E182: Lessons from 17 Years at Menlo Ventures and Accel w/Tyler Sosin

So, everybody comments on your name,

villain.

What is the origins for your name, and how did that come about?

Well, the origin for villain

comes from a quote from Batman.

Harvey Dent said to Batman over a dinner, You either die a hero or see yourself live long enough to become a villain.

And just as like a cinephile, I always loved that quote.

But when I reflected upon my investing career, you know, it truly resonated with with me as sort of a North Star of what success can be.

And that is

finding companies that basically survive and grow and continue to survive and endure through many decades

often and become

essentially the dominant players in their category.

And obviously, these companies, when they're young, they start off as heroes.

But if they do manage to get to, you know, a 20, 30 year mark, they're often villains at that point.

They express really interesting tendencies that

rational capitalists should love.

They have got amazing customer lock-in, really dominant relative market share, pricing power, and they're really hard to dislodge.

And so that's why I like them as my more starters.

What are some examples of some now villains that you invested at Menlo?

Well, I'd say more generally, like, hey, the universe of tech companies out there, like who would be, you know, in my opinion, a villain.

And this is coming at it from a

compliment, like Oracle would be a villain.

They've been around for a long time.

In the vertical software categories, you know, that I love so much, you know, Jack Henry and FIS in core banking, Vertifor and Applied and Insurance, you know, Epic and Cerner

and medical health records.

You know, these are companies that have been around for multiple decades.

They're very large.

They are extremely dominant in their categories.

And often, if you were to ask people who use the products or people who are trying to disrupt them, they are the targets because they're no longer innovating.

They capture a lot of economic rent,

but it's in some ways almost impossible to displace them.

It's almost like this full circle of the innovator's dilemma.

It's a startup incumbent now disrupted by a new startup, but on its way to being a hundred or

$500 billion company.

Yeah.

And I should say, I don't think villains necessarily have to be enormous to be that way.

I think they just need to be very dominant in the categories they compete in.

As Peter Thiel would say, like, he hates competition.

He likes monopolies.

Competition is for losers.

Competition is for losers.

And I feel the same way.

Like, I'd rather be in a business where, for a variety of reasons, at some scale, it's very hard to compete with them.

And so then they can start to display some villainous tendencies and

basically have amazing shareholder returns as a result.

So villainous tendencies are a side effect of having so much market power.

It's also the capacity

to have a relationship with a customer where you can extract economic rents.

And that's very hard for most businesses to do.

Most businesses compete in commoditized markets.

They have to basically run on that treadmill or sprint on that treadmill forever.

But there are a few companies out there that don't have to do that.

And those are the best investments.

I know you didn't define it by market cap, but let's define that now as a $100 billion company.

How many of those companies have this kind of extractive relationship with their customers?

And how many are their customers just love to give money, like a Starbucks?

There's different sorts of customer lock-in that you can appreciate.

I sort of see myself as an anthropologist.

And so, like, the question is, what are the

circumstances and the behavioral tendencies that create lock-in with a customer.

And on the human side, habit formation is a huge one.

It's why the nicotine companies have

been so successful over time.

It's why the Starbuckses of the world have been so successful.

In fact, if you look at, I believe it's the profit margins of addictive businesses, there's a strong correlation between how addictive they are.

and how profitable they are over time.

And then there's some secondary effects, reinforcement effects that really matter.

But for, I'd say, consumer products, addiction is a major point.

And then the other major point is things around habituation and just becoming

really familiar with something and therefore not wanting to give it up because it's what you know and there's a friction to changing to something new.

You have a bank account.

That bank account is connected to all these different bill play partners.

Your entire financial life is set up on it.

It's a hassle to move.

And it's that cognitive load and perceived friction that keeps people from switching, regardless of whether it's easy to do or actually really difficult to do.

So you invest at the earlier stage into these companies that you want to be a villain, to be mature and be a villain at some point.

What characteristics are you looking for?

If I come back to what I'm doing at Villain, I'm very focused on vertical software and technologies.

I'd say vertical software, vertical AI, vertical payments.

These are the sort of substrates that I will be dealing with at this firm.

The very best companies have very, very sticky relationships with their customers over time.

In a more dry sense, it's basically they develop annuities with these customers.

And the best businesses build a widget or whatever it is.

And that widget creates an annuity by selling it to that customer who basically consumes it for many, many years.

And so I want to see the earliest evidence of that annuity and the earliest evidence of a founder who knows how to sell that annuity with some amount of efficiency.

And if I find that in a vertical software market, I can get really excited.

That's evidenced by a low burn rate.

So soft customers continue to purchase the product month after month.

Is there any other

metrics and leading indicators that you're looking that a customer would would has this annuity type of relationship with the company?

You'd have to see what their behavior and usage are.

You'd have to test pricing and their willingness to churn if you were to suddenly raise pricing.

I'd like to know that a founder with an initial wedge in the market that's efficiently developing, generating these annuities, has a roadmap.

for basically building new products and features that they can sell to that existing customer to deepen the relationship significantly over time.

And you would argue that you're creating more of a feedback loop from the customer when they're buying multiple things from the same company, then they're more likely to become a long-time customer.

Yeah, and there should be two, maybe three reasons for that.

One, in cloud software, and this is like an important tenant of this business, like you have this data plane that you're creating, maybe with that initial wedge product.

And

in the best of cases, that data can be used in a second or third product to give you the right, like the permission to build a product that would be better than what someone else building that product, de novo, would build, because you're already using, you already have the data that's relevant.

So it's a matter of a different workflow system or a different set of computations, but you have an advantage by having the core data set that's used in a variety of different tasks.

So that's number one.

Number two is, you know, as you develop a deeper relationship with a customer and have multiple products to sell them, there's a

very powerful phenomenon, cross-subsidization, that can occur.

You are pricing and packaging multiple products together.

Often these products

work better together in terms of a synergistic

outcome.

But also in terms of pricing, you might be able to say, hey, if you buy this product and this product, they both work together.

And we can give you a discount where if you bought these products separately, it would be more expensive.

And over time, that's a very compelling way for more incumbent companies to compete against startups.

It's the bundling effect.

Give me an easy to understand example of a company that started with one product product and then successfully sold multiple products that most people would be aware of.

Microsoft would be a villain and would be very well known for having multiple products in a bundle where over time they have a lot of success

bringing out that new product, bundling it into their existing suite and ultimately

killing competitors or really driving competitors into sort of a state of commoditization as a result.

Going back to these companies that you look for that you think think could be villains or market leaders, what's the first kernel in a company that you see that this might be one of these companies?

When you think about competition

and how to find markets where competition is less of a threat, you know, there are probably a few ways of doing it.

One is

network effects.

I mean, that's a wonderful business model if you can attain it.

The second is

something like a Carvana, where it's like the amount of infrastructure and capex spend required to get to a scale where there's this virtuous cycle that is just so hard to disrupt is enormous right Amazon would have you know similar characteristics working for it I'd say the third that's lesser discuss discussed is market size and I read a book probably about 10 years ago that just opened my eye to this and it was a fascinating book called competition demystified I encourage everyone to read it but it was basically this sort of anthropological survey of monopolies and how they fail, right?

So you think of of monopolies as like, hey, these things really like they shouldn't fail, but every once in a while they get disrupted.

And the question is why?

And the answer, which is compelling to me, is it's an exogenous effect or something happens that actually increases the size of that market.

And as a result, it creates this sort of pocket of oxygen that allows a new entrant in to get to a certain amount of scale, where then they're able to basically compete with the incumbent.

And that it comes back to one of of the big areas where competition can be controlled is, you know, one of the big factors is market size.

And actually, it's smaller markets that I tend to like or sort of mid-sized markets because you have, there's just less revenue to go around.

And this results in behavior where because the market size is perceived smaller or is smaller, there is less capital.

funding new companies in that market because the perceived outcome is smaller.

Often these markets, when they're smaller, they're just like less understood.

They're more niche.

They're more technical.

It requires someone who like has exposure to that market and a build mentality.

That's hard to find.

And so there's fewer, I'd say, credible entrepreneurs who go into these markets.

And as a result, you have fewer competitors.

And when you have fewer competitors competing with each other, maybe a couple can grow up to be at scale.

And that's fine.

And then there's usually some sort of rational consolidation that occurs.

And so in smaller and medium-sized markets, as a result, you end up with these market share constructs that are often quite lopsided, where it's like, hey, there's three players who control 85% of the market or two players that control the market.

Look at a lot of the businesses I mentioned earlier: Epic and Cerner, Vertifor Applied.

I mean, these are relatively large markets, but they are dominated by two people.

And it's largely because they were small markets to begin with that grew over time, but these two players captured those markets.

And then, once you are a large player in a small market with a lot of the lock-in that I described earlier, even if someone wants to disrupt you, the fixed cost of doing so can feel prohibitively high.

And so that keeps a lot of people out.

So, again, like my thesis for vertical software, it's not to say that vertical software can't build really big businesses, but I think a lot of great vertical software is great because it is actually going after.

a smaller market where you can have less competition from day one, less competition entering over time.

And therefore, it gives you a lot more freedom, like a lot less pressure to have have to grow at any certain rate or to have to have like a build velocity that's you know keeping up with seven other competitors.

And it affords you, therefore, a chance to be much more capital efficient and take a much longer-term view.

So

put some numbers on it.

What is considered a small market in your playbook?

I would say

anything below like 100 million of Sam, you know, like, or TAM, total addressable market, is considered a

so 100 million of customers spending money in that market.

Yeah, we're like the perceived, hey, if we acquire this entire market, we could build a hundred million dollar business.

I think that's like, that is like relatively small.

Um, and for me, I would be interested in companies pursuing markets of that size up to, you know, 500 million.

Let's just go in the middle of that $250 million total market per year.

A bunch of venture capitalists are going, looking around the table at different firms, and they all see the same $250 million market and they say this can't return the fund.

Double-click on the rationale on why it's not as competitive.

Exactly that.

I think you would find a business.

I mean, my ideal villain investment, you find a company that is expressing that early efficiency, building an annuity with the wedge product that they're selling and therefore is growing efficiently.

And when you look around, you see

very little competition, right?

Like maybe there's one legacy incumbent and then that's it.

That's great.

And then the venture guy looking at that says, well, geez, you know, it's a nice business, but my opportunity cost is like enormous.

And so if I put a $5 million investment in this company, like I might make a 10X, but that doesn't move the needle for me.

I need to make my fund function.

Yeah, I need to believe that I can make 150, 200x on this investment.

And I hopefully with the funds the way they're organized now is I need to to believe I can not only invest that $5 million, but to really make it worth my time, I need to be able to invest another $50 million behind that or a hundred minimum behind.

It's a viable check size or

check size per company.

Yeah, there's a minimum check size that's in the way most funds work is like, hey, they've got a certain amount of slots, a minimum check size.

A fixed number of board seats.

There's a fixed number of board seats.

And then they think about the amount that an investment can return as a percentage of a fund.

And they're looking to basically with every investment they make, believe that they have a fund returner on their hand.

Funds, as they've gotten a lot larger,

it's just much harder for them to get excited about a business where it's like, wow, that's great.

That's a $400 million TAM.

Company is growing really nicely.

Like, whoop-de-dip.

It doesn't move the needle because...

I'm looking for the $50 billion company that I can write that first check, and then I can write a much larger check from my growth fund, and then I can do something even larger from an SPV.

And that's a very different

mode of thinking and capital allocation.

How do you make your mouth?

Three things matter.

One is fund size.

I think a fund size of $150 million or less is suitable for this strategy

because you could have a bunch of $3 million, $5 million investments where you're making a five to 7x.

And I think that those could have like a real, like they could be needle movers for that fund.

Fun size matters, concentration matters.

Like I think we would be looking for a portfolio that's a bit unusual in the venture industry where it's 15 to 20 investments versus I'd say 25 to 30 or 25 to 40.

And nominal pre-money matters.

Most liquidity in venture outside of the mega IPOs are acquisitions in the $100 million to $500 million range.

And so building an investment philosophy and a strategy where we make a lot of money on those outcomes.

And then if you were to reverse engineer into that, let's just say the average outcome you're thinking about is a 200 million EV once you sell it.

Therefore, what does the pre-money have to be in order to make a 5 to 15x return?

And my guess is that for us, it's going to be somewhere between and 30 million pre, depending on some of the underlying characteristics of the company.

And so then you might say, hey, well, Tyler, how do you find companies that have that early product market fit that you're looking for,

where you can sort of get them at pre-monies that sort of make sense, you know, that are nominally on the lower end?

And the answer is, well, you're looking for businesses where there's a fly in the ointment.

There has to be something that is countervailing, that is uninteresting to the mainstream VC.

And for me, the two things that I'm willing to take risks on are one, the market size.

And two, is the growth rate, right?

And so market size, we discussed earlier, growth rate, It's a longer conversation, but when you look at the venture industry today, I think there was a guy, like a benchmark partner interviewed on a podcast recently where he said, hey, like these new AI companies are growing at like 4x year over year.

It's now venture guys.

2x is 4x.

Venture guys always speak in like multiples of growth rates for the first three or four years.

I never understood why exactly, but it's like, now it's like, you got to be 4x, 4x, and then 3x, or like you mean nothing to me.

Right.

And you look at these companies and it is incredible that can grow from like zero to a hundred million in 18 months like it is phenomenal right but um like i'm delighted when they say this because it means like there's this like wide swath of companies out there who are only growing at like you know 120 who are like completely uninteresting as a result um and so when you get those factors like hey they might be growing a little bit slower um and 120 is like exceptional growth in my opinion they might be growing at like 70 to 80 percent

That would be fine with me, too.

They might be going after smaller champs.

That's fine, too.

As long as the pre-money valuation makes sense and the companies are efficient, and the founders and I lock arm in the ethos of compounding the business as opposed to just growing the business at the highest rate possible at all costs, we can have a very, very productive and lucrative partnership over time.

Is there a different psychology with these founders that are looking to build a two, three, hundred million dollar company?

Are they older, more experienced, less kind of in their 20s looking to become billionaires?

And is there something different about these type of founders?

I often think the founders who are willing to grow, go a little bit more slowly

have been burned.

Like I was actually speaking to a founder today who has this ethos of growing a bit more slowly, but also just like efficiently.

And, you know, his last company ran out of money.

It just cash zero and died.

The other phenotype of founder is one that's like been in the woods for a while.

I've done a few angel investments as we've gotten villain off the ground.

And some of these companies have been, you know, in the woods for five or six years.

And they started with something and they had to pivot and they had to pivot again.

So by the time they get to this product market fit that I love, like, I don't know, they've been kind of burned by the venture industry.

It's just very hard for them to raise capital.

The instincts of like survival and frugality are like in their DNA at that point.

In what ways is being burned like that an asset?

And what ways is a liability?

I think it's an asset, right?

To me, it's much more.

Because you could argue the opposite, which is it keeps them from making bold bets and compounding and all these other benefits.

But you would argue it's an asset.

Generally, I would say it's an asset.

In what ways?

Because I think the vast majority of even great businesses that fail fail because they grow too fast.

There's this urgency to

keep up with the Joneses, which again is like that 4x growth rate.

It's this feeling like, hey, if we don't achieve this perceived set of numbers, like no one's going to fund us, we're going to die.

Our competitors are going to overtake us.

I mean, there's like this panic that sort of you see as they start walking through their mental models.

And

I think that can lead to some really, really shitty capital allocation decisions, right?

Like most companies fail, in my opinion, in the venture landscape because they try to grow too quickly, they try to build too much product too quickly, and they basically parallel process too many things that need to be done in a more sequential manner.

And some of this also is just like certain markets require just more time to sort of like break.

And there's a learning curve to any business being built that just requires time.

And so I actually get quite like nervous about companies that are just growing fast,

whether they're permitted to because they have great economics or not,

there is something that frightens me a little bit because

I think

organizational capacity can get strained to the point where things can break

in a way that it's hard to put back the pieces.

And you've seen that in the venture landscape.

We've got all of these assets out there that are basically hung right like from 2021.

all these mega funding rounds chasing a lot of growth.

And

you could say there's probably

an alternative history where if these founders had a different mentality of just like growing,

I'd say taking a compounding mentality where it's like an endurance compounding mentality, where it's not, you know, triple, triple, double, double or 4x, 4x, 3x, but it's more, hey, I'm going to grow this business between 60 and 80%

for the next seven years or the next 12 years.

And I'm just going to do it on my timeframe, but we're going to continue making progress.

We're going to do it with precision and with capital efficiency.

I suspect a lot of the founders who now have hung businesses would be in much better places.

Aaron Powell, Jr.: It seems like there's like a dialectic here, like two opposing philosophies.

One is

about

founder market fit.

So you have like a Facebook that's literally plowing and burning billions of dollars trying to build their network effect before they even knew whether they had a business model.

That was like the question for many years.

And then there's a question in 2012, whether they could port their business model into mobile.

They had to deal with all that.

Sam Altman is another example, OpenAI just burning all this.

People still don't know whether LLMs will have a sustainable model, but they're just going out there and doing market share.

And then there's the businesses that like Qualtrics that grew and compounded over 20 years, oftentimes not in New York or San Francisco, in these like, you know, second-tier cities where they're compounding.

And maybe it's one of these industries that starts out as a $500 million TAM and it also compounds 12% per year.

And suddenly in year 20, it's a $5 billion industry and they have this kind of monopoly position.

So both models could work, but they're certainly different personality types.

You make a great point with Qualtrics.

You look at Procore.

I think that was a 20-year overnight success.

I think Service Titan was sort of under the radar building for a long period of time before it really broke out as an asset that VCs and growth equity firms liked.

But

I think there's something about that journey that makes these businesses amazing.

And for me, hyper growth is much less exciting than seeing a business that was a kind of a slower grower that actually over time starts to see their growth accelerate.

And often it's the case because like the sort of the flywheel is working, the multi-production product strategy is working.

The

familiarity of the market with the product is working.

They're becoming the standard.

The ecosystem is converging around them.

And these these create, you know, these flywheels of operational leverage where a business that was kind of sleepier, you know, growing at, you know, 70, 80%, maybe suddenly is growing at 120% at a much larger scale.

And when you see those things, you got to be like, wow, that's going to be an incredible business.

Sometimes the different arms of the business

aren't individually that spectacular.

When you put them into one system, they they achieve product market fit.

It's interesting.

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You bring up like, you know, Google or Facebook or or open ai you know i i there's a podcast i eventually wanted maybe do myself called like the first five years which would be going back and trying to get to like the first five years of financial data of like these you know really amazing companies uh because i actually think that you know facebook um was quite profitable early on.

If I look back at like their S1, like business grew like an enormous amount through the early years.

I don't know what the quality of revenue was.

Obviously, like Facebook had these network effects that were just incredible.

And so it's a business I really understand and appreciate.

And same with Google.

I think Google actually was really quite profitable out of the gate, growing at several hundred percent a year.

And so there are special businesses like that.

You know, OpenAI is a very different business.

It hemorrhages cash to the extent that these other businesses at their scale did not.

As a sort of a someone interested in company history or economic history, it reminds me a lot more of the the memory business, where the need to reinvest in the next generation model

feels like it's important for surviving and continuing to be the best LLM out there.

And I personally just think that's a really, it's a hard place to be.

I do think it's an interesting study today of these businesses that are being funded that have enormous burn rates in their early years and they're growing fast.

And the question is like, when they get to be more mature, how valuable are they and how defensible are they?

Startup history is also something that I'm really interested in, just how these things came about.

And one of the most interesting things is this kind of three-person club that Reed Hoffman, Mark Pincus, and Peter Thiel had talking about social networks before Facebook.

Talk about having a prepared mind.

They would just talk about this.

Obviously, Reid Hoffman also started LinkedIn.

I think Mark Pincus started a social network that ended up not getting off the ground.

They were kind of developing this thesis both in real time individually and also as a a group.

So they had this really powerful prepared mind for when Facebook landed on their lap.

They were almost waiting for the Facebook to come about versus to the rest of the world, the rest of the

7 billion people,

it just seemed like a totally novel, totally idiosyncratic business.

They were really ready for it.

For Facebook, it was probably some combination of cloud computing and modern...

software engineering and behavioral psychology, understanding addiction and how to get users engaged, that like all of these things needed to come together to make a network, you know, a network effect that we understand it as now,

you know, viable.

And before Villain, you were at Menlo Ventures, storied venture capital franchise,

best known for Uber and I'm sure many other DECA unicorns.

When you were inside Menlo, how much more powerful is it to be around a group of really smart people kind of workshopping these ideas versus I have this thesis.

How much did having a group help help you formulate your thinking?

Certainly in terms of blind spots, I think groups can be helpful, just sort of seeing something from an angle where

you didn't see it or you're not being intellectually honest enough with yourself about that potential issue or that potential upside that you just like haven't been able to accept.

And so

I think for that reason, like having people around who you can talk to about investments and get their feedback, people you trust is important.

And I definitely benefited from that during my time.

And now as a solo GP, how do you build that around you so that you have people to

riff with and to keep you honest in your thesis?

There's a very small subset of people out there who have similar mental models as I do about these types of companies.

They're at other small little firms.

And, you know, I think you can be very collegial.

Your partnership almost becomes this extended group of people who, you know, you're just happy to talk to about investment opportunities.

You're happy to have them look at investments.

And, you know, maybe that changes.

But I think when it's a bunch of small firms looking at stuff, like you can be in a situation where you can like both invest in a company.

The incentives are aligned for you guys to both co-invest versus one firm has to take the

so conscious about not having mediocre or poor thought partners.

Do you think that information could negatively affect you as well?

Any information can negatively affect you.

I think you, you know, thought partners are like this repeat game.

You work with them on something and you can decide after that you don't want to, like you just discounted their thoughts

or they might impress you, in which case, like you re-weight them even higher, sort of in your estimates.

I feel like I've been fortunate to surround myself and be part of firms where there's a bunch of really intelligent people.

And so I've just I've figured out the people who I like.

And when you talk to them over the course of several months, looking at several opportunities, kind of riffing, like you get a sense of like, do they, do they provide some insight that really helps your thinking.

And part of that sense is you know what excellence looks like, what a tier one VC looks like, and that's the standard that you hold your network to.

Whether it's a tier one VC,

my brother is one of the smartest people I know.

He founded

a hedge fund called CAS Partners.

I've learned a lot from him over the years, just mental models around endurance.

He invests at companies at much later stages than I do, but I think our thinking is similar.

What causes these businesses to continue to compound for many years to come?

What's the advantage?

It's both within.

top-tier firms like Menlo and like Excel.

It's within a broader network of people who invest in different asset classes, but can bring unique insights.

It's from reading.

I mean, I think reading is like a wonderful place to find mental models like competition demystified, people like Peter Thiel.

And you might have your own variant on it.

Like Peter Thiel is thinking about how do I build monopolistic businesses?

Like, you know, and he has a different substrate that he can work with.

He's like, I've got the Elon Musk Empire, the Peter, the Founders Fund franchise.

Like he has

advantages compared to me that allow him to invest in incredible businesses that look very different, but can achieve similar economic returns.

For me, I'm taking a more off-the-beaten path approach.

But again, I think our North Star is like, how do you find businesses that can persist?

When you look at tier one funds, is it kind of FOMO and herd behavior, or is it more just

rationally following incentives?

What percentage is herd behavior versus rational first principles thinking?

I think a lot of it is

herd behavior around certain themes and founder personas, and then, again, kind of coalescing around certain metrics that would basically qualify or disqualify a company as being.

And sometimes I think some VCs

don't understand why those metrics are what they are.

You're like, well, this company needs to be growing at 400% year over year.

Okay.

Why?

Or this company needs to have a 3X LTV CAC.

Okay, that makes sense, but why?

Like, what's the underpinnings of that from an economic standpoint?

And are all the 3X LTV CAC companies the same?

Are they the same or is a 3X LTV CAC company where the company has a nine-month lifetime value with its customer different from one that has a multi-year

customer relationship?

Are they the same or different?

The answer is very different.

But I don't, you know, I think there are a lot of very smart VCs.

I think there are, like any industry, I think there's a wide variety of thinkers out there.

One of the things that I really think about in asset management as a whole is there are these incentives for herd behavior in that if everybody goes down, if every long-only fund goes down by 5% and you're down by 5%, the LPs are going to re-up.

But if you're down and everybody else is up, even if the last three years you were up, that's going to put pressure not only on the fund to re-up, but your champion within that LP having to vouch for you.

So there's this kind of rational herd behavior where you could be safe in a losing strategy as long as the entire industry is going in that direction.

The way LPs LPs think obviously

sort of puts pressure on GP thinking.

There's some really interesting dynamics that I think people don't fully appreciate unless they've been in that seat.

Yeah.

Sometimes I question it.

I think that, you know, for instance, people give me feedback that, okay, hey, you know, 15 to 20 investments, like that's just not a lot of diversification.

I'm like, well, you also have...

15 to 20 managers.

Like you're diversified at the GP level.

So then like, why do you want so much diversification at the individual investment level?

I don't always get great answers.

I just think like things are done the way they're done.

And

it's better to have

okay returns with no obvious black eyes than, you know, great returns.

And so, you know, I think that thinking sort of can permeate through the industry.

Part of the art of being a GP is knowing which rules to follow and which rules to break, knowing which hills to die on and being very conscious about that.

And sometimes you could even tell people, I know everybody wants this, this is why I'm doing this, and a lot of

top LPs will accept that, but there's only so many variations to their business model they could also accept.

One of your paradoxical strategies is that your companies will be bought by PE, growth equity, incumbents.

Tell me about that.

And is that a fundamentally different business that

gets bought by strategic MA and IPOs?

Vertical software, when these companies get to a certain scale, and by that I mean 10 to 15 million of ARR, where they can basically float, they can be close to profitability or profitable depending on how fast they want to grow.

They become very attractive assets to a larger universe

than what I think is available to

any random venture-backed company.

Because,

again, vertical software companies, they build these annuities.

They have these very sticky customer bases.

So they're highly sought after by private equity firms or growth equity firms.

And so

those become an additional set of buyers for the companies that we'll be investing in.

And then related to that, there's companies like Constellation Software, who like their entire business is buying vertical software companies.

And so it's not that I don't want to build businesses that incumbents don't want to buy.

When I look at my investments at Menlo, and the acquisitions that occurred, Guildwire was bought by Hilti, an incumbent in the construction space.

Indeo was bought by Applied, again, another incumbent in the insurance space.

Calstone was bought by Carlisle.

Flywire went public.

Carta, I think, will go public.

And so there is more of a diversity.

I just think that at some scale, vertical software companies become great assets.

And that's just not the case for most.

venture-vac companies.

And so I think there's just better liquidity characteristics for these businesses.

So we're not going to orient selling these companies to PE just for the sake of it.

I just prefer that there are additional off-ramps.

The vast majority of MA in the venture market is still $1 to $500 million.

And I want to play to the fat part of that curve.

And so that includes all of the potential liquidity participants.

Does that make your fund kind of a mix of VC and PE, almost like a combination of both?

Yes.

I think it's kind of VC and like micro-growth equity.

I think the distinction is,

you know, I think a lot of PE firms, when they buy businesses, like that's the end of innovation or, you know, it's a lot about cost reduction and rationalization.

Like, I want to invest in businesses that, you know, are pushing products.

I want to invest in product-centric founders

who have just a long timeline ahead of them to build and compound their businesses at some reasonably high rate.

And I think that's a different ethos than what like PE would be bringing to the table for most of these assets.

I'm on the boards of several companies now in, that are vertical software businesses that have

grown to be much larger than I probably ever anticipated they could be.

And so that is a core tenant of this thesis,

which is that like

I think that one of the hardest things, one of the areas where VCs make the most mistake, most mistakes around actually like saying no to businesses that end up being very successful

saying no to businesses that at their earlier stages look like they're in nichier markets or smaller markets, and they turn them down for market size, but the businesses are working.

And eventually, as they scale, they discover new areas to expand into.

For me, like, for instance, when I was at Excel, you know, sourced this business called Peer Transfer at the time that turned into a company called Flywire.

And I remember like, this was a company that sold a reconciliation platform to college universities.

Actually, they gave it away for free, but it allowed them to monetize international student tuition payments.

So the value proposition was, hey, really hard for these college universities to manage international student payments, and also very expensive for students to send these payments through their traditional banking networks.

So you kind of solve the problem on both sides and you actually monetize through FX.

And we did it as like a Series A investment.

with Spark

at the time.

And I remember the company went out to raise like a Series B and like everyone turned down this company

except for

small town.

It was like, hey, this could be $150, $200 million.

So even after your investment several years later, it was too small even then.

Yeah, it's still a small business, but it's working.

Small, but working.

Right.

And

so that.

Which might as well be dead for VCs.

Might as well be dead for

some VCs.

One of the partners at Bain ended up funding it at the Series B.

And,

you know, the company eventually ended up compounding me much larger than anyone imagined, including myself.

And I think it's a $500 million revenue business today.

At one point, it was a $5 billion market cap.

It's, I think, closer to like 1.3, which is still much larger than 150 million in terms of enterprise value.

And I remember my colleague at the time, Adam Valkin, he was talking to the bain partner, and this is after the company IPO'd.

He's like, did you know, did you have like any sense that this company was going to be like a multi-billion dollar outcome?

And he said, no, like I underwrote it to a Forex and I was like completely surprised on the upside.

And in my career, like I've just, I've seen that time and time again, like whether it's, you know, Carta, which today is, you know, close to a $500 million business starting in the small dinky market of cap table management, or it's something like Qualia, which is like a really like amazing business in title software.

where ostensibly the core TAM that they were going after was $200 to $300 million.

Or even Everlaw, which today is an amazing business in e-discovery, where historically the size of e-discovery outcomes was quite tapped, or I should say quite limited.

There is a history of VCs when they say no to deals, they say no to companies that are growing really nicely, have really strong founders with great product DNA.

and where the blemish is the market size.

And I think what really people should be thinking about is how receptive is a market to the product.

Like if it's a small market, but people are buying, like that's something worth investigating.

What are some patterns across those four companies?

You get to a certain size and credibility where like you start to see adjacencies, whether it's like an adjacent constituent in the ecosystem that you can sell products to because the data that you're harvesting for your core products is relevant to them, or it's just other products within the broader stack of the constituency that you're selling to, it becomes like bigger and bigger and and bigger.

People could challenge me on this, but I have never found a business that has been like, well, I ran out of market size.

Like I just stopped every single customer and we ran out of market and could never figure anything out again.

It's that is not what happens.

Like companies stop growing.

They may start to saturate their market, but they typically stop growing because they their ability to build new product, you know, declines.

And so for me, like if we're going to go after, if we're going to invest in a company that ends up being the size of Carta, which now has four or five products, or the size of, you know, Qualia, which has, you know, several different products, like it is a, it is a long-term commitment to building product.

And I don't necessarily think it needs to be in some like hyperbolic, you know, eight-year period.

It could be over a longer period of time.

And as long as you have a really efficient business, it affords you that time to build that product.

And so

never underestimate a business that's working and a founder who builds while a business is working to unlock new opportunity.

It happens.

It's almost like a belief system, but it's magic.

I would add one other factor to that is the ability to fundraise and storytell.

Henry Ward has done a phenomenal job telling the story of Carta and connecting all the threats together into Carta's competitive advantage.

But other founders as well are able to sell past their current vision.

A good fundraise is something about selling the future, but the ability to sell the future is what makes the best fundraisers the best.

I agree, especially in the venture context.

What are those components that allows you to grow to 50 million, saturate a market, now grow to 500 million?

Double-click on that.

The number one thing is you have to become dominant in a certain vertical, like the size doesn't really matter, but you have to become dominant.

That sort of dominance allows you, you know, affords you a book of business, like ARR.

that gives you just a lot of cash running through the company.

So you have resources you have so then you consistently what about team you built a team that that executes that not a big factor team is very important um you know i companies can fail because there are there's a deficit of of quality hires and an ability to attract talent um but i think people can mistake like hiring lots of people for like hiring a great

quality versus yeah um like you can have a much smaller team that that really kind of

does incredible things over time.

And so I think it's about keeping the bar high, especially for the businesses that I'm going to be funding.

Like in especially in the earlier days, it's like they've got to approach the problem from, hey, everyone that we hire is high, high impact, but we're not hiring a lot of them.

Yeah.

So as your company, as you invest in these companies and they saturate the market, should they be taking

small shots on goal for their next market?

How do they operationalize finding the second market?

Often I think it's

very continuous conversations with customers and with

counterparties to customers.

Seeing where the market is pulling.

Yeah, yeah.

I wish you'd have this product at your.

Yeah, it's like, oh, wow.

I remember India was ultimately sold to Applied, but it was kind of an interesting story.

Like, they started out as this product that sat next to the AMS system that enabled

Cord's data to be collected more efficiently from customers of commercial insurance agents or you know brokerages and um they built this like this was the wedge products right like like ams systems are their data architecture like they are not structured to collect house this data do anything with it um and they didn't have the front end workflows and so this is what indeo built and got this really nice flywheel going building you know like basically a nice book of ar with um

with insurance agencies.

Lo and behold, you know, as we're starting to get get to a certain scale and thinking about the next products, obviously there's a bunch of other stuff we wanted to sell into the insurance agency.

But these insurance companies came knocking on our door and said, well, look, you have all of this Accords data that we essentially take from you in a PDF and then re-key it into our underwriting system so that we can

create

a policy or a quote for that customer.

sell us an API and we'll just consume the data that way.

Another way to look at it was what is a company?

It's mostly a brand promise.

So I go to Tyler and he delivers this to me.

Let's say

you do laundry and I come to you and you do laundry so well and I'm like, oh man, I wish you would do dry cleaning.

Why don't you do dry cleaning?

And I could start selling you for many months.

Like, this is the market.

I could bring my friends.

The customer actually driving the supplier to start something is even next level to product market fit.

Hey, if you built this, like I would love this.

This other product sucks.

Like we've got this huge problem.

And then it's a question of sequencing.

Like,

when you've got an empathetic founder who's product-driven and listening to their customers and has good instincts

themselves, then it's a question of prioritization.

All right, there's these five different things we could build.

Maybe three of them are for the existing customers.

So that's an easier sell because you're selling to that existing customer you already have a relationship with.

Or two are to their counterparty that, like, you know, we could like get some sort of network effects selling to them through our initial customer.

There's some sort of forcing function, like, we should consider that.

And you just have to think about, like, okay, well, how scaled is our business?

How much volatility is there in our core business versus, you know, like, how many things do we need to solve in our core before we start to think about what's next?

That's always the question.

Then, once you feel like you can do something next, it's all right, of these five different things, you know, what is the thing that we are most excited about, either in terms of like confidence in it succeeding or, hey, it really opens up this big new opportunity for us.

And you used a very specific term, sequencing, which is not necessarily shot selection.

I have these five industries.

I'm going to pick one.

I might do three of these five, but here's the exact order to do it.

Because if I do it this way, I'll get more profit, which will allow me to hire and solve these two problems faster.

Versus if I go this way, it's going to take 10 years to build a profitable business.

And then those two opportunities might not be there.

So it's also like the the seat, literally the sequence, not necessarily which business do I want to go to.

And I think a lot of times people confuse those two.

In asset management, for example, you know exactly what your business will look like at a trillion AUM.

There's five of these companies.

They'll have real estate, private equity, maybe some venture capital, some secondaries.

So it's not actually what will your business look like.

It's what is the best and most efficient way to get there.

It's kind of like this maze.

One thing that I always kind of look down on is these founders like a Naval Ravikant.

I would sit and he's like, I make nine months to make a big decision.

And I always egotistically thought, well, he's just being, he's just not proactive enough.

He doesn't have the courage to go out and act.

Like, why doesn't he just go do something?

But oftentimes, these are one-way doors.

You come in and you're now committed to this business for five, maybe 10 years.

So spending nine months could be very efficient to make that decision versus to use Jeff Bezos' analogy, it was two-way doors.

You could go in and go out.

Those maybe you do act quicker.

So there is a lot of wisdom to knowing when you do spend a lot of time deciding the next stage of the business.

If you could go back 17 years ago when you first started a venture in 2008, what would be your advice to a younger Tyler?

What nugget of advice would you give him in order to accelerate his career?

Hmm.

That's a great question.

You know, you stumped me.

I could ask myself that question.

I just started thinking about it.

The number one concept I would teach myself is this concept of ignorance debt, which is when you start something, there's a lot that you don't know about it.

And you have to methodically go out to seek the knowledge to make at least the known unknowns.

If you can make the unknown unknowns into known unknowns, you're going to progress much faster than if they remain unknown unknowns.

And I think the way to do that is just to get the right peer group and the right mentor group around you to accelerate your knowledge.

And then I've tried to teach myself how to do that because that's also

you have to learn those skill sets.

But

basically, trying to pay down my ignorance status quickly as possible.

That's a term coined by Alex Ramosi.

I like that.

You know, you flummoxed me.

The Thelians are like an interesting bunch.

Like, I feel

like it, you know,

sort of being close to that kind of founders fund kind of group would have been interesting.

Like there's just, I clearly take a much more conservative, you know, almost growth equity approach to venture building,

but there's, there's very clearly a,

you know,

I don't know if it's the classic venture model, but like kind of more the risk frontier model.

And not to say that I'd

be good at it.

I just I think it's fascinating, you know, what he's able to accomplish.

So the TL Fellowship and that whole ecosystem is really interesting.

It's very powerful.

It's like it's a very powerful, interesting ecosystem.

I think it's a very,

you know, their thinking is extremely first principles based and

it's quite foreign to me.

So I'm not saying I

would want to like do anything differently than I do today or think necessarily differently.

Like I like the mental models that I've accrued over time, but I'm impressed with they've been able to build.

How do people follow you and stay up to date with everything that you're working on?

If you're interested in getting in touch with me, either through LinkedIn or Tyler at villaincapital.com.

Awesome.

Thanks.

Thanks, Sally, for sitting down.

It was a real pleasure.

Thank you for listening.

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