operational willingness to go deep with these pros and these small business owners. I don’t see any evidence of that, and so I would presume that the way it plays out is they develop an ad unit so that they can capture sort of a better take than what AdWords can do that’s specifically tailored. And one already exists in Google Home Services, but I don’t fear them doing it sort of themselves.
Marco Zappacosta: And then finally, Amazon I think is from a DNA standpoint by far the best place. But what I’ve seen is that they have moved away from our approach because they weren’t able to make it work, and now tried to do it in a truly commodified way as a way of offering services to spur big ticket home good sales. If you’re buying a treadmill or a dishwasher or washing machine, most humans, myself included, need somebody to come set it up. And they know that to break into those categories, they need to offer that to you. But in these sort of more traditional or sort of more our bread and butter, like an interior painter, they don’t have any of that, and their attempts of it have failed. And it speaks to the fact that it’s fragmented. It’s also not organized. There’s no publicly available metadata, like skews that you can use to jumpstart your sort of ontology. Nor is there any point of aggregation, like a wholesaler or distributor, that you go and sign one deal with and instantly you have sports goods as a category is now available on your e-commerce site.
Marco Zappacosta: I think it’s uniquely fragmented and sort of opaque digitally, which makes it very hard to break into. And the competitors that we honestly look to the most are, on one hand, Angie’s Home Advisors, which is the sort of merger of Home Advisor and Angie’s List, which is our purest competitor. And then Yelp, which is thinking hard about this category and trying to monetize it better. And I think, yeah, happy to speak to both of those, but I listen to the earnings calls, or actually I read the transcripts, because earning calls are slow and boring. But I read them every quarter, and we have a team internally sort of in the finance team that catalogs it, that reads it, and we think about it. And we discuss it as a leadership team, because that is critical to stay abreast of and to learn from. Not to copy, not to sort of react to, but to learn from.
Pete Flint: Yeah. I wrote a piece most recently about hyper competitive battles and the sort of the classic battles that I experienced in Trulia versus Zillow, and you see Uber versus Lyft. It’s a kind of popular public narrative. And I think there’s one component in there which was more focused on sort of peer competition around what can be copied, often will be copied, and the importance of culture, and the importance of brand. Brand is just much harder to copy. And it sounds like this brand for you is, seeing the billboards around San Francisco, that’s increasingly a big push.
Marco Zappacosta: Oh, it’s a huge push.
Pete Flint: What is Thumbtack as a brand? What does that mean, and how does that manifest itself in the product experience as well?
Marco Zappacosta: I think at the end of the day, we need to be the most trusted place to hire the right pro for whatever you need done. That’s the aspiration, such that you can accomplish anything with Thumbtack. And people need to trust that, because first and foremost, it delivers. I think your product and the service that you deliver is the fundamental sort of arbiter of whether you can or can’t be or live up to your brand promise. But then also the personality of the brand needs to reinforce that point of view, such that it feels… I mean, the point that brand marketers rightfully make is that people remember feelings and emotions, not value propositions, not statistics, not facts. And so the way that your product or service makes people feel is going to be that key thing to generate a memory with them, and through that, drive retention and repeat usage. Fundamental, it’s something that I feel like-
Pete Flint: The product is the brand in digital businesses. It reinforces the brand and needs to create that kind of remarkable experience that you remember and you’ll return to. We talked about the future of marketplaces, and there are some schools of thought that things become increasingly online, increasingly digital. Certainly, I’ve seen that in kind of through the evolution over the last 20 years in marketplace businesses. How do you see that? How do you see the future of that online to offline interaction?
Marco Zappacosta: Oh, I think you’re right. I mean, the broad trend is towards digitization and digitally native sort of experiences mediating the exchange of goods, services, really everything. At the end of the day, what we facilitate is the exchange of time for money. You’re renting somebody’s time with dollars. And I think to take your point a little bit further, I think it’s about removing key points of frictions rather than taking the transaction online. I often talk to marketplace founders who are sort of obsessed with this notion of whether they should sort of be transactional and find a way to bring the transaction sort of within their sort of marketplace, and my first question to them always is, “Are you solving your problem or your customer’s problem?” And when you push on that, what you often hear is, “Well, I really want to be a commission-driven business model, and I think that sets me up for success. I think that’s what people want to see.” And I push, and they’re like, “Well yeah, for customers it’s not that bad.” It’s like, “Well, then why are you wasting your time doing that?”
Marco Zappacosta: In my case, you go talk to 10 homeowners, 10 busy moms, 10 potential customers of ours and ask them the most painful part of getting something done. 100 percent of the time, you will hear finding that pro, finding and trusting that they found the right pro. I have never heard paying for that pro. Now, I want to make paying magical and effortless, but not if it comes at the expense of making, finding, and hiring effortless, and that has to be the core. And once I’m sort of, not 100 percent, but further along than I am today, I will add in those other steps. But actually, from a motivation standpoint, in large part to fuel the matching, because it makes a better and better matching experience. Not because of something that I want as a business, be it the business model opportunity, or the ability to attract GMV more explicitly as such that I can put that as sort of the top line in my P&L.
Pete Flint: Yeah, but consumers don’t care about the end-to-end marketplace dynamic. They care about a successful transaction.
Marco Zappacosta: It doesn’t make their life better.
Pete Flint: Yeah.
Marco Zappacosta: And look, for something like ride sharing, payment was key. And it was, I think, a key way to make it… Booking was a big part of it, but being able to walk out that door and not worry was a big, big enhancement. But paying your painter? You spend very little mental energy worrying about or sort of… It doesn’t grate you. Now, we can make it better and we will, but it’s not my first order of concern.
Pete Flint: Marco, great to have you on the NFX podcast. Thanks for joining us today.
Marco Zappacosta: Pete, thanks for having me.
by Pete Flint (@PeteFlint). Pete is a General Partner at NFX, a seed-stage venture firm based in San Francisco.
Industry: PropTech (real estate technology)
What they do: Modus is building novel software for real estate transactions providing title, escrow, and security services to simplify the home closing process.
Round & Size: $12.5M Series A
Co-Investors: Felicis Ventures
In NFX tradition, we want the entire Founder community to benefit from funding announcements so we’re sharing the 3 biggest reasons we invested in Modus. As Founders ourselves who’ve started 10 venture-backed companies, we believe this level of transparency can shed greater light on how VCs see your startup during the pitch process.
Here’s what we saw in Modus…
1. Modernizing the real estate transaction process
For most home buyers today, the transaction process of buying a home continues to be complicated and takes place mostly offline.
In the past we’ve written that changing consumer expectations will create a massive and growing opportunity in real estate tech for startups that are able to improve and update the antiquated real estate transaction process.
Solving this is an enormous and complex process, and many startups are taking novel and exciting software-first approaches focused on different segments of the market or different elements of the transaction. Given the size and fragmentation of the US real estate market, we see an opportunity for there to be a number of large and successful customer-focused software companies being built around this broad thesis.
We are excited by and impressed with the Modus approach and how they have focused on simplifying and digitizing title and escrow services and providing essential security. Modus is looking to capitalize on that clear opportunity to help modernize real estate for both consumers and real estate agents.
2. Talented team with a unique blend of expertise
Title and escrow services represent a complicated and somewhat esoteric part of the real estate industry. While it’s an enormous industry, it’s not what your average tech startup Founder spends their evenings and weekends obsessing about.
The Modus founding team features a unique blend of expertise in real estate with a deep appreciation of the nuances and complexities of this industry, as well as the ability to build modern software and exceptional user experiences. In a short period of time the team has demonstrated their ability to be exceptionally fast learners and are students of all aspects of this product and business. Rapid and constant learning which enables companies to out-learn and then out-execute competitors or incumbents to become a category leader are at the core of all great businesses.
It’s rare to find people that have both top-class technical ability as well as a detailed understanding of this market category, and Modus’s founding team has both.
3. Superb Execution
Ever since we got to know Modus, we have seen how they have not only built a great product in a big market, but also built the foundation of what we think can become a great company. Strong execution in order to rapidly scale usage of a compelling product is what leads to impressive traction. As we emphasized in the fundraising checklist, the number one thing that Series A investors look for is traction. Modus has certainly achieved plenty of that.
Since their launch in July 2018, they’ve grown to 50+ employees and facilitated over $1B in residential purchases. They have captured 3x market share compared to their next closest competitor, despite being a newer company than the competition. We know Modus is just getting started.