Current Startup Market Emotional Biases

Bill Gurley wrote an incredible post yesterday titled On the Road to Recap: Why the unicorn financing market just became dangerous … for all involvedIt’s long but worth reading every word slowly. I saw it late last night as it bounced around in my Twitter feed and then read it carefully just before I went to bed so the words would be absorbed into my brain. I read it again this morning when I woke up and I expect I’ll read it at least one more time. I just saw Peter Kafka’s summary of at at Re/Code (We read Bill Gurley’s big warning about Silicon Valley’s big money troubles so you don’t have to) and I don’t agree. Go read the original post in its entirety.

Fred Wilson’s daily post referred to the article in Don’t Kick The Can Down The RoadFred focuses his post on a small section of Bill’s post, which is worth calling out to frame what I’m going to write about today.

“Many Unicorn founders and CEOs have never experienced a difficult fundraising environment — they have only known success. Also, they have a strong belief that any sign of weakness (such as a down round) will have a catastrophic impact on their culture, hiring process, and ability to retain employees. Their own ego is also a factor – will a down round signal weakness?  It might be hard to imagine the level of fear and anxiety that can creep into a formerly confident mind in a transitional moment like this.”

Fred and I have had some version of this conversation many times over the past twenty years as we both strongly believe the punch line.

Entrepreneurs and CEOs should make the hard call today and take the poison and move on

But why? Why is this so hard for us a humans, entrepreneurs, investors, and everyone else involved? Early in Bill’s post, he has a section titled Emotional Biases and it’s part of the magic of understanding why humans fall into the same trap over and over again around this issue. The “Many Unicorn founders …” quote is the first of four emotional biases that Bill calls out. If that was it, the system could easily correct for this as investors could help calibrate the situation, use their experience and wisdom to help the founders / CEOs through a tough transitional moment, and help the companies get stronger in the longer term.

Of course, it’s not that simple. Bill’s second point in the Emotional Biases section is pure fucking gold and is the essence of the problem.

“The typical 2016 VC investor is also subject to emotional bias. They are likely sitting on amazing paper-based gains that have already been recorded as a success by their own investors — the LPs. Anything that hints of a down round brings questions about the success metrics that have already been “booked.” Furthermore, an abundance of such write-downs could impede their ability to raise their next fund. So an anxious investor might have multiple incentives to protect appearances — to do anything they can to prevent a down round.”

Early in my first business, a mentor of mine said “It’s not money until you can buy beer with it.” I’ve carried that around with me since I was in my early 20s. Even when I personally had over $100 million of paper value in an company I had co-founded and had gone public (Interliant), I didn’t spend a dime of, or pretend like I had a nickel of, that money. In 2001 and 2002 I learned a brutal set of lessons, including experiencing that $100 million of paper money going to $0 when Interliant went bankrupt. And, as a VC, I experienced a VC fund that was quickly worth over 2x on paper that ultimately resulted in being a money losing fund. I didn’t buy any beer or spend all the money on random shit I didn’t need and fundamentally couldn’t afford.

This specific bias is rampant in the VC world right now. As Bill points out, many funds are sitting on huge paper gains which translate into large TVPI, MOC, gross IRR, or whatever the current trendy way to measure things are. However, the DPI is the interesting number from a real perspective. If you don’t know DPI, it’s “distributed to paid in capital and answers the question “If I gave you a dollar, how much money did you actually give me back?” This is ultimately the number that matters. Structuring things to protect intermediate paper value, rather than focusing on building for long term liquid value, is almost always a mistake.

Let’s go to number three of the emotional biases in Bill’s list:

“Anyone that has already “banked” their return — Whether you are a founder, executive, seed investor, VC, or late stage investor, there is a chance that you have taken the last round valuation and multiplied it by your ownership position and told yourself that you are worth this amount. It is simple human nature that if you have done this mental exercise and convinced yourself of a foregone conclusion, you will have difficulty rationalizing a down round investment.”

This is linked to the previous bias, but is more personal and extends well beyond the investor. It’s the profound challenge between short term and long term thinking. If you are a founder, an employee in a startup, or an investor in a startup, you have to be playing a long term game. Period. Long term is not a year. It’s not two years. It could be a decade. It could be twenty years. While there are opportunities to take money off the table at different points in time, it’s still not money until you can buy beer with it, so the interim calculation based on a private valuation when your stock is illiquid just shifts you into short term thinking and often into a defensive mode where you are trying to protect what you think you have, which you don’t actually have yet.

And then there’s the race for the exit, in which Bill describes the downward cycle well.

A race for the exits — As fear of downward price movement takes hold, some players in the ecosystem will attempt a brisk and desperate grab at immediate liquidity, placing their own interests at the front of the line. This happens in every market transition, and can create quite a bit of tension between the different constituents in each company. We have already seen examples of founders and management obtaining liquidity in front of investors. And there are also modern examples of investors beating the founders and employees out the door. Obviously, simultaneous liquidity is the most appropriate choice, however, fear of price deterioration as well as lengthened liquidity timing can cause parties on both side to take a “me first” perspective.

This is one of the most confounding issues that accelerates things. Rather than making long term decisions, individuals optimize for short term dynamics. When a bunch of people start optimizing independently of each other, you get a situation that is often not sustainable, is chaotic and confusing, and inadvertently increases the slope of the curve. In the same way that irrational enthusiasm causes prices to rise faster than value, irrational pessimism causes prices to decline much faster than value, which increases the pessimism, and undermines that notion that building companies is a long term process.

Those are my thoughts on less than a third of Bill’s post. The rest of the post stimulated even more thoughts that are worth reflecting deeply on, whether you are a founder, employee, or investor. Unlike the endless flurry of short term prognostications that resulted from the public market decline and subsequent rise in Q1, the separation of thinking between a short term view (e.g. Q1) and a long term view (the next decade) can generate profoundly different behavior and corresponding success.

Looking for Interactive Video Artists

Amy and I have started to buy some video art. I’m personally fascinated with the interactive stuff and am starting to learn more about different video artists. Here’s an example of one – Rafael Lozano-Hemmer – that my dad aimed me at.

If you have ideas of folks I should look at, can you toss them in the comments? Oh – and I’m also looking for giant sculptures of monsters, like the one I have of the predator in my backyard, which I’ve named The Shrike.

The Shrike

Techstars 2015 Global Impact Report

Techstars had an incredible year in 2015 and grew the organization on many dimensions. If you want a full view of what Techstars is – and is doing – today, take a look at the 2015 Global Impact Report.

http://impact.techstars.com/

To everyone who has been involved in Techstars in any way, thank you!

A User Manual To Working With Me

Jon Hallett, a prolific angel investor and successful entrepreneur who I’ve gotten to know over the past few years, dropped a major knowledge bomb on me yesterday afternoon when he sent me a post from David Politis titled This is How You Revolutionize the Way Your Team Works Together… And All It Takes is 15 Minutes.

I remember having a meal in December 2011 with David at the Plaza Food Hall in New York and talking about BetterCloud which we foolishly passed on investing in. So I wasn’t surprised to have the reaction I had after reading the post, which I said out loud to myself.

“Fucking brilliant!”

The simple idea is to write a user manual about how to work with you. My partner Seth has an email he sends out to companies he joins the board of titled Welcome to Foundry which is a roadmap for working with him, but also reflects how to work with all of us. It’s similar and touches on some of the questions that David addresses in his article, which he based on a presentation from Adam Bryant, a columnist for The New York Times, titled “The CEO’s User Manual.”

In this presentation Adam gave there were two sets of questions to answer to sketch out the User Manual. The first set, focused on the individual person, were:

  • What are some honest, unfiltered things about you?
  • What drives you nuts?
  • What are your quirks?
  • How can people earn an extra gold star with you?
  • What qualities do you particularly value in people who work with you?
  • What are some things that people might misunderstand about you that you should clarify?

The second set are focused on how the individual acts with others.

  • How do you coach people to do their best work and develop their talents?
  • What’s the best way to communicate with you?
  • What’s the best way to convince you to do something?
  • How do you like to give feedback?
  • How do you like to get feedback?

I’m going to do this exercise over the weekend and share with my partners and all of the CEOs I work with to get their feedback on whether (a) it’s helpful and (b) it’s truthful. I’m going to let them give me feedback (which will help me learn myself better). As I iterate through it, I’ll eventually publish it on this blog. And, if the exercise works, I’m going to encourage every leader I work with to consider doing it.

How To Beat Michael Jordan At Sports

I had a great interaction with a friend several months ago. The question he asked was:

“How do you beat Michael Jordan at sports?”

I thought about it for a second. I knew Michael Jordan was a good golfer and I don’t play golf. I figured he was in better shape than me and could beat me on a track. There is no way I could ever beat him at basketball. And baseball – well this video kind of says it all.

So I eventually said “I don’t know.” My friend said:

“Take him surfing.”

What he meant, of course, was play a totally different game. Now, I’m not a surfer, but let’s presume neither is Michael Jordan (although he’s so physically talented that a dangerous assumption.) But let’s assume it’s true. When we are both on a surfboard we are each beginners. Assuming he doesn’t already surf, he’s probably not inclined to get on a surfboard. So I can have a huge head start on him if I start surfing now and practicing every day. After a few years, if he eventually decides to try to surf, I’ll likely beat him at a sport.

I’ve been a long time believer in Jack Welch’s famous thesis that if you aren’t #1 or #2 in a market, you should get out of it. Interestingly, for those who don’t realize it, he challenged his own thinking about this in his final shareholder letter at CEO of GE.

When I reflect on our investing approach, we have a very strong focus on helping the companies we invest in become the #1 or #2 player in their market. When we find ourselves in an investment where we aren’t #1 or #2 in a market, we try to follow the meta-point of all of this, which is to change the game and have a different point of view.

When I go through our portfolio, there are a bunch of companies that are clearly #1 or #2 in their market. These are very satisfying to be an investor in and their paths are clear.

Then there are some that aren’t #1 or #2, or are in very crowded markets where it’s hard to figure out what #1 or #2 is. And there are some that are in unformed markets, or their ultimate product and strategy is not clearly defined, so it’s hard to put them clearly in a market segment. This is the blessing and curse of being an early stage investor.

Then there are some who should simply go surfing. We try to tell them that when we realize it and in some cases they’ve gotten very good at surfing. When this happens, it’s especially satisfying.