The Vision/Conviction Axis
As an investor, I think the two opposing forces that drive any decision to invest are (1) the potential upside in an investment and (2) the known weaknesses to an investment. This can also be thought of as reward versus risk.
The first thing I want to make clear is that upside and weaknesses are not direct antonyms to eachother. The opposite of upside is downside, and the opposite of weakness is strengths. The reason I am using these specific words, and not their direct antonyms, is because they provide the context each word exists in (and it is for this same reason that “upside” and “weaknesses” are stronger words than the ubiquitous “reward” and “risk”). In the positive case, we are looking toward the future, the “upside” of an investment implies future gains once all the work has been done. In the negative case, on the other hand, “weaknesses” implies all the objective information we have in front of us that should cause us to be critical in this decision. Anything that might cause a post-investment train wreck, barring an alien invasion, exists in the facts we have at this present moment. Upside is infinite — what could go great, in our imagination? Weaknesses are limited — what facts of this case might derail some of our optimism?
Every investment is made with a mix of focus on upside and focus on weakness, potential rewards balanced by objective risk. I would argue that there is an optimal mix, and the mix of upside focus versus weaknesses focus should depend on the type of deal and the resources available. Usually, however, investors utilize a similar mix across all deals regardless — aka their individual investment strategy.
Investors that operate with a higher upside mix and a stronger consideration for the future might be considered visionaries. They see the future in this investment and, while the data ideally supports their vision, they don’t need to over analyze facts to gain confidence in an investment. Alternatively, investors that operate with higher weaknesses mix and a stronger consideration for the present might be considered high-conviction investors. They de-bias, question, and evaluate until they are certain making the investment is the objectively smart thing to do based on the information in front of them.
The Vision/Conviction axis is a way of thinking about investment strategies. Every deal has a place on the axis, and it is possible that, with a bit of shifting right or left, better deals could have been made. In 2023, early stage investors would be better off making higher-conviction investments as they navigate hype cycles. However, breaking free from hype cycles and investing in less popular categories requires a visionary approach.
More data = higher conviction
Data is a very specific objective fact. As an investor, every relevant data point available should be considered when evaluating an investment. Data, its accuracy, and its robustness, are all tools that help generate conviction and paint the picture of the deal.
Investors (especially traders) in data-rich markets, like public equities, have enough data to think completely objectively. You don’t have to be a visionary to be an amazing trader (and arguably, you shouldn’t try to be). However, you can be a visionary in using data creatively to generate alpha and get an edge.
Similarly, Stephen Schwarzman has described running his PE firm Blackstone with as little upside consideration as possible, using a method he has called the “only criticism” rule. Focusing on the weaknesses of deals, and working with his team to leave no stone unturned, allows them to make better decisions because they are not lured into a deal by upside. They pick the deal apart, weakness by weakness, until they are sure that the deal is actually good. High-conviction investing has driven Blackstone to a market cap of $120B (11/12/23).
Public and private equity investors lean heavily toward conviction because they have more facts about the deal they are making. In exchange for robust data and resources, upside can be a distraction.
Venture Capital on the Vision/Conviction Axis
Venture capitalists have been portrayed thematically as visionaries. It makes for a great story: VC institutions are responsible for the genesis of the world’s largest, most impactful, and most culturally significant companies. Without VCs, who would we be?
The media feeds into this narrative. The Forbes Midas List ranks the top tech venture capitalists, 100 people born with the ability to turn startups into gold. To the layfolk, venture capitalists are gods who finance the way we will live tomorrow. Having not been in the room, it is easier and more fun to imagine that Sequoia’s 1977 investment in Apple was driven by a strong upside focus and a desire for a world with personal computers, rather than a fierce debate on the weaknesses of the deal.
Early stage investors have less data on the companies themselves to support their investments, but that does not mean visionaries by nature are successful investors. All venture capitalists are visionaries, but great venture capitalists see their visions through with high levels of conviction. If the 2020s have taught us anything, it’s that being vision-anchored can be bad, especially because of individuals’ high propensity to participate in hype cycles. One illustration for this argument is the NFT bull run that began in 2021. By September 2023, 95% of NFT investments completely lost their value (value = 0 ETH) (Source: The Guardian, Yahoo). What happened here? Investors bought NFTs because of an over-consideration of the upside and an under-consideration of the weaknesses. They had a vision that their new asset would be valuable — it’s what everyone was investing in at the time — but no critical conviction. Hype cycles contribute to group think and bandwagon investing, which erases personal accountability when it comes to making smart investments. NFT sector funds still exist. Hopefully, these investors have managed to invest in the 5% of NFTs that have maintained a >0 value.
How can VCs shift toward higher conviction investments?
Evidently, the best way to generate conviction is through data. VCs need to be more creative about how they are using data across all stages of the investment process. My understanding of how to do this is in progress.
In the meantime, it is possible to generate more conviction in VC deals even at the current state of VC quant. Back in my article on dealflow, I spoke about how conferences are okay sources for dealflow, but might be intellectually harmful as they breed group think. In contrast, I think the best way to breed conviction in an early stage investment is to disagree with anything you hear until you yourself can prove it agreeable. This is consistent with Schwarzman’s “only criticism” method. I recently spoke to a PE investor. He had been pitched generative AI software to source dealflow, and was trying to decide if the software would be a good tool for his company. I asked what the downside to buying the software might be — it seemed pretty epic to me. He explained that his firm’s hesitation was due to a belief that ChatGPT itself will be smart enough to generate dealflow in future iterations. He believed buying the software would only generate alpha for a few months to a year, at which point, everyone would have access to the same AI generated dealflow through public generative AI. I loved this answer, not because I agree with it inherently, but because it forced me to confront the possibility that this software wasn’t as obviously awesome as I initially felt.
Criticism should be applied to both individual deals and the terms therein, as well as sectors. If, as I have said, venture capitalists finance the way we will live tomorrow, they have a responsibility to scrutinize over any category they choose to make investments in. If an investor wants to make multiple investments in one sector, each deal should be evaluated on an individual basis, regardless of any sector investments made before or after.
Another way to shift toward conviction is to consider any use case for the product. Many startups solve one problem, but have multiple use cases: Selling data to hedge funds is one of my personal favorite alternative revenue streams for any company that collects data. Every use case has upside, and every use case has a set of weaknesses the company will be vulnerable to as a result. No shame, but for me, it is hard to get inside of an NFT investor’s head. The weaknesses of any use case are so numerous. If anyone has invested in NFTs and can shed some light on this for me, it might be really fun to have a conversation.
If a conference breeds groupthink, the opposite of a conference is a conviction machine. Surrounding yourself with a diversity of expertise, opinions and exposures will help the team find more weaknesses as the deal is evaluated. If you are motivated to learn from others’ mistakes, expand that definition of “others” to broaden your net and unearth more weaknesses.
Venture capitalists are visionaries
While making intelligent deals requires conviction in any stage of investing, venture capitalists need to be visionaries. Being critical of momentum is one thing, but imagining what will come next as a result of the current hype cycle is another. Venture capitalists also need to be visionaries because the deficit of hard facts in early stage investing make it impossible to rely on a conviction based strategy.
When I was at Yale, I had a conversation with a friend who started a CPG brand. He asked, if self driving cars are a technology we can expect to be ubiquitous in 10 years, what problems will need to be solved as a result? Forward-thinking questions should drive how early stage investors invest. If VCs expect a return on their investments in about a decade, they should be investing in products 10 years before the market matures.
By this logic, visionary investors can take advantage of hype cycles too. Rhetorically, what precedes a NFT bull run? As one example, Web3 technologies with multiple use cases have been born out of this era.
Being a visionary venture capitalist is not about superimposing short term success onto a company by investing in it, or by securing favorable deal terms when you know the company has a medium-low chance of success in a hot sector. Being a visionary is about identifying solutions before the existence of the problem.
