Mental Models and Pre-Seed Founders

I am a big fan of mental models.

These heuristics provide a convenient way to rely on experience and intuition in lieu of formal analysis. The emphasis on the former can provide quick, valuable insights that defy traditional means-tested ways of achieving the same conclusion.

As an investor, I often use heuristics to guide my investment decisions. At my fund, we see roughly 1,000 deals per year. Over time, and with enough pattern recognition, we’ve crafted a few heuristics that have made filtering these companies in a short time almost second nature.

One I cite often is Founder-Product Fit: is this founder or team the best fit to build the product or service that will disrupt an industry? That question makes the team slide one of the most important for us, but also conveys how quick mental shortcuts like this can save time from moving forward with a deal that otherwise would require a more involved process of diligence.

While investor-specific heuristics can be a fun topic, I think it more valuable to discuss a few that I find applicable and meaningful to builders and early-stage founders.

Below, I have listed several "rules,” each with a problem or situation, a case study for the rule applied to businesses at scale, and its application to pre-seed founders. This essay is intentionally brief, emphasizing the abstraction and simplicity inherent in heuristics.

Arndt-Schulz Dosage Rule:

The Arndt-Schulz rule emphasizes that the effects of a substance or action can vary significantly depending on the dosage, particularly in a pharmaceutical context. In small doses, a medicine may stimulate or benefit, while moderate doses can inhibit or hinder, and large doses may even be harmful or fatal.

• Problem: Many problems come from doing the right thing in the wrong dosage.

• Case Study: Around the turn of the century, Segway, an ambitious entrant in personal transport, erroneously applied the Arndt-Schulz Dosage Rule. Amidst changing trends in urban mobility, Segway devoted its resources to perfecting its revolutionary vehicle design (right thing), but neglected the essential demand for user-friendly and practical solutions (wrong dosage). This strategic error allowed simpler, more convenient alternatives like bicycles, electric scooters, and compact cars to surpass Segway. The company's misstep was not a lack of ingenuity but rather an overemphasis on product sophistication at the expense of market demand.

• Application: Pre-seed startup founders, particularly those with a strong technical background, can sometimes become overly focused on product development and innovation. While creating a superior product is necessary, it’s not necessarily sufficient: it's equally important to stay in tune with building something people want. Innovation is a difficult balance between demand, invention, and distribution.

Zipf's Distribution Rule:

Zipf's law posits that, in any large set of data or occurrences, a small fraction tends to contribute disproportionately. For instance, of approximately 1 million words in the English language, only 1,000 account for 75% of all usage. This concentration phenomenon extends to business, where a select group of companies or products often command outsized influence and market share.

• Problem: It can be both easy and fulfilling to fall into the trap of prioritizing incremental improvements, failing to acknowledge the high opportunity cost of not focusing on the primary, step-wise innovations that can cement a company’s legacy.

• Case Study: In 1997, Apple was on the brink of bankruptcy, cluttered with unfocused product lines. Steve Jobs, upon his return, trimmed the fat: he cut the product line from 350 to 10. He concentrated on a few areas where Apple could distinguish itself, leading to the iMac, iPod, iPhone, and iPad. These product lines continue to fuel the engine of Apple's economic and technological prowess, elevating it into one of the world's most valuable companies. The key wasn't incremental tweaks but ground-breaking, monopoly-inducing innovations.

• Application: Pre-seed startup founders should concentrate on developing monopolies with deep, unshakeable moats rather than incremental products that create a race to the bottom amongst competitors.

Dollo's Loss Rule:

Named after the Belgian paleontologist Louis Dollo, Dollo's Loss Rule originally applied to evolution, stipulating that an organism can't regain a complex trait that it has lost. Applied to the business world, this rule conveys the importance of safeguarding intangible, irreplaceable assets within an organization. Assets like brand value, relationships, and reputation aren't commodities that can be casually bought or replaced. They are built over time through deliberate action and sustained effort. Once they are compromised, they can be irrecoverable.

• Problem: It’s easy for a company to devalue its reputation and brand in its infancy, only to learn that it cannot be recovered once lost.

• Case Study: Uber serves as a stark illustration of this rule. The company, during its early years, fostered an aggressive, 'win-at-all-costs' culture. This culture led to many public relations and legal troubles, tarnishing the company's reputation and stunting its growth. Uber overlooked the importance of a balanced, respectful work environment, focusing excessively on rapid growth and market dominance. However, the true cost of this imbalanced approach surfaced when allegations of sexual harassment and discrimination came to light. The fallout was significant, leading to leadership changes and a painstaking process of cultural rebuilding.

• Application: For pre-seed startup founders, this rule necessitates leading with unyielding integrity and a holistic view that considers not just the immediate but the full range of potential costs. The knock-on effects of short-sighted, margin-focused thinking can be severe.

Latent Diseases Rule:

The Latent Diseases Rule refers to the concept that harmful issues, like some medical diseases, can hide unnoticed for a long time before they become so large that it causes substantial damage. This rule applies not only to health but also to businesses and macroeconomics. In these contexts, significant problems can lurk undetected, appearing harmless or even non-existent, until they take a swift, detrimental stronghold, often when it's already too late to fix.

• Problem: It can be easy for a founder to lead with both ego and excitement at the prospect of raising at an overinflated valuation, especially in an environment of low-interest rates and cheap money, only to face the cost when unable to meet metrics for subsequent rounds at favorable metrics.

• Case Study: WeWork's journey offers a salient example. In a low-interest rate environment, the company's valuation skyrocketed, seemingly divorced from its actual financials or business model. When the veil was lifted during the company's attempted IPO, the latent disease of overvaluation became clear. The outcome is well-known: a reversal in the company's valuation, a withdrawal of the IPO, and a significant loss of investor confidence. WeWork continues as a stark reminder of the potential downstream impacts of unchecked valuation inflation and raising with ego.

• Application: Founders at all stages must understand that valuation is more than just a number; it signals to the market your startup's health and potential that you realistically can live up to. An inflated valuation could hide underlying issues, leading to a painful correction. Always be transparent and realistic in your startup's valuation, focusing on long-term sustainability and growth.

These rules and their corresponding examples offer a few insights that can guide founders in making decisions that will shape the course of their startups. From understanding the importance of balanced priorities and strategic focus to recognizing the value of safeguarding key assets and proactively addressing potential issues, each heuristic offers a unique lens to view and navigate the entrepreneurial journey.

The takeaways are simple:

• Arndt-Schulz Dosage Rule: Don't merely perfect your product; aim to solve a pressing, significant unmet need. Prioritize transformative innovation over mere refinement.

• Zipf's Distribution Rule: Remember that a few key decisions can define your success, so discipline your thinking to focus on enduring, transformative value-creation.

• Dollo's Loss Rule: Protect your reputation and relationships like the irrecoverable assets they are, and never underestimate the full cost of your decisions.

• Latent Diseases Rule: Maintain a vigilant eye for latent issues that can unravel your startup from the inside out. Ignoring these can lead to significant damage down the line.

Special thanks to Zoe Enright for assisting in the abstraction of the notes and to George Mack for inspiring the post.