Monthly Archives: September 2017

Private information

I spend a lot of time consuming and processing information to inform my thinking. This thinking is what eventually informs my investment decisions. I believe that success in VC is determined at least as much by the quality of your investment decisions as by how much value you add to the business post-investment. So the time I spend consuming and processing information is very important.

There are two types of information that one can access. These are public and private information.

Public information, by definition, is information that everyone has. And since everyone has access to this information, it’s difficult to gain a competitive edge when investing based on public information.

A great example of public information is news articles. By the time something is covered by the media, the action has already taken place. As a result, any returns to be gained based on acting on the information in the article have already been taken by others.

The fact that public companies need to make most of their information public is why it’s much more challenging to generate outsized returns in public markets than in private markets. In the public markets, you’re making investment decisions based on information which is accessible to everyone willing to put in the time to research, read, and understand it. Trading based on insider (in other words private) information is illegal. To produce a return, you need to have an insight that others who have access to the same public information don’t have. That’s challenging and rare.

In private markets, however, having an insight that others who have access to the same information don’t have is just one way to make money. And it’s the difficult way to do it. The second and relatively easier way is to have access to information that others don’t have.

This private information comes largely from personal connections. Whether it’s an entrepreneur you’ve backed who shares the new business idea that their friend is working on, another investor who tells you about a company that they’ve decided to invest in for which they can’t fill the entire round, or another opportunity that you discover because of your local network in a particular geography, it’s these personal connections that give you an edge when investing in private markets.

This is also why being able to make follow-on investments in your winners is so important. As an existing investor in a company, you have private information about what’s going well at the company and what isn’t which others don’t have, and you’re able to use that private information to inform your investment decision.

You want to act on opportunities before they hit the news. You want to be front-running and helping create the news. And having a unique insight is just one way to do that. Having access to private information is the second and easier way.

Building a network

There are two ways to build a network.

One is to set networking as a goal and to go out and meet people. The other is to do things that are interesting to you, in which case your network builds naturally as a result of the people who you reach out to in order to progress in what you’re doing, and the people who reach out to you because they find what you’re doing interesting.

The first approach results in a random network, while the second produces a network that is aligned with your perspective on and what you want to get out of life.

In addition, the probability of building strong connections is lower in the first approach because people recognize that your goal is to meet them rather than to learn from and contribute to them. This produces a less positive response.

As a result, doing things that are interesting to you produces a more valuable network of stronger connections than when networking is your end goal.

Interests and emotions in negotiations

When two parties first begin to negotiate, there’s a blank slate. Each party focuses on the issues in an attempt to, in light of their negotiating power, trade away those issues that are less important to them in exchange for getting what they want with regards to those issues that are more important to them. The exchange is primarily interest-based.

However, as a negotiation progresses, emotions emerge.

If each party is respectful of the other, they may feel good and continue the negotiation even if their ranges of acceptable outcomes seem unlikely to overlap.

On the other hand, if one party is repeatedly conceding ground, they begin to feel bad. Similarly, if a party feels like their good intentions are being abused, they also begin to feel bad.

The negotiation develops an emotional history which becomes an important determinant of the negotiation’s outcome, beyond that suggested by a purely interest-based approach.

Depending on the emotional history of the negotiation, one or more parties may take actions contrary to their own interest in order to prevent their counterpart from getting what they want. In other words, they might trade away their interests in order to not trade away their perceived fairness of the eventual outcome.

They may also refuse to budge on what is actually a relatively less important issue to them in order to get back at their counterpart for their actions on a more important issue.

At the extreme, since a party’s negotiating style is a signal for how they will act post-negotiation, a party might leave the table due to the emotional layer of the negotiation, even after securing an outcome that is otherwise in line with their interests.

In order to not let the emotional layer of a negotiation get in the way of an otherwise mutually beneficial partnership, it’s useful to keep two principles in mind:

  1. Treat your counterpart as you would like to be treated
  2. Communicate kindly

Acting in line with these maxims isn’t easy in the heat of a negotiation. And they don’t guarantee that you’ll reach a mutually satisfying outcome.

However, if you’re able to act in line with them, they go a long way in ensuring that the outcome that you do reach reflects the interests rather than the emotions of both parties.

Succinct communication

Succinct communication is the practice of using as many words as necessary, and not more, to make your point.

Succinct communication, whether written or verbal, is a signal of understanding. The other ends of the spectrum, which are not communicating at all or communicating with too many words, often suggest a lack of understanding.

The ease with which written content can be created on the web, and the resulting content explosion, make succinct communication increasingly valuable. The desire to communicate succinctly is one of the reasons behind the length of my blog posts which are often shorter than most other written web content. However, I know that I still have room to improve.

Here’s a succinct piece on the benefits of succinct communication.

Owning failures

Success comes after failure, and often multiple instances of it.

But failing isn’t enough to succeed. You have to learn from your failures.

And to learn from your failures you need to own them rather than pretend that they didn’t happen.

Here’s an example of owning your failures from SpaceX’s multiple attempts at, and recent success in, building reuseable rockets.

Making your reputation on the ones that don’t work

Venture capital is a private asset class that has a greater global supply of dollars than great startups where those dollars can be put to good use. The private and globally oversupplied nature of venture capital (there are pockets of undersupply in some emerging markets like Turkey) makes seeing and getting into deals as important determinants of success as the exercise of sound judgment when evaluating companies.

And seeing and getting into deals is not only a function of the success of the companies you invested in in the past, but also your reputation in how you dealt with these companies.

Your reputation, in turn, is at greater risk when things go wrong than when things go well. The reason is that, in the former, there’s more to correct, including that which often requires stepping on some people’s toes, as well as more blame to go around.

That’s why I really like this quote from Andreessen Horowitz’s Marc Andreessen:

“We make our money on the [startups] that work and we make our reputation on the ones that don’t.”

The reasons for bridge rounds

Startups receive bridge rounds of funding from existing investors in two different contexts.

The first is to give them additional runway to achieve an important milestone which will position them to raise a larger round at a higher valuation.

The second is because existing investors don’t sufficiently believe in the company’s future to fund a large round, the company has been unable to find a new investor, and existing investors would rather have the company continue to survive in the hope that it will find funding or reach profitability than to see it close.

Since most startups fail, the latter is a more common scenario than the former.

Correctly distinguishing between the two reasons why bridge rounds take place is an important skill for investors evaluating new investments in companies with a history of past funding.

Conversational culture at VC firms

Success in venture capital requires being very good at making qualitative assessments while being good enough at making quantitative assessments. The reason is that startups tend to have limited operating history and hence limited financials, so being able to envision a startup’s future is a more important predictor of investment success. The reverse is true for private equity, where one can accurately assess the extensive and more stable financial performance of a company and thereby project its future with relatively more certainty.

This is a topic that I wrote about in greater detail earlier.

As a result of the more qualitative nature of venture capital investments, successful venture firms tend to have a culture that facilitates the surfacing of these accurate qualitative assessments. This, in turn, requires being able to see a business’ strengths and weaknesses, as well as the likely future paths that it may take, from different perspectives. This is difficult for an individual to do because of human attributes like confirmation bias, where one naturally looks for evidence to support a given perspective while discarding evidence that goes against it.

It’s easier to see different perspectives when you have multiple people around the table sharing their ideas with each other. This requires a conversational culture where people are comfortable sharing their views, respect the views of their teammates, and are willing to change their views when necessary to arrive at the most accurate qualitative assessment of the future. In other words, it requires seeing conversations as a means of arriving at the truth rather than an opportunity to show that you’re right.

For these reasons, successful venture firms tend to have a conversational culture.

Capital efficiency

When a VC-backed company achieves an exit, the media focuses on covering the exit value.

However, as important as the exit value is the amount of capital that was invested in the company until it achieved its exit. There’s a big difference between a company that exited for $100M after raising $5M and one that achieved the same exit value after raising $30M.

This difference in capital efficiency, together with other terms like liquidation preference multiples, anti-dilution clauses, and earnout provisions, can produce very different return distributions for the founders, team, and investors of two companies with the same headline exit valuation.

This effect is particularly pronounced in times when there’s plenty of venture capital which makes it relatively easy to raise large amounts and be less capital efficient. The current environment is a great example.

What stays the same

There are two types of information you can take as input to inform your decisions. These are information which stays the same and information which changes.

In a general context, the fundamental laws of physics are examples of the former while the 24 hour news cycle is an example of the latter.

In the specific context of investing in startups, the factors which make for a successful company are examples of the former while the tactics which a startup is using at any moment in time are examples of the latter.

Trying to keep up with that information which changes is like running on a never ending treadmill. You’ll eventually fall off.

On the other hand, identifying that information which stays the same, which we can also call the fundamental truths which govern the behavior of a particular system, is sustainable. They’re limited in number and you don’t need to worry about missing a few of their changes.

As long as you have a good grasp of what stays the same and use this to inform your decisions, the things that change will eventually change in a way that justifies your decision.