I believe that we live in the world of Power Law, I have written about it before. I even wrote a paper to show that Iceland or any microeconomy is governed only by power law. All natural phenomena follow a power law as well. It is understandable that many of us don’t see the relevance of the power law in our day to day activities, but understanding the implications of power law is extremely important. Especially for Startup Founders and Entrepreneurs. I am not referring to those entrepreneurs building a lifestyle business or those startup founders not into growing rapidly.
Understanding power law clarifies the requirements of venture investing. I think it is also important for Angel Investing. The first heuristic of Venture Capital Investing is to ask the question if a single investment has the potential to return the entire fund back to you. What do I mean by this? lets say you are managing $50m in Venture Capital. You have been working with a Founder and she and the team has all the right ingredients, the question to ask is if you invest lets say $500k does the company have the capacity to return a 100 times your money. This a difficult criteria to evaluate, it more or less rules out many of the opportunities. That is the nature of this business. The thing that really trips investors is that gauging the market potential is not a trivial task. This is why I believe strongly that Venture Investors need to be humble, I meet so many Venture Investors who are of the type “King of the World” i.e they seem to think they know the market better than the Startup Founders, this is hubris.
No-one knows the market potential. The only way to know the market potential is to work on problems with the Startup Founder and see if you can navigate to a place where higher potential to address a broad market evolves. At the early stage the addressable market always looks small and that is a good thing. This is one of the main reasons I believe that Iceland and other smaller markets are great places for Startups. Anyways, the follow up question to ask is can this market potential be expanded? Facebook started with an addressable market of just Harvard University students i.e 10,000 people, the broader question that Mark Zuckerberg was asking was why is there no People and Relationships part of systems on the internet and true identity. Bringing true identity and getting everyone connected through “Friending” was a broadly addressable issue. Building a business model on top of that leads to Power Law type returns. This is what Startup Founders need to do. I also strongly believe every Startup Founder is an investor, they invest their time effort and a good part of their life to build a company, therefore they need to ask themselves the same above question.
The reason why I believe it is difficult to understand Compounding and Exponential growth is due to our incremental thinking. In addition, we are surrounded by optionality i.e everything is important, 90% of us believe we are better than average drivers. See my problem? A simple trivia proves that majority of us don’t get exponential scaling.
A Bacteria is 10 liter container doubles every minutes after 55 minutes the container is full, how many minutes before the container was half full?
If you answered 54 minutes congratulations you either knew the answer or have solved a similar problem. We are blind to this in our day to day life, because we don’t see this happen in front of our eyes. I constantly look for power law curves, a good trick that makes you think about exponential scaling is to think about the rule of 72.