Episode Transcript
Hello. It's Andrew from XO capital, where we buy small software businesses, hopefully profitable today. I'm going to be talking about maybe a thesis. This is version four of our. Ever evolving thesis. Now we say the reason we don't really have one is I think that we're a bit too small. We need to be a little bit. More opportunistic. Then the average bear. But I do think it's a good exercise to always think about what our thesis is and how we're filtering deals. And you know, we just raised our first fund. So as we think about raising others in the future and they start to get a little bit bigger. I think it's nice to narrow in, on the thesis.
So this one's a little poetic, but bear with me. I think part of this should not be any, anything new. And then part of it should be some new information or at least a new angle. So I'll start with just regular kind of venture backed company building. So company building is hard. Hard and capital and efficient. Both of those things are true. Irrefutably I think because of this many businesses raised venture capital, which has a business model. That business model requires outsized returns following a power law distribution. Okay. So venture has a business model. Venture capital companies are businesses themselves. They need to make a profit and the way that they do that, they invest in a bunch of businesses. Most of them fail. The ones that do work though, the power law distribution piece is that the winners have to have an outsized return, a very out-sized return.
So it doesn't look like a bell curve. It looks like a dumbbell. If you took off. You know, the left side of the weights and just left the right side at the weight. So there's basically nothing, nothing, nothing. Maybe a long tail. And then on the far right of the curve, it's just like hockey sticks up. Right? So a very small number, let's say in a hundred. We're talking three or four payback, all of the fund. And then some that's typically how a successful fund goes. So that's the power law distribution piece. So a high percentage of these companies fail, not news to anybody. You know, this is a little prescriptive, but failure is binary for a VC firm. Either the business has an outside positive outcome or it's irrelevant. So that is, that is directionally true. I wouldn't say it's absolutely true, but it's directionally true. You might have a couple that you can then pay back the fund with and then. Anything above that is gravy, but generally speaking, that is not how that tends to work out. It tends to be that. A very few number of the businesses end up returning all of the value for the fund. And then, so so that's not new information. What's new here, I think has our view. So, so failure for us is relative a failed VC backed startup with some revenue and some positive growth rate is an opportunity. So this happened to me, raised a bunch of money. Spend a bunch of money in the thing. You know, I don't know that. The current state of it, but I'm pretty sure it's, I'm pretty sure it's zero. I don't think that it should be zero. I think there was an opportunity for a sale there and the, you know, there was just no real infrastructure back then, too. To do something like this or not a lot of, not a lot or nothing that we found. So XO buys businesses that quote unquote fail from the venture perspective. So again, failure from the venture perspective really just means in the current market, are they able to raise the next round? So in a, like a rather constricting market, like this or constructive market like this, where interest rates are going up You need to be really on your, a game to go raise like a series, a B, and C, et cetera. And of course I hate scenarios like this, but you're in a room with a hundred people. And one of those they're all founders, right. Somebody's going to win. Somebody is going to end up, they all keep going. All right. And some of the businesses will fail. Somebody is going to win in that game. And that's the venture game, right? You. You're trying to pick that one person from the crowd. And I think the reality is, is that a different stage firms? That on like many of them. And then as they start to take off, then they pile more money into the, into the winners anyway. So, so if a business fails to reach the next stage of raising capital because they need to write that generally hire big teams. So generally focused early on, on product to get, this is really only for a B2B SAS, by the way. It doesn't, I don't really, we don't really think about. Other businesses that often. So immediately sass at the beginning, you're generally speaking, investing a lot in products. You have a lot of engineers are very expensive, et cetera. So they failed to re raise their next round in venture. But that doesn't mean the business sucks. That doesn't mean that, that almost says nothing about the business actually, other than it is not at a sort of bacteria level growth rate. If it's doing something like 3% month over month growth, I like that number because that means the business doubles in about two years. And that's pretty cool. Especially if you own a hundred percent of the thing, doubling your money every two years, you would sign up for that every time. If you could do it consistently. That's what we aim to do. So that's the, that's what I mean, when I say XO buys businesses that quote unquote sale from the venture perspective. So we buy the best products in the category.
This is relatively new as a sort of like checkbox item. I am personally tired of buying second, third, sometimes six seventh rate products in the market because that's all we can afford as we continue to not necessarily move up stack, but as we continue to go on to our 11th acquisition and beyond, I want to get increasingly better at buying the best product in that category.
Or. Some angle to become the best product in that category. However, we're really not at this stage. Operationally able to take. Product that's like the six best in the market and make it the best in the market. That's a significant engineering effort. And I think that that's not where we're going to, that's not where we're going to win, which brings me to my second part, which is we buy complete products that are sellable today.
So I want the best product in the category. Right. Or, you know, I don't know, top three, right. It's a big markets have many competitors, which is totally fine. But we want to buy a first rate product, a really great product. And we want to buy it complete. So I need to be able to have something that can sell today. Particularly for the flip fund. For example, if we only have 12 to 24 months and I have six months of engineering work before I can really step on the gas to do any kind of product led growth experiments that doesn't work right. I need more time than that. And so when we buy it, it's important that we're buying a product that is complete for the use case today. Now that's not to say it's not missing stuff, or we won't build incremental stuff, but I don't want six months of heads down engineering work before I can bring it back to market.
That's not really our game. I don't think that's how we will win. What else we buy a promising channel. So I want to buy their current source of customers. I don't care if that's ads. I don't really care if it's you know, search, whatever it is. I just want to buy that, that channel. We buy a growth rate, however, nominal. So we've bought stuff and, you know, very early on, we, we played around with little snack snack positions that are, that are $0 in revenue and they're kind of just experiments and you know, maybe potential for high alpha, but you know, they're, they're dollar wise, they're quite small. Generally speaking, we're always looking for some kind of growth rate. Even if it's nominal like a 3% month over month growth rate. That's totally fine, right. Again, that means the business will double in two years. We are happy with that. What else we buy initial customers. So I, I, you know, I've. Talked a little bit about product market fit and past articles. It's not necessarily that we're buying only products that have product market fit. But we do want to buy some initial customer base, ideally in product led growth land. That is going to be like a hundred plus customers. With no one customer representing more than, let's say 20% of the business. Even that might be pushing it on the PLG. On the PLG side of the house, but yeah, that's what we look for. So in one sentence, XO buys, VC backed companies with amazing products that ran out of time. So some notes here. That's not to say we're anti VC at all. I just think it's a very specific tool, a tool I've tried to use in the past. And I think it just tends to be applied to liberally. So that's like, oh, this, anything could be a venture backable business. Which is sometimes true, right? That is the, that is the whole game. Right? You have to be contrarian. And correct. And that second part is really hard. The other side of it is just that many businesses just don't reach the next level of funding or the founders get a little bit burnt out and that's really, it. Do we deviate from this? Yes, we deviate from this all the time. So you know we'd take this with a grain of salt but again if i had a bigger war chest this is this would be the preferred thesis it would either be this or we'd go vertical and just by like sales tools for example or everything had to be a developer tool that might be another angle but i really liked this distress venture the kind of cheeky way to put this is i want you to meet paul graham at the start of your journey and xo at the end of your journey That's all i got this week that is our maybe a thesis version for.
