I’ve been thinking a lot about this exchange between two successful investors that popped up in my Twitter feed last week.
To make money as an investor, must you back unreasonable, mercurial, irrational entrepreneurs? This feels on the surface like it has a grain of truth to it. And both these guys have generated spectacular returns in their investment portfolios, so they should know what they are talking about.
Chris is most notable for betting big on Twitter, by acquiring a ton of common stock from employees and former employees, both for himself and on behalf of other investors. I don’t know Ev, Jack or Biz well, so I can’t personally grade them, but given that is Chris’ primary investment, he is likely referring to that. And if you’ve read Hatching Twitter, the book about the founding of Twitter, you’d find nothing to contradict that. (And I do recommend you read it, a really compelling story!)
I have a hard time reconciling it with my own experience, however. I generally think being seen as a bit crazy is a source of street cred in Silicon Valley, so I hope I am not insulting anyone I am working with too much by calling them well-adjusted — but I have had equal or superior success backing steady, reasonable business types, and while there is a mix of both across my portfolio and the Matrix portfolio, there are a number of recent or soon to be >$1B companies created by people who I think would widely be described very accurately as “steady, reasonable and well-adjusted.”
More personally, in the two businesses I have run, I would without hesitation characterize my three cumulative co-founders — Vince, Jack and Mark — as this. Again, I apologize for the insult, I know people won’t think you’re cool unless you’re a wild man. But it’s true. And those businesses made a ton for investors — Betfair is multi-billion market cap and public, and eHow returned hundreds of times our investment.
Yet, I am sure this has at least some kernel of truth, and fits with the conventional valley investor wisdom. Should stable, steady founders grow wild facial hair and act really unpredictable in pitch meetings? Where does this notion come from and what can we learn from it?
Some potential reasons:
Cool-Factor: Just like that love interest of your youth who always chased the bad boy (or girl), there may be some sort of ego reason to back and win with people who are edgy. I think this element has some truth but is pretty small.
Investment Styles: Different people make money different ways. Maybe Chris and Keith have a style that best fits with that kind of entrepreneur, and this is a truth for them (and some others) but not a wider truth about investing. I think there’s something in that, and as I look across the eight partners in our firm, there’s definitely a different mix of styles in this regard.
Doubling Down: When I saw the price for which Google bought Nest, a startup that people guessed has maybe $100M in revenue with terrible gross margins my first thought was: “Who said no to a price of $2 billion?” — on the thought that somebody had to first say no to that to get to the number they ended up with. Facebook saying no to $1B from Yahoo was thought by many to be the mark of a madman. And some feel that only a crazy person would want to be the CEO of a public company in today’s environment.
I think this notion that to get the really outsized outcome, you have to say no to offers that no rational person would refuse along the way, is the biggest root of this theory. I think this is, at most, a partial truth, and one that is becoming less true due to structural changes in the industry.
This is most applicable to social businesses, or businesses where the value is strategic rather than based on the P&L the business is generating. The strategic need may go away, or the circumstances of the buyer may change, and you could be left with nothing. If your business generates real profit, your worst case scenario is much better.
In cases like that of Facebook turning down Yahoo, to believe the business would be more valuable than the current offer in the long run, you had to take a leap of faith that the business would accomplish something that is uncertain and in fact unlikely. Something no rational person would bet on. To me, this is the kernel of truth. What’s missing?
We’ll give Chris and Keith a little slack for hyperbole and 140-characters, but “never made money” is a wide net, and while Facebook like outcomes are clearly the goal of VC, a lot of money is made across a lot of other deals that never get offered a buyout years-ahead of their current state.
Even this subset of outcomes are declining in my view due to the emergence of early liquidity. A decade ago it was nearly unheard of for a common shareholder to sell any shares before an IPO or acquisition of the business. Investors thought it would keep the entrepreneur motivated to generate a return for investors, and that if they let him or her take cash out early, they might be less driven to earn a profit for them. Now, the pendulum has swung completely, and VCs want exposure to the “long tail” of outcomes and often try to encourage founders to raise “secondary financing” — i.e. sell some shares — so they will let the investors ride the investment longer.
This is a smart response: there were a number of cases where good companies sold early: if the founder owned 50%, and got an offer for $200M for the company, they would make $100M. Who needs more than $100M? The temptation to sell was high. This, in part, is why investors made big money from irrational founders: the rational guy sells here, but the crazy man keeps going.
However, in the new environment, the investors would encourage the founder to take $20M off the table — and retain most of his or her ownership in the company. With enough in the bank for “no regrets” if things go south, they can chase the outlandish goal of changing the world. So you don’t necessarily need an irrational founder to go for the long ball, though you may have a decade ago.
What I do think you need to get really great companies is a distinctive vision, courage of your convictions, an ability to see something that others can’t, the imagination to believe the world could be structured in a way that the establishment thinks is impossible. To me, these are non-negotiable traits, but are attributes that can co-exist with being steady, reasonable and well adjusted.
So, at least for me, no need to dye your hair out and act unpredictable when pitching your startup — a little bit of crazy is OK, but well adjusted is fine too, and being yourself is paramount.