Three Rules of Entrepreneurial Diversification
Three Rules of Entrepreneurial Diversification
When and when not to diversify time into side projects
TL;DR
There’s a lot of social pressure to do side projects. While sometimes diversifying into side projects is a good thing to do, there are times when it’s absolutely the wrong thing to do.
A little diversification is good for your health. Being 100% all-in on something is bad for mental health and bad for business.
We break our time into “main things” and “side things” which give us returns on our time in the form of money, network/audience, skills, and domain expertise. There’s usually a point of diminishing returns on our “main thing,” which is the point at which diversification into side projects is a viable option. We shouldn’t diversify earlier than the point of diminishing returns.
Sometimes it’s worth investing in our “main thing” beyond the point of diminishing returns if it can result in breakthroughs that help us level-up our careers (which results in higher ROI on any time investment).
Becoming world-class at something requires investment beyond the point of diminishing returns, but makes it easier to diversify into high-ROI investments later.
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Three Rules of Entrepreneurial Diversification
Estimated reading time: 8 min
Over the course of building an entrepreneurial career, we manage a portfolio of investments. At any point of time, that portfolio is made of a main thing (usually a day-job), along with side things.
Throughout our careers, we can play with the dials of how concentrated we are on our main thing vs. how diversified we can be into different side things. As I wrote in my post everyone is an investor:
If we have investments that are producing high returns, then we can choose to increase our concentration and double down to maximize our overall portfolio returns. If we hit points of diminishing returns with some of our investments, we can slightly divest and diversify into other areas…. We can create personal flywheels with these investments, where the returns of one investment automatically increases the value of our investment in another, resulting in the compounding growth in our entrepreneurial assets.
While entrepreneurs don’t talk explicitly about “diversification,” you can see it everywhere, and it can cause us to wonder, “am I not doing enough?” Founders are starting their own rolling funds, VCs are writing books, operators are starting podcasts, I’m writing this newsletter – everyone’s doing more, more, more. And there’s good reason for that – maximizing the output of an entrepreneurial career requires some diversification and experimentation (AKA getting shots up). But more is not always better. Often, focusing on doing less allows people to become world class at something (or just really freaking good at their job), which results in high-ROI opportunities finding them, making it easier to diversify into high-ROI time investments down the road.
This begs the question, “when and how should we diversify our entrepreneurial investments?” There’s no silver bullet answer, but through my own experiences and my conversations with other entrepreneurs, there are three rules I’ve observed:
Rule #1: A little diversification is good for your health
Rule #2: Use the point of diminishing returns to determine when to further diversify (if at all)
Rule #3: Diminishing returns can be worth it if the time investment results in breakthroughs
Rule #1: A little diversification is good for your health
A few weeks ago, I saw some fortune-cookie-tweet startup advice that made me throw up in my mouth.
While founding a startup requires a more-than-ordinary level of personal commitment than other jobs, the only way this is good advice is if your goal is to become mentally ill.
In a post I wrote in 2018 called How Getting Your Identity from Your Startup Can Hurt it, I share how lack of diversification was not only unhealthy for myself, but for the business:
Compass quickly became my obsession, and with my entire identity wrapped up in it, my Compass accomplishments became my sole source of self-worth.
In the early stages of starting up, I didn’t notice this as a problem. In our first 18 months, we experience a lot of the early stage accomplishments that you may achieve if you’re all-in, like getting our first 10 customers, attracting co-founders, getting our next 50 customers, raising an angel round, hiring our first employee, and consecutive months of growth.
...I didn’t realize how dependent I was on these accomplishments to feel good about myself. If anything, I attributed these early successes to the very fact that I was betting my entire identity on my startup. I thought, “I’m accomplishing these milestones because I’m obsessed.” It positively reinforced a dangerous idea: that betting my identity on my startup was not only healthy, but that it would result in more accomplishments.
Spoiler: it was not the case. Thinking that my startup was my identity wasn’t only bad for my mental health, it was bad for business. I became dependent on the self-worth immediate gratification that came from short-term growth, and I wasn’t able to embrace the delayed gratification that was required for us to find break-out success. Over time, the accomplishments slowed down, my mental health declined, and ultimately we failed.
Avoid becoming over-leveraged on your main thing. Cultivate side things (even if very small and non-ambitious) that give you energy and a sense of self-worth.
Rule #2: Use the point of diminishing returns to determine when to further diversify (if at all)
The law of diminishing returns states that at some point, continued investment in time will result in lower incremental returns.
If we measure returns on our time as the combination of money and entrepreneurial assets (Network/Audience, Skills, and Domain Expertise) we collect, then time invested in our “main thing” might look like this:
For example, Brain Bosche, whose personal flywheel I featured in a previous post, has a day job at Smart Sheet, where he’s the product owner for marketing and creative solutions. Brain has diversified into side projects including (1) his weekly podcast that goes behind the scenes with marketing and creative leaders and (2) building a social media following by creating content at the intersection of basketball and photography/videography tips. For Brian to be diversifying into these side projects in a way that maximizes his returns, he would be spending 60% of his time on his day job, 15% of his time on side project #1, and 15% of his time on side project #2.
But sometimes, our “main thing” can give us high returns that seem to keep increasing the more energy we invest.
If you found a game at a casino that predictably gave a 1% return on investment, would you still want to spend time on the roulette and blackjack table? Hell no! You would play that game for as long as you could until the casino realized it was bleeding money.
In entrepreneurial careers, there are examples like this when it’s more valuable to be more concentrated than to be diversified into side projects, like if you’re running a startup that’s taking off, or if you’re working in a job where you’re advancing and learning quickly. I found that to be the case when I first joined Amazon. Diversifying too much into side projects in my first two years at Amazon would have prevented me from getting a lot of the returns that I’ve gotten in the past 2+ years. In these cases, the point of diminishing returns is actually at a point greater than the time we have available to invest, so diversifying would come with significant cost.
Rule #3: Diminishing returns can be worth it if the time investment results in breakthroughs
Jack Altman summed up the potential downsides of diversification well with this tweet:
Jack is touching on the higher level idea of breakthroughs, which is a counterargument for diversifying at the point of diminishing returns. Achieving breakthroughs usually requires time investment beyond the point of diminishing returns. If achieved, a breakthrough can increase the ROI on your time.
For example, if you’re spending time in the shower or on walks thinking about certain challenges, you may have breakthroughs that help you solve difficult challenges, come up with new ideas, and completely change what the ROI curve looks like. People who become world-class at something often have to invest far beyond the point of diminishing returns to have many small breakthroughs on the path to becoming world-class. But then high-ROI opportunities find their ways to people who are world-class at something.
The example I think illustrates this most starkly is outside of the world of startups: Serena Williams. As of 2011, she had an incredible tennis career. She was widely considered a top 10 all-time tennis player, but slid from #1 in the world to #4. It was unclear what more there could be for her. After all, the only thing better than being a top-10 all-time tennis player would be to become the greatest of all time. There’s only a marginal increase from top-10 all time to #1 all-time, but it would require require all-in investment for another decade. At that point in her career, she was at the point of diminishing returns. Logically, it would have made sense for Serena to ride out the long-tail of her career and begin diversifying.
Serena then broke the law of diminishing returns by breaking through and going from a top-10 tennis player on the other side of her prime, to returning to #1 status for 3 straight years and dominating the sport for another decade. This solidified her status as the greatest ever, one of the greatest athletes in any sport of all-time, and a cultural icon. That stature has enabled Serena to later diversify in so many ways – Serena is now a successful VC, involved in countless business ventures, and is still one of Nike’s top-paid athletes.
While none of us will be the next Serena Williams, this rule is an important counter-argument for us to consider when thinking about diversifying into side things. If we think there are opportunities for breakthroughs with our main thing and we want to realize them, then we need to invest our time beyond the point of diminishing returns. Becoming regarded as an expert in paid media, hiring, or sales operations likely requires investment beyond the point of diminishing returns. But those who develop true expertise end up getting access to the best opportunities long term.
Given these three rules, are there any side projects you should start? Any you should kill so you can concentrate elsewhere?