How to choose a great problem space and why it matters

A mediocre team in a great problem space will outperform a great team in a weak space. What makes a great problem space?

In some ways it’s a “you’ll know it when you see it” thing. In others its quite measurable. There are problem spaces that are exciting for investors, and others that are exciting for customers. Sometimes they overlap. Usually something that is exciting for customers will eventually be exciting for investors–but things don’t always happen the other way around.

What a great problem space looks like

For investors, a great problem space fits a thesis or theme. It’s best explained with examples. Right now AI is hot. Within AI there are subcategories that are even hotter–like, as I write this, agentic AI. If you cold-email a popular VC with a credible AI idea you’ll likely at least get a response–if not a meeting. Ecommerce, social networks, mobile, adtech, martech, SaaS, mobility, crypto–there are countless examples where for 2-3 years all investors chase the same types of companies. Most hot spaces go cold eventually.

For customers, it’s where there is massive demand–whether in attention or budget. Online video is an example in ~2005: the whole market experienced massive growth because consumers simply liked consuming the video they wanted, when they wanted it. This happens to be a good example of a hot market for both investors and customers, and resulted in big exits (e.g., YouTube) even though the revenue hadn’t arrived yet (advertisers took much longer to convince).

In B2B areas, customers have budget for things in a hot space. They are looking for solutions. Around 2010, social was hot. Wildfire grew like wildfire until it sold to Google because companies would spend anything on social. Google paid a huge multiple because social tools were hot. In mobile in the 2010-2015 time period, every company had millions in budget to build apps and “get into” mobile. The same happened with crypto in the 2018-2020 timeframe. You could launch a half-baked project and raise $500mm because there was simply demand for it. Why? Maybe ZIRP. Maybe FOMO. Maybe crypto really IS the future of currency. It doesn’t really matter. You don’t need to know why a space is hot to take advantage.

Why problem space matters

Being in a hot space gives you real advantages. First, investors are more willing to invest at all stages. Second, acquirers will overpay, or at least pay higher multiples. Third, customers have budget and urgency (or attention) which are critical to building a venture-scale startup. Intrinsic budget and urgency make GTM work in a way that you cannot manufacture on your own. Finally, employees will want to work in a hot space–making it easier to build and retain a great team.

Some examples from this week: I met a company at TechCrunch that was 100% comprised of recent Stanford graduates and had raised a $15 million Series A, pre-product. You can’t do that today with an ecommerce idea, but you can in AI. Both things–raise $15 million pre-product AND hire a bunch of Stanford grads.

Another AI company I met built a competitor to the big LLMs for specific agentic use cases, which they claim outperform those big LLMs. It turns out, companies are spending 5- to 6-figures on AI agents like Claude every month. It’s been easy for his team to get meetings, and from there easy to get customers to try theirs. If it really is better, they’ll convert. Because the budget is already there.

How to tell if you’re in a hot space–or not–with VCs

If you’re getting a lot of meetings, then you’re probably in a hot space. Most VCs won’t entertain ideas that are in boring or uninteresting spaces (unless they have really, really good metrics). If you get a response, it might be to politely decline the meeting entirely. This is because they know that even if they invest at the seed round, it’ll be very hard to find someone to lead a Series A.

If it’s difficult to get meeting, that is usually an indicator that you are working in a space or on a problem where interest is low. Great metrics get you meetings–but that won’t improve the bigger issues, such as harder fundraises, worse terms in general, lower multiples in rounds and at exit.

Even if you are getting meetings, it might be because of who you are or your metrics rather than the space itself. Ask partners in meetings–is there a thesis around your space? You’ll find patterns if you speak with enough VCs. Obviously, AI is an example of one such pattern. But within AI there are different areas–some are hotter than others. For example, building fundamental models still seems to be more interesting to VCs than wrapping ChatGPT to solve specific use cases.

Note that angels can be uncorrelated to professional VCs. Professional VCs tend to think more similarly to each other and chase trends more than angel investors (who, to be fair, also chase trends). That can be because they go pitch their funds to limited partners (LPs) and they need a compelling pitch–e.g., we’re AI experts and we’re going to find the best AI companies. So most are at the mercy of what LPs want to invest in. If you’re doing it right, you’re talking to angels who are interested and knowledgable about your space–even if it’s passé. Angel investors, due to their subject matter expertise, may also be earlier to hot spaces than professional VCs.

How to tell if a space is hot from the customer POV

Just because investors are into a space does not mean customers are. With customers, determining if you are in a hot problem space is far easier than with investors. It’s frequently easier to get meetings with potential customers than VCs anyway, but if you’re in a hot space you’ll get meetings even easier and with less proof or traction.

Customers will have urgency and budget if it is a hot space. They will ask if they can use the product immediately, ask what it costs, and other leaning-in questions. They might immediately sign up for a waitlist, newsletter, or other way of keeping informed. For enterprise motions, getting time with executives or other key buyers will be easy, and getting budget will also be easy for companies that like to innovate. Your customer advisory board will be oversubscribed. People who aren’t even on it might say they are on LinkedIn.

Customers are more correlated than investors. If you find one customer that is into a particular thing, chances are high that similar companies will also be into that particular thing. And vice versa: if you can’t get meetings with a few prospects, chances are you won’t get meetings with most. Some of that could be you (bad pitch, lack of PMF, etc.). But it could also be the space.

There are plenty of examples of great spaces that investors never realized were hot–SurveyMonkey bootstrapped to $20 million in revenue with less than ten people, for example. Better to find a space where customers are excited.

Why matters more with customers than with investors because it can help you avoid passing fads. Investors will eventually move on to the next big thing, and mostly that just means valuations will come down. If customers move on that means revenue could dry up and you could be out of business. Fear is always a major motivator–fear that a CEO will be ambushed by her board is a thing from the seed stage through public companies. I’m sure right now every CEO needs to have an AI strategy, and that’s driving a lot of the market. ROI, cost savings, revenue exapnsion–lots of other things seem to make it real. This was not the case for other hot spaces (e.g., personalization or virtual reality).

Selling–or not

I’ve worked with companies that got legit 500x revenue valuation multiples because they were a leader in a hot space. It is an absolute certainty that these multiples come down over time. If you get an offer at a ridiculous multiple, seriously consider taking it. If you are early in a hot space, and sell, perhaps there’s time to build a second company.

However I can tell you for certain that it will take many years to grow into that valuation, if you ever do. Let’s say you’re doing $500k in revenue and a public company excited about your space offers you $250 million. Assuming you’re SaaS, the average revenue multiple pre-covid was ~10x. When the market comes back to earth, you’d need $25 million in revenue to be worth the same $250 million at that lower multiple–and statistically speaking, you’re unlikely to get there. If you do, it’s probably 3 years out at least. Is that a risk you want to take?

Pivoting–or not

If your space isn’t hot, should you pivot? You can absolutely make a bad space work–but it’s hard to make one compatible with venture capital. So what do you do if you find yourself in a bad space? Maybe pivot.

There are two things to avoid. Don’t pivot for pivoting’s sake. I had a successful Y Combinator founder share with me that an investor he met was pushing him to look at a different market, even though their product was selling well and they had more demand than they knew what to do with. Why? Because maybe their market wasn’t big enough. But pivoting here makes little sense–GTM was working, and they had no reason to believe they could do as well in an unrelated space chosen for TAM, not customer need. If you’re getting early traction with customers and they value your solution, don’t overthink it. Customer excitement and traction trumps investor excitement.

The other thing to avoid is stubbornness. If you’re stuck in a tough space and haven’t figured out growth for 1.5-2 years, what makes you think the next 6-12 months are going to be different? Chances are you did your best for that 1.5-2 years, so unless something truly changed, consider a pivot. The struggle bus is not going to magically turn into a rocket ship overnight unless you really change things. So many companies did this–Slack, Nextdoor, Docker, Segment… the list is endless.

How to find a hot space

There are several great ways to find an exciting space. First, talk to customers. There are countless problems to solve, if you’re really listening. Second, talk to investors. They’ll tell you what they’re looking for, what their thesis is, what they think is over- or under-hyped. Just know that even if investors are looking for a specific thing, you might not be the right person to build that thing–or, they might be very wrong. Third, use public resources to find interesting spaces. Google Trends shows you what keywords are trending. Forums and meetups can point you to emerging spaces very early. Posts from venture publications like TechCrunch, PitchBook and others might be bad for your mental health but certainly highlight what is hot right now.

Working in a compelling problem space has key advantages that nothing but a great space can provide. The choice of problem space has a tremendous impact on success–far more than your skill or ability, team, or anything else. I personally have worked with teams who flailed in a space that wasn’t great, pivoted, and exploded (in a good way) when they found a good space. Things that didn’t work all of a sudden worked brilliantly.

If you’re stuck–especially in fundraising–consider your space. But don’t pivot just to pivot; if you’ve found something that works, stick with it. If you haven’t found something that works, take a BIG step back. Perhaps you’re in the wrong space entirely.

Thanks for reading! If you enjoyed this please reply and let me know. I’ve been getting a lot of emails lately about the last few newsletters, and it helps to know what’s useful. Also, tell me what you’re interested in hearing about so I can keep writing stuff that hits!

Want to meet and talk about this subject? Calendar here. Prefer a 1-hour course? Free one here on how to prepare to sell (what you need to do now to sell in 3 months or 5 years).