The Antifragile Entrepreneur pt 1: Luck
Maximizing luck in a world with so much variance.
by Calvin Ong
“Whoever has the sword will have the earth”
-Oliver North
John Maynard Keynes once drew an analogy between investing in the stock market and picking a beauty pageant winner. Entrants are asked to choose the six most attractive faces from a hundred photographs. Those who picked the most popular faces are then eligible for a prize.
A naive strategy would be to choose the face that, in the opinion of the entrant, is the most beautiful. A more sophisticated contest entrant, wishing to maximize the chances of winning a prize, would think about what the majority perception of attractiveness is, and then select based on some inference from their knowledge of public perceptions. This can be carried one step further to consider the fact that other entrants would each have their own opinion of what public perceptions are. Thus, the strategy can be extended to the next order and the next and so on, at each level, attempting to predict the eventual outcome of the process based on the reasoning of other rational agents.
The same happens in the stock market. Investors price shares not based on what they think an asset’s intrinsic value is, or even on what investors think other investors believe about the asset’s value, but on what they think other investors believe is the average opinion about the value of the asset, or even higher-order assessments. This phenomenon is why we currently witness the bubbling asset prices of meme stocks and dogecoin.
In our rapacious high school environment, this same trend can be applied to a student’s choice among universities. Many of my classmate’s choices during the college application process now depend much less on what any individual may think, and much more on what the “panels of experts” (that have no real achievements other than ranking schools) think. The US News annual “best college” ranking issue has become by far the magazine’s biggest seller. Accordingly, the number of applicants for the “best” schools then fluctuate sharply in response to the most insignificant changes in these rankings. When Cornell’s Johnson Graduate School of Management jumped from 18 to 8 in the Business Week rankings in 1998, applications for the following year’s class rose more than 50 percent.
In all scenarios, there is zero consideration for who you think will win, but rather who you think others will pick. The attention given to these rare equities, crypto assets, and universities is just a byproduct of public hype.
Hierarchy is nothing new, of course, and it has always been a big part of our decision-making process. The idea of small minorities achieving disproportionate results shouldn’t be surprising. In 1906, economist Vilfredo Pareto discovered what became the “Pareto principle,” or the 80–20 rule, when he noticed that 20% of the people owned 80% of the land in Italy — a trend that he found just as natural as the fact that 20% of the peapods in his garden produced 80% of the peas. This pronounced pattern, where a tiny few drastically outcompetes all rivals, surrounds us everywhere.
We are in a winner-takes-all world.
The high-school student in the top 20% percentile will get accepted to 80% of universities. Students of the top 20% of school will get 80% of the job offers. Most sayings are forgotten but a select few people like Einstein and Shakespeare are constantly quoted. Everywhere, there is a commanding advantage for those at the top but nothing like it for those, however good, who are second or third or further down in the hierarchy. A Billboard Top 100 artist will get paid millions of dollars more than what most aspiring artists can ever hope for, even when their pay is not proportionate to how much better their voice actually sounds.
In business, this distribution rule is ruthless. Only a few rare companies ever get the attention to attain exponentially greater value than all others, and the remaining companies usually become duds or fail. No one works in a normal world; we all work under the Pareto Principle.
At the Berkshire Hathaway shareholder meeting in 2013, Warren Buffett said he’s owned 400 to 500 stocks during his life and made most of his money on 10 of them. Charlie Munger then added, “If you remove just a few of Berkshire’s top investments, its long-term track record is pretty average.”
Peter Thiel, founder of PayPal and Palantir expounds on this law and its application to the world of venture capital. As he puts it:
“The error lies in expecting that venture returns will be normally distributed: that is, bad companies will fail, mediocre ones will stay flat, and good ones will return 2x or even 4x. Assuming this bland pattern, investors assemble a diversified portfolio and hope that winners counterbalance losers. But this “spray and pray” approach usually produces an entire portfolio of flops, with no hits at all. This is because venture returns don’t follow a normal distribution overall. Rather, they follow a power law: a small handful of companies radically outperform all others. If you focus on diversification instead of single-minded pursuit of the very few companies that can become overwhelmingly valuable, you’ll miss those rare companies in the first place… The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined.”
When we study investment strategies of our role models, especially ones that are renowned as geniuses, it is easy for us to overlook how most their gains tend to come from a small percent of their decisions. Like everything else, in investing, long tails — the farthest ends of a distribution of outcomes — have the most tremendous influence.
Our mental models have accustomed itself with treating failures as something bad. Growing up in school, we have been punished for being wrong. In sports, we have dealt with failure by not being on the podium. At home, being wrong might have resulted in scolding. So, it is not hard to understand why we treat failures as a sign of defeat. But people tend to underestimate how common it is for successful people to fail. This concept is counterintuitive, even if you understand the math. It is hard to grasp that a top-tier investor can be wrong 80% the time and still make a huge fortune. For this reason, we need to critically rethink what it means to fail (the next essay will dissect this concept of failing a little deeper).
However, investing and starting a startup are two different stories. When you plan on becoming a successful startup founder, the Pareto Principle applies from a different perspective. For a startup, the Pareto Principle applies in the decisions you make as an entrepreneur — a small number of key decisions will drive most of the momentum for your company. But unlike an investor — working in a startup means you must fully commit to one company and thus do not have the flexibility of diversifying your portfolio. You do not have the flexibility to fail since failure also means that you are out of the game — and become part of the 80% of all startups that have failed. Your company not only has to survive, but to be part of the rare few companies that will reap all benefits, you must also drastically beat your competitors.
And what I am about to say is probably the hardest thing for most entrepreneurs to swallow. The biggest factor leading a company to success is luck. This is hard to swallow because unlike getting into an Ivy League school where your efforts can drastically increase your chances of getting in, luck is something we can’t really control even with hard work. I am not trying to take away the credit of great ideas, products, teams, and execution in the billion-dollar startups. And I am certainly not saying people like Bill Gates and Jeff Bezos are successful only because of luck — but I am confident saying that their success is a product of ingenuity mixed with a lot of luck.
In 1968 there were roughly 303 million high-school-age people in the world, according to the UN. About 18 million of them lived in the United States. About 270,000 of them lived in Washington state. A little over 100,000 of them lived in the Seattle area. And only about 300 of them attended Lakeside School. Start with 303 million, end with 300. One in a million high-school-age students attended the high school that had the combination of cash and foresight to buy a computer.
Bill Gates happened to be one of them.
With the chances of one in a million (literally), Bill Gates went to one of the only high schools in the world that had a computer. He is not shy about winning the lottery. In 2005, Gates told the school’s graduating class, “If there had been no Lakeside, there would have been no Microsoft.”
A successful startup requires being at the right place, at the right time, with the right mindset to come up with the right products that are right for the market.
Bill Gross is the founder of Idealab and has helped entrepreneurs start hundreds of companies. Earlier, he helped start a company called Z.com, it was an online entertainment company. The team was so excited about it — they raised enough money and had a great business model. They even signed incredibly great Hollywood talent to join the company. But broadband penetration was too low in 1999–2000. It was too hard to watch video content online, you had to put codecs in your browser and do all kinds of fancy stuff, and the company eventually went out of business in 2003. Just two years later, when the codec problem was solved by Adobe Flash and when broadband penetration crossed 50 percent in America, a company that got luckier with its timing was born. It is now called YouTube.
Z.com was at the right place, with the right team, right product, and right funding. They had everything, except for right timing — so they failed. You see what I am saying? Having everything aligned is something we can’t control. It’s more luck.
We will never be able to quantify the exact amount of role luck has on the success of a business, but no one thinks luck doesn’t play a role in business success. We might not want to accept it, but we all know it. We grew up in a society that praises hard work and merit, and because luck is uncontrollable, the fact that luck is the main driver of success is hard to accept.
We can’t work harder to get lucky. Or can we?
When preparing for a startup, studying a specific case study can be dangerous because we tend to study extreme examples — the billionaires, the CEOs, or the massive failures that dominate the news. The problem is, given their complexity, extreme examples are often the least applicable to our own situations. Here is a good rule of thumb. The more extreme the outcome of the case study, the less likely you can apply its lessons to your own life because the more likely extreme ends of luck influenced the outcome.
In fact, it is somewhat irresponsible to emulate the most successful businesses. Of course, skill is still vital, and we can learn a lot from profitable business models and work cultures developed by successful people, but that won’t be enough to help us become the rare successes in the world of business. Remember, everything must align perfectly.
Instead of simply just learning from role models, what aspiring entrepreneurs should also learn is to maximize their chances of getting lucky.
Luck is like a drop of rain from a big cloud. Although we can’t control the weather, what we can do is expand and stretch ourselves, so that we can increase our chances of catching that lucky raindrop. You stretch yourself by being skillful, but another equally important factor is making sure you stay under the clouds long enough to maximize the chances of catching the lucky raindrop.
It is not common to achieve success in your first startup, and any innovative founder experimenting with new ideas should expect failure since you are statistically bound to fail. But it is important for entrepreneurs to rethink failure. Like I said, people tend to underestimate how common it is for successful people to fail. Arianna Huffington got rejected by 36 publishers. Bill Gates watched his first company crumble. Walt Disney was told he lacked creativity. Steve Jobs was fired from his own company. Milton Hershey started three candy companies before Hershey’s. George Steinbrenner bankrupted a team. And the list goes on.
The central illusion in life is that failing is risky, that it is a bad thing — and that eliminating failure is done by eliminating volatility. An important point of volatility is that it is most influential (and will largely determine your success) when the event is unpredictable and beyond what is normally expected. Reliance on standard forecasting tools can both fail to predict and counterintuitively increase vulnerability to failures by propagating risk and offering false security to the business. Professional forecasting makes you more fragile because it is impossible to predict and eliminate the long tail — or more simply, the unpredictable.
The more practical yet underrated concept is that when dealing with a world with so much variance, the trick to harvesting luck is to become robust and survive after each unpredictable failing step.
I believe that this is the key to becoming the rare successes in business. You must persist and survive long enough in the startup world so that when dealing with your failures, you have the option to arrange yourself in a way that a bad investment here and a missed financial goal there won’t wipe you out. You won’t be forced to find a new job. You won’t have to move to a cheaper city because you can’t afford rent. In a nutshell, you won’t have to give up your dreams and passions because you can’t afford to chase them.
Respect the power of luck and risk and you’ll have the option of controlling skills you can actually control — things such as creating a good business model, forming a good team, and building excellent products. Skills are still crucial. A mediocre founder will only build a mediocre company at best. As Ray Dalio of Bridgewater Associates once said, “Luck — both good and bad — is a reality. But it is not a reason for an excuse. In life, we have a large number of choices, and luck can play a dominant role in the outcomes of our choices. But if you have a large enough sample size — if you have large number of decisions (if you are playing a lot of poker hands, for example) — over time, luck will cancel out and skill will have a dominant role in determining outcomes. A superior decision-maker will produce superior outcomes”.
For the purpose of this essay, what I want to highlight is this often-overlooked portion of the quote: we need a “large enough sample size.” Entrepreneurship becomes less luck-dependent when it is thought of as an experiment of optionalities with trial-and-error. In fact, most innovative breakthroughs come from tinkering with trial-and-error.
Historians, academics, and researchers (collectively “theorists”) are quick to point to theories to explain why things in our world work. For example, a theorist would say that we are able to fly planes today because of the theories and formulas of Aerodynamics and Aerospace engineering.
In reality, we have been building and using jet engines in a completely trial-and-error experiential manner, without anyone publishing the theory until the jets are built. Builders pushed the original engineers who knew how to twist things to make the engine work. Theory came later, in a lame way, to satisfy the intellectual bookkeeper. But that’s not what you tend to read in standard histories of technology.
The idea that the theory comes before the practice is, quite simply, incorrect; it has zero supporting evidence. Innovation has always involved messy tinkering of doing the unknown. Textbooks and theories tend to come after. This notion contradicts conventional ideas of innovation and progress, as we mostly believe that innovation comes from “bureaucratic funding, through planning, or by putting people through a Harvard Business School class by one Highly Decorated Professor of Innovation and Entrepreneurship (who never innovated anything) or hiring a consultant (who never innovated anything).” (Nassim Nicholas Taleb)
What we see here is a teleological fallacy. Teleology is an explanation given for a thing as a function of its end use or purpose. In other words, it is the final cause of why something came to be. For example, the teleology of a fork would be to assist in human consumption of food. When we attribute innovation as the product of scientific textbooks, we fall for the teleological fallacy since we are attributing final causes to things incorrectly. It is equivalent to the assertion that the human face was designed with a nose so that humans could wear glasses. By saying this, we are attempting to attribute an obviously fallacious final cause to the existence of our noses.
In his book Antifragile, Taleb speaks about the teleological fallacy in the context of his rational flaneur. Taleb’s rational flaneur strolls around and concocts ideas for how to enjoy spontaneously. In Taleb’s words, “the flaneur is not a prisoner of a plan.” He travels and revises his travels as he goes. In contrast to the rational flaneur, the classical tourist travels with a rigid plan, a check list, and perfectly organized breakdown of how he’ll spend every hour and minute of his trip. In retrospect, if we are to imagine ourselves at the end of the rational flaneurs trip, we can conclude that he had a variety of experiences, he visited bars, saw his friends, got a massage in the hotel spa etc. but the entirety of his trip wasn’t planned or purposeful per say, and therefore implication that the individual experiences of the rational flaneur were premeditated and rigidly constructed would be example of the teleological fallacy. In other words, it would be the misattribution of a purpose or end goal to the travel style of this individual.
Profitable businesses are all around us. They thrive by making themselves seen. The question that arises is, how did these businesses arrive at profitability?
In answering this question, falling prey to the teleological fallacy would involve the implication that entrepreneurs are profitable because they followed a set and rigid script for how to obtain profitability. The reality of building a profitable startup is that it is usually not achieved by following rigid structures, models, or recipes shown in the textbooks. Successful businesses are like the rational flaneur — they have a successful method to their business strategy but at the same time, we can’t simply conclude that their success is a result of their business strategy.
Instead, achieving success often involves tinkering with new ideas with trial-and-error, testing creative solutions to difficult problems, and as we mentioned earlier, hitting luck. And one (unless insanely lucky) should expect to encounter errors and failures in the process of tinkering. The key is to become robust enough to survive after each failure.
Surviving is the secret so that you can keep playing the game until the odds fall in your favor. That is the only way you can maximize your luck in building one of the few rare companies. The fragility of entrepreneurs are often byproducts of businessmen who, trained in static thinking, tend to believe that generating profits is their only mission, with survival and risk control something to perhaps consider. They miss the strong logical precedence of survival over success. To make profits and buy the Ferrari, it would be a good idea to first survive the game of making profits. Notions of skill are empty and meaningless when presented without accounting for fragility of the entrepreneur.
Now you may ask, how in the world do I become robust?
Before getting into that, let’s quickly talk about the purpose of a startup.
If you are starting a startup just for the money — stop. You are more likely to lose a sh*t ton of money, and there are many easier ways to get wealthy. Counterintuitively, the easiest way to obtain large sums of wealth in the startup world is not to start a company but instead to join an early fast-growing startup that you believe is promising (they’ve hit luck). This shouldn’t be an easy job and you should still anticipate years of continuous sleep deprivation working for a startup. But by joining early rather than starting a company, you take on a fraction of the founder’s risk, while increasing the prospects of getting lucky, and still benefiting from a generous amount of equity. For example, If you joined Facebook in its early days as its 100th employee and Mark decided to pay you with 0.1% of the company’s holding, that 0.1% equity in the company will be worth roughly around $993,000,000 today.
The only reason you should invest the energy and capital of becoming a startup founder is passion. After all, any startup commands psychotic obsession from the founders if it wants to succeed.
Now, going back to methods of becoming more robust. Financial independence, when used intelligently, is what makes you robust; it gives you options and allows you to make the right choices. But we first have to understand, wealth and money are two different subjects. Wealth is older than human history. Even animals have wealth. Money is a relatively new invention, acting as a mover of wealth. Paul Graham puts it like this:
“You can have wealth without having money. If you had a magic machine that could on command make you a car or cook you dinner or do your laundry, or do anything else you wanted, you wouldn’t need money. Whereas if you were in the middle of Antarctica, where there is nothing to buy, it wouldn’t matter how much money you had.”
Wealth is what makes us financially independent, not money. But if wealth is the important thing, why does everyone talk about making money? Because money is a way of moving wealth, and in practice they are interchangeable.
But they are not the same thing. And it is crucial for us to understand the difference between money and wealth. When talking about business, people think of organizations that make money. That’s wrong. Money is just the mover for whatever people want because bartering does not work in a specialized society. Wealth is the prospect of being able to create value — and value is what people want. What businesses really do is make wealth. Businesses create products and services that (mostly) benefit society. They add value that people want into our world.
I can remember believing, as a child, that if a few wealthy people had all the money, it left less for everyone else. Many people, even adults, seem to continue to believe something like this. In reality, wealth is not a zero-sum game. If you combine wood with rubber and lead, you make a pencil and thus created wealth. It isn’t taken away from the poor. Wealth and value are created.
Now, here is the reason why I put so much emphasis on separating wealth from money. Wealth is what you don’t see. What you see is money. We tend to judge wealth by what we see, because that’s the only information that is presented to us. Mansions. Jewelry. A trophy wife. That’s what we see. But ironically, wealth is intangible. Wealth is the ability to create value. It is the Mercedes not purchased. The watches not worn. The expensive wine not drank, the Gucci bag forgone, the first-class upgrade not chosen. Wealth is the financial assets that haven’t yet been converted into the stuff you see. Money spent is what we see, and that doesn’t add value anymore. What we want is wealth.
Since we don’t see wealth, it is hard to learn about it. It is easy for us to think that having wealth is to spend money, but understanding the differences between the two terms can help us see the restraint it takes to actually be wealthy.
Wealth’s ability to retain and generate value provides you the ability to have freedom and flexibility as it functions as a limit to your downside risk. The greatest intrinsic value of wealth is that it gives you control over yourself and you won’t worry ending up in ruin. Being wealthy is a level of independence and autonomy that comes from unspent assets that provide you with greater control over what you can do and when you can do it. (Given that you don’t lose your wealth, which is something we will get into in the next essay.)
Money spent on a Ferrari won’t give you more freedom or flexibility. We don’t want that. As aspiring entrepreneurs, what we wish to have is wealth because that is the only thing that will provide us freedom and flexibility when we fail. The most precious asset an entrepreneur can have is having control of doing the business you want, when you want to, with who you want — and this asset is especially precious after failing.
If you are a peer of mine in your teenage years, the easiest way to achieve wealth is to start investing and harness the powers of compounding. I always say this — if you are young, your biggest advantage is time. Compounding works miracles. Consider this: Ben, a 20-year-old college student, saves $300 per month into an account earning 15% per year for 10 years. Then at age 30, he starts a family or maybe his business fails, whatever — he needs the money.
By then, Ben had accumulated $85,000 of his own money. He doesn’t have to worry because he has built a strong foundation for freedom and flexibility.
But let’s say, if instead of 10 years, he cashes out 15 years later. Ben will have accumulated almost $200,000 by then.
If he cashes out 30 years later, Ben will have $1,800,000.
40 years will be around $7,500,000.
50 years later, he will have $30,000,000.
60 years will give him $120,000,000.
65 years will equate to $243,000,000.
The growth of compounding is magical and unintuitive. The longer you build your wealth, the wealthier you will get exponentially. Time is your best friend.
Investing in a business other than your own startup will provide you with value-generating assets that set a limit to your downside risk. Again, what we want is to compound wealth so that it will provide us with freedom and flexibility in the future, which is the financial assets not yet spent. Your wealth will act as a safety net to your future failures.
People tend to learn these lessons later in their life, but the real value of these concepts come from the time value of money. This is why I believe financial literacy and investment knowledge is one of the most underrated topics to learn as a high schooler.
However, if you are a little older and you are in a time crunch, don’t lose faith. Building wealth isn’t only about your income or investment returns, there is another independent variable called your savings rate. Here is a formula to keep in mind:
Wealth (freedom/savings) = Money (income/returns) — Expenses (ego)
In the end of the day, the value of wealth is relative to your expenses or what you need. If you lower the amount of money needed to sustain your lifestyle, you will also build more wealth. It is appalling to see how much attention is given to the Money variable of the equation, but none is given to the Expenses variable — especially since your Expenses are parts of the money equation that are much more in your control.
Spending beyond what you need is often a result of ego approaching income. It is a way to spend money to show people that you have money. Savings is the difference between your ego and your income. This explains why so many people with seemingly large incomes may not always enjoy the luxurious freedom of being wealthy; it’s because their expenses grew as quickly as their income. It’s a psychological blind spot for us to compete and desire what people around us have. As René Girard’s mimetic theory states, “Man is the creature who does not know what to desire, and he turns to others in order to make up his mind. We desire what others desire because we imitate their desires.”
To save is to acknowledge this psychological bias and develop a temperament that does not give a damn what others think about you. Nassim Nicholas Taleb explained: “True success is exiting some rat race to modulate one’s activities for peace of mind.”
Now tying this back to building a startup, accumulating personal wealth is a hedge to the failures you will most likely encounter. The freedom provided by wealth is what will give you the flexibility to stumble through your darkest days. It is what will keep you from not getting evicted. It is the tape holding your family’s last few strains of faith in you. And most importantly, it is what will give you the courage to continue down the not so pleasant road of encountering failures while building a startup.
Financial independence applied to trial-and-error entrepreneurship creates a scenario where your downside risk is limited (in turn giving you freedom) and your upside potential is unlimited. Not only are you robust, this creates an asymmetric payoff that actually benefits from volatility, since if you have less to lose than to gain (more upside than downside) volatility, on balance, bring benefits.
Let us use an example from finance, where it is easiest to explain, but misunderstood the most. If you put 90 percent of your funds in boring cash (assuming you are protected from inflation) or something called a “numeraire repository of value,” and 10 percent in very risky, maximally risky, securities, you cannot possibly lose more than 10 percent, while you are exposed to massive upside. Someone with 100 percent in so-called “medium” risk securities has a risk of total ruin from the miscomputation of risks.
This is the typical Barbell approach: With two extreme ends and nothing in between. That is extreme risk aversion (your wealth) on one side and extreme risk loving (your startup) on the other, rather than just the “medium” or the beastly “moderate” risk attitude that in fact is a sucker game (because medium risks can be subjected to huge measurement errors). But the barbell also results, because of its construction, in the reduction of downside risk — the elimination of the risk of ruin. This asymmetry in the payoff matrix is what will help you survive even after failing. It remedies the problem that risks of rare events are incomputable and fragile to estimation error; here the financial barbell has a maximum known loss.
But what if you do not want to start a company? You may question what is the point of accumulating wealth if it is not spent?
The answer is simple: Wealth can bring you ease in a world with so much variance. Note that I am not saying money. Morgan Housel, author of the Psychology of Money, beautifully explains why people should save for the sake of saving:
“Some people save money for a down payment on a house, or a new car, or for retirement. That’s great, of course. But saving does not require a goal of purchasing something specific. You can save just for saving’s sake. And indeed, you should. Everyone should. Only saving for a specific goal makes sense in a predictable world. But ours isn’t. Saving is a hedge against life’s inevitable ability to surprise the hell out of you at the worst possible moment…
Everyone knows the tangible stuff money buys. The intangible stuff is harder to wrap your head around, so it tends to go unnoticed. But the intangible benefits of money can be far more valuable and capable of increasing your happiness than the tangible things that are obvious targets of our savings. Savings without a spending goal gives you options and flexibility, the ability to wait and the opportunity to pounce. It gives you time to think. It lets you change course on your own terms…
More than your salary. More than the size of your house. More than the prestige of your job. Control over doing what you want, when you want to, with the people you want to, is the broadest lifestyle variable that makes people happy.”
The choice to developing quality relationships, partaking in part of something bigger, and spending quality time with your children is what the flexibility and freedom of wealth can bring you. You can save for the sake of saving. It’s great to save for a business, or a house, or your kid’s tuition. But it’s greater to accumulate wealth for the unexpected chain of surprises life throws at you. Like everything else, in life, the unexpected events — the farthest ends of a distribution of outcomes — have the most tremendous influence. Wealth that isn’t planned for anything is an insurance against fate’s special ability to scare the hell out of you at the worst possible moment. The currency of not having to panic is most valuable when everyone is panicking.
Disclaimer: I am not a professional financial advisor. Many ideas in this essay are inspired by people way smarter than I am, and I do not take credit for their smartness.
Note from author: Hi, my name is Calvin, currently a 18 wear old army recruit for Singapore. The sole purpose of me sharing essays is to share my thoughts, and I am really here to look for criticism to help uncover the mental blind spots I have. So please comment and let me know what you think! Don’t shy away from being harsh :)
