Over the last couple of days a lot of people have been linking to Jerry Neuman’s great essay on the history of venture capital. It’s US focused, starting when the venture industry started in the 1970s and analysing all the up and down cycles of investment and returns since then. It’s a long read, but highly recommended if you are a student of the industry.
What follows from here leads on from what I see as Neuman’s two main conclusions:
when investors stop taking risks returns plummet
the best returns have come from taking market risk rather than technology risk
That chimes with my experience. When I’ve seen VCs go after ‘safe’ 3x deals rather than chase 10x deals it hasn’t worked because the success rate doesn’t go up enough to compensate for the reduced returns, and investing in technology is difficult because it’s hard to ascertain whether progress is being made and it’s too easy to invest good money after bad.
You may now be thinking that venture should be about taking technology risk, but when you look at history that’s not been the case. Neuman discusses this in a bit of detail, but the headline is that the majority of great venture winners took market risk not technology risk. When VCs invested in Apple the technology already worked they just didn’t know if anyone wanted computers. Similarly with Google and another search engine, or Facebook and another social network, and so on. If this feels counter-intuitive it’s because as an industry we are guilty of romanticising the idea of big technology bets, I think because they sound more exciting than bets on new markets.
Neuman doesn’t go into this, but perhaps the defining feature of startup financing over the last decade is that it’s become much cheaper to assess market risk. That’s partly because of declining costs and partly because we’ve developed new and better techniques. I’ve written about both these developments at length on this blog before so won’t go into them now but the end result is that companies can now eliminate a lot of risk from their business plans and hence generate a lot of value for shareholders with their first £250-500k investment. That’s why we choose to play at these very early stages.
I just watched a great Ted talk by Julian Treasure on how to speak so people will listen. It’s embedded below so you can watch the whole thing (highly recommended) but the takeaways so you can remember easily after watching are seven ‘deadly sins’ to avoid:
and for things to do more of:
be honest (clear and straight)
have integrity (be your word)
have love for the listener (genuinely wish them well)
Listening to the talk and thinking about them whilst writing out these lists the truth of them is self-evident to me (which is not to say that I could have come up with them myself). I see myself and others tuning out when people commit the deadly sins and responding well to people who are honest, authentic and who have love for the listener. Especially this last point.
Making this personal, as an investor I have to make decisions on investments everyday and that can easily slip into judging. Certainly that happens to me more than it should. It’s a nuanced point, but after listening to Julian it’s clear to me that we should try to make investment decisions without passing judgement, particularly on anything that could be construed as personal. I’m going to work hard to do that.
The other point for me is to have more love for the listener. Since my sojourn to India eighteen months ago I’ve been slowly understanding that beyond being a good thing in and of itself having greater love for the world is a way (possibly the best way) to deliver personal happiness and increased impact. Consciously wishing the best for people I’m talking with is an easy way to get started on that journey. You could even call it a happiness hack.
Ursula le Guin’s writing on where writers get their ideas from throws light on the age old question of whether entrepreneurs are born or made. The short answer is a bit of both.
On the ‘secret’ of being a writer Le Guin says:
The “secret” is skill. If you haven’t learned how to do something, the people who have may seem to be magicians, possessors of mysterious secrets. In a fairly simple art, such as making pie crust, there are certain teachable “secrets” of method that lead almost infallibly to good results; but in any complex art, such as housekeeping, piano-playing, clothes-making, or story-writing, there are so many techniques, skills, choices of method, so many variables, so many “secrets,” some teachable and some not, that you can learn them only by methodical, repeated, long-continued practice — in other words, by work.
The conclusion is that with sufficient application and persistence any of us can be a writer. I think the same is true of entrepreneurship. All of the tricks and methods of successful entrepreneurs are learnable.
However, we are all born with pre-dispositions. Again from Le Guin:
My talent and inclination for writing stories and keeping house were strong from the start, and my gift for and interest in music and sewing were weak; so that I doubt that I would ever have been a good seamstress or pianist, no matter how hard I worked.
The pre-dispositions that an entrepreneur needs are things like ambition, a tolerance for risk, a love for highs and lows, a desire to make an impact and a love of the limelight. Without at least some of these it will be tough to find the courage to get started and the energy to stick with it when the going gets tough.
There are other characteristics of successful entrepreneurs, e.g. tenacity and charisma, but this list of basic pre-dispositions is interesting to reflect upon.
This Tweet from our friend Nilan Peris in my feed this morning led me to re-read Paul Graham’s essay from December: How to be an expert in a changing world. The main point is that in a world of accelerating change predicting the future is very hard and the most important thing is to retain an open mind and not get stuck with obsolete beliefs. The secondary point is that human nature is relatively constant and therefore easier to predict, particularly with experience. That leads to the conclusion that it’s smarter to bet on people than to bet on ideas.
Here at Forward Partners we bet on people AND ideas. We look for great founders, but will only invest if we also believe in the idea.
Nilan’s tweet and re-reading Graham’s essay made me think again why we do that. When I boil it down there are two reasons:
Whilst predicting the future is hard, predicting whether an ecommerce idea will gain traction in the next couple of years is a tractable problem. Even at day zero we can get an idea of the market size, likely price point, margin potential and competitive dynamics. We do this mostly by looking at consumer behaviour and at substitute products. I wrote more about this when I explained Why we are stock pickers.
Post investment we work extensively with our partner companies, especially with our idea stage partners. We have 13 people in Forward Partners and only 3-4 of us are on the investment side. The bulk of the team spends all day every day with our partners and that wouldn’t work if we didn’t believe in the idea as well as the entrepreneur.
Narrowing from the general case to compare us with Y Combinator the other difference is that we make much fewer investments – 8 per year compared with over 100. That gives us much more time to think about each one.
Much is written about how the fear of failure is a strong disincentive to entrepreneurs here in the UK. Most of the explanations are societal – law punishes bankrupts more severely here than in the US and failure carries greater social stigma.
These explanations have always seemed a bit too simple to me, largely because some level of fear of failure is rational. When businesses fail it hurts. Founders suffer emotionally and financially as do many of their employees. Understanding this issue properly requires a more nuanced understanding of what level of fear of failure is appropriate and how to get to the right point, as individuals and as societies.
The following passage from the excellent brainpickings throws some light on the psychology of the fear of failure:
“impact bias” — our tendency to greatly overestimate the intensity and extent of our emotional reactions – …. causes us to expect failures to be more painful than they actually are and thus to fear them more than we should.
Then the article goes on to describe our “psychological immune system” which fights “threats to our mental health” but operates “largely beneath our conscious awareness” causing us to avoid taking risks that might cause us pain, partly by underestimating our resilience in the event of failure.
Thus fear of failure is another cognitive bias.
It’s irrationality is evidenced by the fact that when we look back on life our regrets are not focused on the failures we suffered but the things we didn’t attempt in the first place. Regrets of inaction outnumber regrets of action by two to one.
As with seemingly all things in life there is a balance to be struck. Not taking action leads to regret, but at the same time being reckless isn’t sensible either. For most of us, however, our psychological bias takes us down the path of inaction more often than it should. That’s something to bear in mind.
Everyone this morning is talking about the WhatsApp user data released yesterday, as per the chart above. And you can see why. Getting to 700m users is a phenomenal achievement and growing 75% YoY at that scale is the cherry on the icing on the cake. You can see why Facebook paid $19bn for the company.
But they are far from the only messaging company. Snapchat has 30m active users, Line and Wechat are starting to build their presence in North America, and everywhere I go now somebody asks me to join a Telegram group.
And then Slack, perhaps the biggest story in enterprise software last year, is showing what messaging can do for businesses.
Messaging is definitely the story of the 2010s …. so far anyway. As the pace of change continues to increase who knows what we will see in the next five years.
I just read Evan William’s post making the point that comparing different companies using a single metric (say unique visitors) is dangerous. He draws an analogy with rectangles, saying that anyone with half an education wouldn’t judge the size of a rectangle if they only knew the length of one side.
He then goes on to say (and this is my point today):
Most Internet companies would build better things and create more value if they paid more attention to depth than breadth.
Which echoes Peter Thiel in his recent book Zero to One, where he says that it’s better to own a small market than to be a bit player in a large one.
People are also making the same point when they advise entrepreneurs to focus on ‘doing one thing really well’ and when they extoll the values of having a small group of passionate customers.
All great advice. When I look at the companies we back they have, or strive to quickly find, a first group of customers that love their product, and then they build from there.
All good advice, but for me ‘be courageous’ is the most interesting on the list. The article expands on the point thus:
3. Be Courageous. The definition of courageous tells us that it is a quality of mind and spirit that enables us to face difficulty, danger and pain without fear. Furthermore, it is to act in accordance with one’s beliefs especially in the face of criticism. Courageousness is a learned response and behavior that requires discipline. Fear is a wicked demon and when we are gripped with fear we cannot act in the best interest of those we are responsible for, especially ourselves.
That sounds great. In the startup world dealing with difficulty is a pre-requisite for success, making courage a necessity. I also like the point that courage is a learned response that requires discipline. With work we can all have courage.
If you want to increase your courage it turns out there are three things you can do:
Put yourself in situations that demand courage – e.g. go to networking events and force yourself to talk to people, ask somebody out, etc. Courage is a muscle, and the more you use it the more you will have.
Fake it till you make it – tell yourself and others that you have courage and you will start to believe it, display it, and the muscle will grow stronger. Preparation is your friend here – plan difficult conversations, talk through things that scare you etc.
Meditate – practices learned from mindfulness and meditation help enormously when fear strikes. Rather than be overwhelmed mindfulness practitioners can identify and isolate the fear. As a bonus, brain scans of long time meditators show that the region controlling fear (the amygdala) has shrunk and the region which manages fear (the pre-frontal cortex) has grown thicker.
With all the wars and murder we see on the news it often feels like the world is falling apart, but what’s happening is that news services are feeding our in-built preferences for bad news by aggregating bad news stories from the whole world, and when you look at the stats you find that the world is actually becoming more peaceful.
Slate just published a round up of those stats yesterday showing that on 10-20 year basis homicide rates, violence against women, violence against children, mass killings, and battle deaths in armed conflicts are all falling fast.
That’s good news for us all to take into the holiday season.
Thanks for reading everyone, and I hope you get some good R&R with your families.
Regular readers will know that it’s the level of support we provide to our partner companies that makes Forward different from conventional venture capital – particularly at the idea stage. If you run the maths then we invest about as much again in support as we do in cash.
Yesterday my colleague David Norris put the embedded presentation on Slideshare which details what that support looks like.