What SB 49 illustrates: Asymmetric Risk

One of the things I’ve realized spending time with VCs at the top of their game is that they are obsessed with asymmetric risk. In a recent interview, Tony Robbin’s talked about a similar take away from the interviews he did with top investors across trading strategies:

They believe in asymmetrical risk reward. It simply means they take the smallest risk possible for the largest return possible.

The average person goes out and invests a dollar hoping to make 10% or 20%, if they’re lucky — so if they’re wrong they’re in the hole majorly. Paul Tudor Jones [had a principle he used to use] called 5:1. And 5:1 is this: If he invests a dollar, he doesn’t part with that dollar he’s investing unless he feels certain he’s going to make five. He knows — he’s not stupid — he knows he’s going to be wrong [sometimes] so if he loses a dollar and has to spend another dollar, spending two to make five, he’s still up $3. He can be wrong four out of five times and still be in great shape.

Venture Capital is an extreme example of this as you can loose up to the money invested, but at the seed stage the upside if you invest in a company that ultimately goes on to dominate an industry can ultimately be worth more than 20 times the money invested.

When I started at Birchmere, one of my mentors shared a great Warren Buffett quote with me:

I’m a better investor because I’m a good businessman and a better businessman because I’m a good investor.

Having had so many VCs come back to this same general point around asymmetric risk has impacted not just how I evaluate investments but also how I think about and advise our startups on business strategy. So many choices have either limited downside and huge upside or conversely small upside but massive downside. The process of picking a path forward is often trying to understand these different scenarios and the probability of them occurring. I find this is particularly helpful when thinking through business development partnerships.

As I’ve tried to make this point to entrepreneurs, I’ve realized most people don’t think about the world through this asymmetrical risk / reward lens. However, coming back to the lede, I spent Monday in the Pacific Northwest and every person seemed to want to talk about the call and the odd risk / reward tradeoff of throwing a pass from the 1 yard line on second down with less then a minute in the game. Unless you’ve been hiding somewhere, you know the result at this point.

While I’m sorry for the Seahawks Fans who had to experience that heartbreaking loss (although not that sorry as I’m a Browns fan who can’t imagine what seeing my team in the Super Bowl would be like) it does to my mind illustrate the concept of asymmetrical risk / reward. Next time you’re thinking through a tough choice in your business try to understand what the downside and upside is relative to the cost and time invested. You may find the situation has asymmetric risk.

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