This Is Who You Are Up Against Transcript
A conversation with Josh Wolfe
Long-time listeners will have heard me joke before that this podcast should really be called This Is Who You’re Up Against. I’ve been waiting for the right episode to deploy the joke as a title, and this week we have it. The joke’s meant to convey how incredibly impressive these people are who we get to hear from every week. My guest this week is Josh Wolfe, a founding and managing partner at Lux Capital in New York City.
Lux is a venture capital firm, but a highly unique one. They’ve spent more time in the hard sciences and interesting nooks and crannies in the market than the typical VC firm. Some of investing is zero-sum. My outperformance is someone else’s underperformance. Sometimes, though, investing is positive-sum. The combination of capital, ideas, people, drive, and raw energy leads to amazing new things. I think the best investing and the best investors of the future will be more collaborative than competitive. After finishing with Josh, I couldn’t stop thinking, “God, do I want to be involved in whatever he’s doing, if only just to learn.” This conversation made me rethink my joke. Now, I won’t think of it as a zero-sum joke but instead as a reminder. This is the kind of person who is out there. You better find your niche and still be the absolute best you can within that niche. Please enjoy this amazing conversation. Josh and I covered just about everything.
Josh, we were talking before we hit record about the many things that Lux Capital does, and that’ll be a great place to start, just to give people a frame of reference for the sorts of investments that you’ve made over the years. Then we’ll go very deep into a number of different disparate topics that I know we’re both very interested in.
Josh: The firm is pretty rangy. We’re a billion and a half, and the most recent fund was 400 million and we got a 300-million-dollar co-invest fund, and we do everything from super early seed stage things, where you’ve got an entrepreneur in a garage, although often they’re in our office, to a large division of a corporation that we’re going to spin out and recapitalize. Generally, it’s along three areas, so we considered energy and materials as one bucket, and then healthcare is another bucket, which is everything from healthcare IT, which has generally low barriers and capital efficient, and I tend not to love that stuff as much. Then I really love the things where it’s really hard and typically really expensive, so robotic surgery, and med devices, and biotech.
Then the final third is core technology, which is more defined by what we don’t do, so very little, if anything. Internet, social media, mobile, ad tech, video games, things that generally every other VC is doing, and really it’s for two reasons. One that’s intellectually honest and germane to us, and one about the field. If you’re an amazing internet entrepreneur, you should be going to Sequoia, or Accel, or Benchmark, and we’ve always wanted to sort of avoid the adverse selection, but if you’re intellectually honest about the space, the great virtue that everybody talks about is, it’s really cheap and capital efficient to start these businesses, which is true, but the corresponding vice is that you get 5,000 global competitors to companies like Groupon.
Read voraciously, try to understand what the consensus is, find a variant perception, something that people aren’t thinking about, and generally for the wrong reason.
As an investor, then you either spray and pray, which is buy really cheap lottery tickets and hope for a high-magnitude payoff that are improbable, or, and you’ve seen some very famous venture franchises do this, they migrate into something that we call wait and pay, where you’re basically waiting till a winner emerges. You have a higher probability of being correct, but obviously, the higher the price you pay, the lower your expected return, so I like to find things where there’s really high scientific and technical complexity so people sort of don’t understand something yet, and we sort of pride ourselves, like we’re contrarian. We like to think differently, but the truth is, we want people to agree with us, just later.
Really high scientific and technical complexity, intellectual property that imposes a negative right on you, says, “You can’t do what these guys do legally because of composition of matter or some, and field of use.” Then behaviorally, which I know you follow a lot, this sort of triptych of scarcity, so scarcity of attention. The media’s not hyped up on it yet. People don’t know about it. Scarcity of people. The number of entrepreneurs that have actually run a business are few and far between. Then scarcity of capital, because when investors aren’t chasing something, then necessarily evaluations will be low, and if we’re right, then returns should be high. Then on top of that, we do thesis-driven stuff, which is my favorite, read voraciously, try to understand what the consensus is, find a variant perception, something that people aren’t thinking about, and generally for the wrong reason. We’ve got some cool examples of that. Then other partners here love doing people-driven stuff, so find an amazing entrepreneur, set of them, and back her or him time and time again, and you build a portfolio of people.
Then the final or special situations, which is, can you invest in a late-stage business but at an early-stage price? What causes that? A capital market dislocation, a corporate divestiture, spin-off, but generally, somebody else took time and money, risk, and didn’t get paid for it. Then technology risk is gone, or science risk, or market risk is gone, and we get to come in at a very early stage price, and you sort of can get that sort of 10X and five-year profile, but later-stage business.
Patrick: That’s a lot going on there, and it would help to go back to the earliest days of Lux and hear a bit about the formation or formative elements of the investment philosophy. It actually sounds very much like a lot of value-type investor mindset stuff applied to private early-stage businesses, but not necessarily private equity businesses, so it’s fairly unique. I’d be fascinated to hear how that kernel, what the kernel was that led to that early investment philosophy.
We were talking before about ants foraging in a forest, and there’s complete uncertainty, and they’re moving all about, but then something happens in that process where they’re able to very efficiently find food sources, and so after the fact, you can figure out how it all worked, but a priori, you have no idea.
Josh: When we got started, we went out to raise friends and family money. I always joke that we had a lot of friends and we had a lot of family, but none of them had any money. I grew up in Coney Island, Brooklyn. Mom was a schoolteacher. My co-founder Peter Hébert grew up in Stamford, Connecticut, and we met, I was in investment banking at Sali. He was at Lehman Brothers and Equity Research, and we had this idea, at a time when everybody was chasing dot-coms and optical networking, that we were going to focus on the hard sciences. It started with this sort of definitional focus on an area that we thought was totally neglected, and even the derivation, the etymology of Lux, Latin for “light,” was looking where other people weren’t looking. We said, “Let’s go after the chemistry, physics, material science departments.”
Then we met a guy, Bill Conway, who’s one of the founders at Carlyle, which literally changed the trajectory of our life, and Bill put us in business and asked us probably the two most important questions that anybody had. Number one, why should you exist? Why does the world need an incremental venture fund? There’s 1,000 of them out there, and number two, if your hypothesis is right that these are the next waves, what is going to stop Kleiner, and Sequoia, and Benchmark, and Accel from blowing you out of the water and turning their turrets on you and they agree with you?
We spent the first few years building this platform where we developed a bunch of sort of subdivisions underneath the management company where we had a media business with Forbes. We had some public policy efforts. We created a research business called Lux Research. All of these things were intended in the early days so that if you were an entrepreneur, every venture guy says the same two BS things. “We’re value-add investors, and we’ve got proprietary deal flow.” We wanted actually something that was real value, because people didn’t know who Lux was.
They didn’t know who Josh or Peter were, and so we had to have something that was like structural and real and tangible, and so now, with these different entities, if you were an entrepreneur, we could get you tens of millions of dollars of non-dilutive government money or foundation money. We can get you partnerships with Intel, and Kodak, and HP, and Saudi Aramco, that were the clients of our research business, and we can get you visibility in the media, with full disclosure, because as Conway admonished to us early on, “10 years to build a rep, 10 seconds to lose it, so just any time you ever write about it, anybody just full disclosure,” and that became this platform. Then from there, we raised subsequently larger funds and had better deal flow and better reputation.
I always say, I call this randomness and optionality ex post facto. You can explain everything as like this perfect linear chain of events, but a priori, if you’re intellectually honest, you have no idea, so you meet everybody, and you talk to everybody, and you learn as much as you can, and then one piece falls into the other, and you look back, you’re like, “Oh, okay, yeah, it all makes sense.”
Patrick: That seems like a really interesting idea to pick apart a bit, so randomness and optionality. I’m a huge subscriber to those ideas, but I’d love to hear your formation of it and why that’s important to you.
Josh: It was more of an observation that so many things in my life happened, and not a religious person at all, but I would look at these things and say, “Okay, well, how did that happen,” and then post facto you can trace these things, sort of curious like, “How did I meet that person? Okay, well, I was at this cocktail party, and I met this person whose brother-in-law knew this woman, and then this woman was like, ‘Oh, you should talk to … ‘“
Just when you trace that, it’s so non-linear and random. We were talking before about ants foraging in a forest, and there’s complete uncertainty, and they’re moving all about, but then something happens in that process where they’re able to very efficiently find food sources, and so after the fact, you can figure out how it all worked, but a priori, you have no idea.
Patrick: How do you cultivate those two things? Once you’ve recognized this kind of randomness and optionality as a driver of a lot of what happens, do you try to push harder on those things and set yourself up for more randomness and more optionality?
Josh: I do, and I think it’s a very personality-driven thing. There are people that are partners at the firm who are much more linear thinkers, and they have a very specific goal. They say, “Okay, I have point B to get to. I’m at point A. What’s the shortest path to that?” I’m more, meet everybody, talk to everybody, go to random lunches, go to parties. I have information anxiety. I skip a page in the newspaper, I’m like, “I got to go back, because maybe there’s a tidbit there that’s going to change my life.” It’s probably not the healthiest thing, because I’m insatiably curious, and I want to meet everybody, and I want to know a little bit about everything, but it’s a humbling thing, because you just never know. I’m highly confident that you just never know where the next thing is going to come from.
We even have an investment philosophy that, again, in hindsight, I’ve called this now 100–0–100. It’s this mix of ambition and arrogance and intellectual humility. The arrogant part is the 100. I am 100% certain that Lux will be investing in the most cutting-edge, crazy things that you can imagine in the next two years. The 0 part is the intellectual humility. I have no idea what those things will be. None. The next 100 is the ambition and the confidence, which is, I know with near 100% certainty where we will find those things, and it’s at the edge of our already cutting-edge companies. As long as I stay curious and paranoid and ambitious, and we listen in the boardrooms about the hard problems that these companies might be solving, it’s just, that’s where the next thing comes from, but it’s all random until after the fact.
Patrick: Curious how you think about your time, because I have the same problem of insatiable curiosity seems like a good thing. I think it is a good thing on balance, but it’s definitely a bit of a double-edged sword in that there’s this kind of flavor-of-the-month type mentality. Sometimes it can be hard to really be consistent and execute the 1% inspiration, 99% perspiration. That’s always in my head. Curious how you manage that balance and that idea, and just generally then how you manage your attention.
Time, zero-sum, like it’s just always running out. You only know in hindsight if you wasted time or not.
Josh: Everybody always says, “Focus, focus, focus.” I’ve structured the firm and my position and my role in a way where I don’t have to focus. I get to talk to everybody and do everything, and now I have to focus when I’m on certain company boards, or I’m pursuing an investment, and there are times, and there are sort of punctuated periods where I become psychotically obsessed with a particular area, and I go really deep. I know that I become obsessed with it, because my wife or my partners are generally like, “Shut up already about that thing.” Right? I know like it’s the only thing I’m talking about. I can give you some examples of that, but the time allocation, it’s the one thing, like we don’t worry about capital allocation because you know that you can always make more money. You can always sort of reverse a mistake. You can be creative about that. Time, zero-sum, like it’s just always running out. You only know in hindsight if you wasted time or not.
For example, we allocate a portfolio, but sometimes we do these NewCos, and so that means literally one of the partner makes an explicit decision, they’re going to take a significant amount of their personal time and found a new company. We’re going to license the intellectual property. We’re going to find the entrepreneur. We’re going to hunt down the thesis. We’re going to construct the narrative. We’re going to recruit the first 20 people on the board, and come up with the syndicate. That’s an enormous amount of time, and we know a priori it might be wasted time, but we also have this colloquialism, and it’s sort of a cliché, but that passion is the best predictor of success. If somebody is psychotically passionate about something, then they’ve got the fuel and the energy to go do that, and so that would be a good allocation of time.
Patrick: What was the last passion?
Josh: Well, I’ll give you … Okay, so the last one that we realized was a contrarian idea when everybody was chasing clean tech and green tech, if you remember, in the venture world. This was like the bubble extraordinaire. It was like religious thinking, which to me generally I start looking at and say, “Okay, what’s the sort of antithetical view to this?” Everybody was talking. I mean famous people. John Doerr, Vinod Khosla, the best VCs in the world, about solar, and wind, and biofuels and ethanol. I wrote this scathing piece in Forbes at some point calling them biofools, sort of crapping on the biofuel movement, and then talking about solar and saying this was going to be the flight of Icarus, and that if history didn’t repeat, it rhymed.
The closest analogy to solar was going to be Global Crossing, which if you remember in the last ’90s, hype got high, cost of capital got low, hundreds of companies got funded. Thousands of miles of dark fiber optic cable got laid and lit, and the winner from all of that largess was the Third World, who ends up getting connected to the internet for free, and the losers are the First World investors left holding the bag. We look at all this and we’re like, “No to solar, and no to biofuels, and what’s an area that nobody’s looking at?” I become obsessed with nuclear. I knew nothing about nuclear, but I spent the next year looking at every part of the fuel cycle. We looked at uranium miners, mostly hucksters and fraudsters in New Mexico and Nevada, by the way.
We looked at modular reactors. Great for society, but too expensive to back. We looked at the service businesses, and then we always point our turret and say, this is a very sophisticated two-word question to figure out where our next thing is, “What sucks?” The thing about nuclear that sucked was, what do you do with the waste? Because there were political issues, and there were economic issues, but the waste thing was a real technological problem. It turns out that there are 104 domestic reactors. There are 440 global reactors. There’s a big market in commercial waste, but then there’s this huge market that nobody knew about which was in defense cleanup, cleaning up nuclear bomb-making materials from places like Hanford, and Savannah River, and Idaho National Labs that nobody ever knew about. Every year, six billion dollars, which was a quarter of the Department of Energy budget, was going towards people like Bechtel and Fluor, these giant engineering companies.
We said, “There’s got to be a better technological way to do this.” If you remember these things that I look for, really high scientific and technical complexity and IP and labor scarcity, we end up starting a company. We named it after Madame Curie, who discovered and would die from radiation, called it Kurion, locked up all the best people, all the best technology, and set our turret on the idea of cleaning up nuclear waste. That was in 2010. A year later, 2011. Earthquake, tsunami, Fukushima disaster, and we became the only company picked for the cleanup. We went from a million in revenue …
Oh, and by the way, this thing was capitalized with less than three million dollars, and that’s the only money this thing would ever raise. Total negative black swan in Japan, total positive black swan for this little company, and we went from a million to 40, 80, 120, 160 million of revenue, 40 million dollars of EBITDA, sold it for 10 times to Veolia. It all started as just this crazy idea in a conference room. I became obsessed with nuclear. A few years ago, I became obsessed with this crazy area of physics called metamaterials. Metamaterials are materials that were synthetically invented that have a negative index of refraction. There’s a glass of water in front of us. If I put a pen in there and you look at it, it looks like it sort of breaks in the water. That’s a positive index of refraction. Negative index of refraction, wavelengths bend around objects. The media goes crazy about this, BBC especially. “Harry Potter cloaks are here. Invisibility is real.”
Okay, it’s not, but I go and start talking to all the scientists that are developing this thinking, “Okay, you can beam steer things like satellite antennas without moving parts, and you can see a world where you’re going to have broad internet everywhere beamed down by satellite, but you need antennas that don’t have moving parts.” I go to the scientists, and they say, “Good news and bad news. Good news is, it’s real, and this stuff is working. The bad news is, Nathan Myhrvold, who used to be the CTO at Microsoft and starts this firm called Intellectual Ventures, has locked up all of our patents.” I say, “Oh, no,” so I go to see Nathan. I say, “Hey, I want to start a company in space, and I’ve got a CEO lined up, and I’ve got customers lined up, and we’ve got money lined up.”
He says, “Good news and bad news. The good news is, your financing risk is really low. The bad news is, Bill Gates wants to fund the entire thing himself.” I throw a tantrum, kick and scream, work my way into the deal, and in a surreal stroke, the board becomes me, Bill Gates, Nathan Myhrvold, and the founding CEO. It was the only other board that Bill was on besides Berkshire and Microsoft. That was five, six years ago. We’ve since had three or four other companies with Bill, and what’s amazing, going back to that 100–0–100 phenomenon, I’m in a boardroom in Bill’s office, and we’re making these antennas for satellites. Then I hear about these young guys in San Francisco who want to take these satellite antennas and put them on these tiny satellites. I knew nothing about these guys. We run and go see them. We end up investing. It’s a company at the time-
Patrick: Oh, I know where this is going. Orbital Insight?
Josh: That will be the tertiary one, but the secondary one was this company at the time called Cosmogia, then Planet Labs, now Planet. Planet is making satellites that look like loaves of bread. You launch them up into space. We invest right before they did their first launch, and then they did 31 satellites, I think, in their first launch. Now we’ve got about 200-plus that are circulating the earth. It’s the largest constellation of earth imaging satellites in history, and it’s amazing. From this crazy idea in metamaterials, it leads to this company with Bill Gates, which leads to an insight in a boardroom that sends us on a hunt to San Francisco.
We fund these satellite guys, and then we get the insight, which is exactly what you just said, Orbital Insight, which was an entrepreneur who said, “Over time, some of these images might become commodity, and the real value is going to be doing the temporal, analytical analysis that you can say, ‘Okay, here’s parking lots,’ or, ‘Here’s the shadows cast on oil tankers as a proxy for their carrying capacity,’ or, ‘Here’s a caravan of trucks in China. Are they going to a ghost town residential facility or are they going to a productive chemical facility?’” That information was legal espionage that was valuable to corporations, to governments, to investors.
Patrick: Hedge funds.
Josh: Exactly. We fund this guy, Jimmy Crawford. Jimmy’s amazing. Built the AI for the Mars rover, ran Google Books, went to Climate Corp, which sold to Monsanto for a billion, so us and Sequoia fund him. Bloomberg and Google come in, and none of that, a priori, was knowable. Something that started literally reading scientific publication in Proceedings of the National Academy of Science, or Science, or Nature, that leads to Bill Gates, that leads to Planet Labs, that leads to Orbital. Another example like that. My partner Shahin, who is psychotically obsessed with cars. I hate driving. My wife, we have a car. She loves driving. For me, it’s an anchor. It’s just the time. Right? We talk about the allocation of time and cash to spend attention on a road. I cannot wait for-
Patrick: Pure self-driving.
Josh: I mean, it’s just the faster that it comes, right, the more time I have to read and talk and … Okay. Shahin is obsessed with cars, and we’re following all the stuff that’s going on early in autonomous vehicles from Google and Uber and Tesla, and he finds these two guys. These two guys claim that they’re going to take on this market, and we think, “They’re crazy. There’s no way.” You meet them, and it’s like Steve Jobs and Wozniak. You’ve got one who’s this amazing orator, narrative, storyteller, and the vision, and one who’s a technical genius. This is Tim and Jesse, who are the founders of a company called Zoox. Secretive facility up on SLAC, the Stanford Linear Accelerator Corp. Us and another venture firm fund them very early on, and we, at this point, I think, had 25 million in the company.
Fast-forward a little bit. I’m in a room that’s the size of an average conference room, and there’s 20 people in there that look like they’re playing video games. I’m like, “What the hell are these guys doing?” These guys turn to me and say, “You don’t understand. Outside the vehicles,” which don’t even look like cars, “they are ingesting, from optics and lidar and radar and vibrational sensors and thermal sensors, all this data and information, and they are processing it at the rate of one second per second, what we call reality. They are doing thousands of simulations a second, and they’re doing it on these crazy new GPUs,” and so I say, “Well, what do you mean?” Then they say, “Well, those two guys are from NVIDIA in the corner, and we’ve got chips that aren’t even on the market yet.”
I tell all my LPs and our hedge fund friends, like NVIDIA, this is like three, four years ago, and NVIDIA takes off, because the narrative changed from this being a gaming chip company to being the soul of the new machine for AI and machine learning. Then we go and say, “Okay, what’s the next NVIDIA? Who’s the next group of people that are developing GPUs?” We go and find these guys run by Naveen Rao at a company called Nirvana, and we fund them. Now, not even a dollar in revenue and barely a product on the market, and I’m out there publicly talking smack about Intel and how they’re a company in secular decline, and Intel buys them for 400 million dollars.
Josh: None of that was knowable beforehand, and so it’s being paranoid and curious and ambitious when you’re in a company that is at the cutting edge that leads you to the next. Just, so that’s where I get the confidence that I know we’ll be investing in crazy things for years to come, and I can’t tell you possibly what they are today.
Patrick: Yeah. It all sounds like your answer, which is better than most, to, “What is your edge?” Right? You sort of build up this internal network effect, the relationships, and the momentum that you seem to have just as a person, but also probably as a firm, just kind of worming your way through deals. From the LP’s perspective, I’m very curious how this works, because you do so many different things underwritten probably very different ways, underwriting a person and a founding team versus a later-stage technology versus a hard science thing, versus originating a company. I mean, this is a really interesting mix. How does that work with your LPs? Are they just kind of betting on Lux in general, or are they differentially betting on, and themselves underwriting like different expected risk return profiles of these different buckets? I’m fascinated by how this might work.
Josh: No, I think that they’re betting on a philosophy that is manifested in a different set of personalities within the firm, but at root, it is people that are thinking a little bit differently. In fact, when all the people that invested with us over the years, and all the people who have rejected us over the years did it for the exact same reason. They’re like, “You guys are sort of different.” They couldn’t bucket us as IT investors. They couldn’t bucket us as biotech investors. We weren’t seed stage people. We weren’t growth equity guys, and they just said, “You guys are just sort of different.” It’s interesting, because we are always on this sort of treadmill, this sort of the Red Queen theory that you have to run twice as fast just to stay in place, and things that we were investing in a few years ago are very hot today. This is, if we’re successful, exactly what should be happening. It’s the four or five-year psychological bias that everybody wants to be invested today where they should have been four or five years ago.
Four or five years ago, we were in AI, and machine learning, and robotics, and satellites, and autonomous vehicles, and today … We have to be careful, because I always say, funnel wide and filter high. We don’t want to be the firm in ’98 or ’99 that is like, “Geez, who needs another search engine,” to miss Google, but at the same time, incremental bar to make an incremental investment in those spaces is very high. Now the kinds of stuff that we’re looking at are things that for the most part nobody’s talking about.
One that we just recently did, maybe there’s one or two investments that people have made in the venture world in this space, but tattoos. Tattoo technology. We looked around, said, “What sucks?” 40 million Americans have tattoos. I joke that generally when you get a tattoo, you are long regret, at some point want to reverse that trait. The asymmetry to get a tattoo, 60 bucks for a small Celtic tattoo, 6,000 dollars with 10 600-dollar laser treatments to get it.
You look at that, you say, “There is this really interesting market.” By the way, just sort of memetic cultural copying, huge prevalence, particularly where I grew up in Coney Island, Brooklyn, of African American, Latinos that have mirrored basketball players’, rappers’ full body arm-length tattoos. You can’t get laser treatment because if you do, you’re bleaching your skin white, so we’ve been looking for three years to find, and we found a ton of technologies, but the missing piece was finding the entrepreneur that could take paternity or maternity and run with it. We finally find this guy, Errol Damelin, successful UK entrepreneur. Us and another venture firm fund him. He found the same Princeton professor that we did at the same time that’s doing femtosecond lasers to remove every wavelength totally painlessly.
I’m convinced that if you can get the removal part, then you can come up with new technologies for application, because that is a timeless form of human expression, and you’d be amazed how many of our conservative LPs say, “If I could have something longer than temporary but shorter than permanent, I would get one.” That’s a funky area that people are not like tattoo technology.
Josh: Oh, I love Ali. Yeah. I had been a fan since right before he started that firm.
Patrick: Yeah. When we talked, I was just talking to him recently about rolling up tattoo parlors and basically parlaying some tattoo artist’s brand into a national chain which doesn’t exist, and this could be the-
Josh: The extension of it.
Patrick: This could be the extension. I love it. We’re going to spend more time on thesis-driven, because I know that’s the area that you’re especially passionate about, but I would love to spend a minute or two on the earlier-stage business where it’s really more about betting on people. Specifically, I love this idea of what sucks. A guy here in New York City, Alex Moazed, who was also on the podcast, who wrote a book about platform business models, the litmus test he had was like, “What’s, X no longer a pain in the ass,” was-
Patrick: … his way of formulating it.
Josh: That’s a good one.
Patrick: I would love to hear about how you evaluate people and their ideas when it’s very, very early seed stage PowerPoint level.
Josh: I would say we get this roughly right. We are always fine-tuning, and it’s actually led to a change in our investment process because of sometimes us getting it very wrong, “it” being our evaluation of people. There are amazing, incredible people, and there are amazing salesmen. Sometimes those two people are one. When they are, you have an amazing entrepreneur, but oftentimes they’re not. We’ve had incredible executor, operators, people that get stuff done, that come up with a plan, they’re executing it, but they cannot go out and raise money, they can’t recruit, they can’t sell a story, they can’t talk to the media, and that is a major deficit. On the other hand, you have people who are amazing at telling stories, and they can lower the cost of capital because they can raise expectations, but they can’t execute. You need a marriage of both. You need the storyteller, and you need the executor and the operator.
Failure comes from a failure to imagine failure.
When we’re assessing somebody, it’s interesting, because we really try to consider ourselves as contrarian, so we’re trying to think, “Well, what is everybody else in the venture world thinking about, and what can we think about in a slightly different way?” Yet we’ve realized at a meta level how hypocritical we are when we have a complete consensus internally around something, and almost all of our mistakes are when an entrepreneur comes in, and we are so impressed with she or he, everybody is looking around the table, we’re trying not to let people know.
In fact, one of my partners used to call this the Pampers effect, because you’re so excited, you’re like just trying to keep it cool and not convey how badly you want to fund them, so you have some negotiating leverage. But we’re sitting around the table, we’re looking at this … We’re looking at each other, we know we want to fund them, but what are we reacting to? We’re reacting to their persuasive ability to tell a story. We haven’t observed their ability to operate. We haven’t observed their ability to recruit. We’re convinced that they can get us to part with our money, they probably can get other investors to part there with their money, so the financing risk is low, but all the other risks are huge. Technical risk, market risk, product risk.
In fact, it’s interesting, because there’s a dichotomy in our partnership in optimism and pessimism. My partner, Peter, is the perennial optimist. He will look at a company and say, “How can this be a billion-dollar business, and what are the assets, and the tools, and the resources that Lux can bear to make it so? Who can we populate the syndicate and the board, and who can we get the media to cover,” and all the positive things. I’ve got a quote that says, “Failure comes from a failure to imagine failure.”
If you can imagine all the things that can go wrong, then you can flick them off the table, because I think of it almost like the first law of thermodynamics, like energy is not created or destroyed, risk and value just change form. Technology risk, product risk, market risk, finance … All those things are risks. I kill one of those risks with time or talent put into it. If you’re a subsequent investor, you should be paying a higher price and demanding a lower quantum of return, because you’re taking a low quantum of risk. When this entrepreneur comes in and is pitching us, maybe they’ve eliminated the financing risk, but all those other things exist.
The biggest mistakes we’ve made have been when an entrepreneur comes in, we won’t let them leave. We want to give them terms almost on the spot. The best-performing companies we’ve had, conversely, are when everybody in the firm disagrees except for one person. One person is the passionate table-pounder, and they’re like, “I’m telling you, she’s got it,” or, “He’s got it. We got to do this,” and everybody else is like, “I just don’t see it,” and that is usually the best-performing company when we do that.
Patrick: Why do you think that is? I’ve heard this a number of times, from firms of all types, public market, private market, etc., that high levels of disagreement, which makes sense in like from a value investor’s mindset. You need a consensus to be very wrong to get a mispricing, typically, and certainly in public markets, but probably in private markets, too. Maybe say a little bit more about why you think that is the case, that it’s the minority opinion that tends to lead to the best outcomes.
Josh: Well, I think it is, on the one hand, somebody is seeing something that everybody else isn’t, and even though, again, within the firm, against the rest of the world, we consider ourselves different thinkers, but then, when you see consensus here, you got to say something’s wrong. Some firms actually implement like a devil’s advocate or a red corner person to actively do that. It’s much better when it comes naturally, and certain people have that disposition where they’re naturally argumentative, but I just think it’s somebody seeing something and feeling so passionate about it that, in a sense, we have confidence that they are going to be obsessed in making this a success.
They’re putting their brand on the line, they’re putting their reputation on the line. By the way, we allow people to get one of those in a fund, and the reason is really, it’s almost like a Josh rule, because I can be pretty persuasive and a strong table-pounder, and if I did that all the time, I would abuse the process. I really have to think about, “What’s the silver bullet that I’m going to really pound my table?” I basically get one of those in a fund, as does everybody else. I just think it’s that phenomenon that you’re looking for that contrary view, seeing something that somebody else doesn’t, and then doubling down with your personal passion to make it so.
Patrick: They’re the best outcomes. Why do you only get one in the fund?
Josh: Well, again, it’s to avoid the abuse of the process, because if you have a partnership, we don’t really rule by democracy. At the-
Patrick: Got it.
Josh: … end, it’s Pete and I make a final decision.
Josh: But I would be table-pounding every time for every deal I wanted to do, and this way I sort of have to treat it as a scarce and really valuable thing.
Patrick: What’s a particularly memorable, maybe recent experience with a founder that really stood out, that kind of fits this mold that you’re talking about?
Josh: I don’t want to name names-
Patrick: That’s fine.
Josh: … but there’s one where they came in, we literally wouldn’t let them leave. We offered them terms on the spot. It was a particular product that all of us wanted to use. It was a future that we wanted to live in. We very quickly realized, after the investment was made, that this person, as impressive as they were, had no intentions to step aside and bring in a real CEO, and they were really not qualified to do it. They had a family member involved. I mean, it was sort of like a failure of diligence on our part.
It turns out, the company’s doing really well, and we’ve had some situations where a process versus outcome, the outcome may be extraordinary for our investors, but process, we considered a total failure. We just, we got it wrong. Our assessment was wrong. I think that has warned us. Like if we’re too excited about the entrepreneur, reining it in a little bit, because something’s off.
Patrick: Let’s talk about thesis-driven now, and this is something we really haven’t explored at all. Most of the venture capitals that I’ve talked to have been earlier stage, probably mostly seed stage, and it really is about betting on founders, and maybe on ideas, and maybe a little bit on markets. I talked to Andy Rachleff about addressable markets and things like that, but talk about this thesis-driven approach to private investing, maybe using some examples.
Josh: Kurion is a great example of that, just because you’re reading voraciously, you’re understanding what is the consensus, and then you find that variant perception. Nuclear was something that nobody else was thinking about. The same thing, we had a thesis around vaccines a long time ago, in part because it was totally contrarian. You go to a pharma day where Mercks and Pfizer’s host a day, and the VCs come in, and they would say, “This is our wishlist, and these are the do not call list,” and on top of the do not call list was vaccines.
We sit there and say, “Well, the pendulum is going to swing. There’s going to be a reversion back, because the thing that’s not wanted today is going to end up becoming scarce, and so let’s go and populate the very best, a company with the very best IP and people.” We ended up starting a company taking that public in the vaccine space. Robotic surgery. You’ve got one mega giant in Intuitive Surgical.
It has been a battleground between longs and shorts, but whatever, it’s 20, 30-billion-dollar market cap, and we end up finding the founder of that, and he’s looking at the scope of technologies that are out there now, and the computational ability to map inside of the body, and all these new tools, and we say, “Okay, this is going to be future of medicine,” instead of having one modality where you’re just focused on hysterectomies, or prostatectomies, in the urology department, you could have these robots that are modular in an ER doing 20 different surgeries. That was a thesis around robotic surgery.
There’s the thesis around the scientific evolution of something like metamaterials. Tattoo was a thesis. We have a thesis that we haven’t executed in a substantive way yet around hearing, where you just see the demographic loss from people wearing headphones and aging, that there’s an opportunity both for therapeutic and devices on the hearing aid side, something novel. Then I can share two that are sort of crazy.
Patrick: I love crazy.
Josh: Okay, so … By the way, I tell my LPs, because we share these ideas. I sort of subscribe to the idea that if any idea is really good, you sort of have to shove it down people’s throats, you don’t have to worry about people stealing it. One idea is really two phenomenon. One is technological, and one is a moral philosophy, and I think that they’re combining. I tell my LPs the idea, and I preface it, “You’re either going to think this is a multibillion-dollar idea, or you’re going to think it’s batshit crazy.” If they think it’s both, then I know I’m onto something, but particularly if people are like, “That’s a little bit too weird for me,” I know I’m onto something.
Technologically, we have better signal processing than ever before. High-frequency sound, low-frequency sound, vibration, gesture, and motion, anything that you can imagine … The modalities that we have to input into a machine are greater than ever before, okay, and that’s for two-legged mammals, but I think it will hold for others.
Second, moral philosophy, Peter Singer’s sense of an expanding arc of moral empathy and inclusiveness. I am not an animal rights person. I am not super left-leaning, although some of the people in the firm are. I like bacon. I like beef. I like burgers, but you can observe, and it is always better to make observations than predictions, that there’s this zeitgeist around animal rights, and so the evidence for this, Shamu out of SeaWorld. Ringling Brothers, before they went out, elephants were gone. Talk of the horses in Central Park being gone. Vietnam outlaws eating cat. China went from middle class that was eating dog to widespread ownership. Anybody posts a picture online hunting, they are instantly shamed.
You put these two things together, and I am absolutely convinced that within 10 years, people look back and say, “My God, how did that never exist,” where “that” is a series of beautifully aesthetically designed devices, Apple-like, for the pet owner where probably for dogs to start, animals are able to express choice, preference, and control. “I want chicken or beef or fish. I want to go to the park or the zoo, or I love you, or I hate you, or leave me alone.” Obviously, this is not going to be like Pixar’s Up movie with the dog’s talking collars, but just, I have to believe that the intellectual and emotional life of animals is greater than them nuzzling up against you and barking at the door and pawing at it to get out. What I’ve been doing here is talking to the very best people in animal cognition and communication and corralling them and then talking to hardware designers and thinking about, what are the kinds of modalities that this might be so that you could basically crudely communicate with animals? That’s a crazy thesis.
Another one, and this one is something that I’m really excited about and where I’m spending a substantive amount of my time at the moment, and again, I know it because everybody’s telling me, “Shut up already about this thing.” There’s a trend through the history of technology where something that was invented for a minority group, people with disabilities, ends up giving them the ability to go from disabled to abled, and then that same technological capability takes people from abled, in a sense, to superhuman or superpowered.
You can look at every sense that the human has and find an example. In eyesight, people that were visually impaired, it led to the technology of optics and ultimately to telescopes and microscopes. People who could not speak when you had speech-to-text, and then Stephen Hawking is a great example of this, that technology would lead to things like Speak & Spell and to voice recognition and all of the Siris and Alexas that we have today. Exoskeletons for paraplegics are being used by the military to create sort of these super soldiers. You can look at all these external peripheral devices and imagine how we’ve gone from disabled to abled and then from abled to superhuman.
Then I started looking at the biotech and genetics piece of this, and here’s the crazy thing. I always say that sci-fi and sci fact are sort of shrinking. That gap between that which was once imagined and that which is real keeps getting closer and closer, and there’s endless examples within the Lux portfolio of something where the founder or us were inspired by something we’ve read in a graphic novel or saw in sci-fi, and it was fiction, but now it’s real.
Professor X in X-Men dons this helmet and from a population of a billion people is able to find the mutants. Now, those mutants are shooting lasers out of their eyes and conjuring fire from their fingers, and that’s absurd, but think about this, that if there are one in a billion chance of some rare genetic condition and there’s seven billion people on the earth, then there’s probably six or seven people walking the earth that have some really unique trait. That could be a super-high threshold of tolerance for pain, or super-low threshold tolerance of pain. It could be somebody that can withstand heat or cold abnormally. It could be somebody that needs very little sleep, somebody that has high metabolism, somebody that has acute hearing or can see in the dark, people with hyperthymesia who can go back 50 years and recount the most acute detail of a single moment of a day. People with muscle hypertrophy who at a young age look like they’re bodybuilders.
Well, if you take that and you can almost Indiana Jones style have a group of people that are gene hunting, trying to find these unique individuals, in the same way that the NBA scouts are trying to find a seven-foot-eight person in China, I think that these people exist, probably through anecdotes and local papers and stories and family history, but you start with that, you sequence some of these people, and then you start using the basis of the extraction of the genetic information for benevolent good. Start with therapeutic purpose. Take rare orphan diseases, people with low muscle tone, and give them high muscle tone, but you can see the direction in China and where things are going where they have less ethical considerations and regulatory apparatus, and you can see a world of human enhancement and augmentation enabled by this.
Those are two theses that this year we will probably start NewCos in, one around animal cognition and communication and really having a jurisdictional line between what’s real and what’s BS in the science, and the other of looking for these X-Men. Who are these rare mutants, and what can you genetically engineer to make people better?
Patrick: I’m really curious about the learning process behind one of these theses. This is something I’ve been kind of refining over the years. There’s books. There’s podcasts. There’s conversations like this one. There’s source material and raw data. What’s kind of your process for feeling your way through a topic? It could be one of those two or anything else.
Josh: On this X-Men superhero one right now, literally the past 10 days I probably had 30 calls. 30 calls with people that I know who are Nobel laureates, people that I know that are CEOs of our existing companies, and every one of those people, and I keep actually like a physical star map of this, I happen to use a program called Popplet that I just start populating these things with.
Patrick: Never heard of that. That sounds great.
Josh: It’s like a connect the diagram. It’s not particularly good, but I’ve been using it for years, and I just start to see the visual connections of who’s connecting me to who and what tidbit they’re having, and it daisy chains. I speak to somebody, they’re like, “You know who you should talk to is this person.” Then that person tells me, “No, actually, the person that you just told me that you spoke to in this other, yeah, they’re sort of full of it.” Right? I start to get the veracity of who’s for real and who’s not, and in this process, I’m stimulating their thinking. They’re on a plane and they’re like, “Oh, actually, I just met somebody I should introduce to Josh.” I just, I activate the network. Information is coming back to me, introductions are coming, and it’ll probably be a six-month learning process.
It was the exact same thing with nuclear. It was the same thing with vaccines, the same thing with robotic surgery, same thing with metamaterials, and it’s just, we have the passion, we have the excitement to do the work, and sometimes you come back and you get disconfirming evidence. Somebody says, “Really great idea, and it sounds like a great story, but the science isn’t there yet.” Those are frustrating, right? Because they end up on the cutting room floor, but that’s the process, just that going back to that idea of randomness and optionality.
You’re talking to everybody, collecting and processing the information, running it down to ground truth, and in the process, you’re also recruiting people. I might talk to four scientists and convince, “Okay, I have to get them all involved in this.” I might talk to somebody else and be like, “Oh, my God, this guy’s amazing. I need to get him on the board.” In the meantime, I have investors who are like, “Oh, when you do that, I want to fund it.” Right? Every one of those risks, I’m thinking about, “How do I kill those risks?”
Patrick: I’m going to try to corral a lot of those ideas into the next question. You mentioned basically finding X-Men. I just started this new book on CRISPR and kind of gene splicing, and I’m always fascinated with uncertainty and blind spots, so biotechnology’s actually a great example in my world, where the outcomes tend to be so binary.
Patrick: I don’t want to plant the axiom that people can consistently do qualitative analysis to pick the next best biotech stocks. I don’t know if that’s possible, but I know that it’s basically impossible to do it quantitatively, so there are just these kind of certain pockets of industries or opportunities that are very hard to get right, so I’m curious how you think about like the exposure to uncertainty and this idea, you mentioned this idea last night when we were chatting back and forth about rebel scientists. Maybe going to that notion of rebel scientists and how you account for stuff like this, where it just seems like impossible to predict what’s going to happen.
Josh: It is totally impossible to predict, and so on the biotech side, by the way, biotech is seemingly rational in that most of the companies end up valued in the Phase II, sort of pre-Phase III at 200 to 300 million, and you can almost say, “Well, okay, if there’s a 10% chance that this is going to be a three-billion-dollar business, the expected value is 10% times three billion is 300 million,” and so you sort of end up around that phase. If you look at the pipeline of what are the underlying base rate odds of a compound progressing from preclinical to Phase I to Phase II, AB, Phase III, actually getting approved, you get to sort of see that probability. It’s like a funnel, but I think that betting on a single … You have no idea how it’s going to turn out and what the adverse indications are going to be and what the toxicity is going to be, and so you have to have, in my view, a platform. It’s a portfolio.
We’ve never really had a single drug biotech. There are people that get lucky and post facto they’re like, “Oh, we knew it all along.” I say, “BS,” but I think you have to have in something like biotech, and even in some of the hardcore really early stage science, a portfolio of these things so that you have multiple shots on goal, you’re not betting the farm on one, and you have to have investors in a management team that can totally embrace that, and you have multiple horses that are sort of running at the same time, to mix metaphors.
On the rebel scientist part, this to me just gives you a higher probability that somebody is thinking really differently. Typically, this is somebody who’s coming from outside the field. I’ll give you a great example. Somebody you should probably have on the podcast, Martine Rothblatt. Fascinating friend who, Martine was Martin, founded SiriusXM Satellite Radio, and now transgendered, but married to the same woman for 30-plus years and multiple kids, and knew nothing about biology and had a daughter who was afflicted with pulmonary hypertension and ends up going and identifying a compound in Wellcome Trust, in GSK, that is totally improbable. They say, “You’ll never be able to formulate it. It’ll never work in humans.” She literally is picking up a high school biology book and teaching herself and then surrounding herself with, but total outsider. Right? In every facet, every definition of it, and ends up with a drug that works, and today it’s a billion and a half dollars revenue. She pays GSK every year 150 million bucks, 10% royalty, and it’s a six-billion-dollar publicly traded company.
That’s the kind of outsider that looks at something and whereas most people are like, “Oh, that’ll never work,” and you always hear that from older entrepreneurs and older executives. The young people are really naïve. Stan Druckenmiller, famous macro guy, was one of my early investors. I remember Stan saying, for the same reason he was investing in us, it wasn’t because we were smart. It was the same reason that somebody gave him money when he was early, which was the same reason that they put 19-year-olds on the front line of war. They don’t know any better than to charge full speed ahead. You want a little bit of that entrepreneurial naïveté, and sometimes that comes from an outsider who doesn’t know all the dogma inside of a sector. We love the rebel scientists that generally have something …
By the way, my favorite entrepreneur to back is somebody that is sort of like me in a way. They have something broken, something from their family, something from a divorce background. They were made fun of as a kid. They had a lisp. They were fat. It doesn’t matter how much money or success they achieved. There’s always that empty sort of hole inside, and I have so many LPs that actually have been attracted to invest with us because they themselves were like those people. It’s just something that is this perennial, inextinguishable fire that drives these people through their life, and some of the great entrepreneurs, maybe they were adopted, maybe they were orphans, they were made fun of, they had some affliction, they were dyslexic, but there was something that was driving them, and it was usually against the masses. Whether they were rebelling against what was around them or people or resentment, I have a lot of debates with people about like, “You should be, have this great positive energy.”
I think that amazing things happen with negative energy, with dissatisfaction, because by definition if you’re happy, you’re complacent. Right? It’s good to find calm and peace, but if you want change and progress, somebody’s got to look at something and literally go back to those two words and say, “What sucks? That sucks.” Then you have to be motivated to want to change it, and I think this comes from this negative energy, and usually you find that in these rebel scientists.
Patrick: Do you think maybe those could even be within Lux, younger analysts or something that you’ve educated or mentored or what have you, that this kind of rebellious mindset can be cultivated in the absence of just like genetics or early experience and negative early experience? It is something that like the average Joe can work on and improve upon, or is it kind of baked in?
Josh: I don’t want to say no. It would be naïve and maybe ignorant, but I haven’t seen it. People that are generally born in good circumstances, people that generally don’t have scarcity, people that don’t grow up wanting, I just, I haven’t found that same kind of grit, so yeah, it’s possible somebody gets inspired and reads, but when you know, “I was driven. I didn’t want to be poor. I wanted to find a great partner in life. I wanted to make my mom proud. I wanted to see all the naysayers who didn’t believe in me and shut them down and prove them wrong.” I just, I’ve never personally found that somebody who grew up extremely wealthy, without adversity, without hardship, without somebody telling them that they couldn’t do something, that they had that same kind of flame and fire. I mean, look, Bill Gates was a brilliant guy. He didn’t grow up poor, but he still had this sort of competitive edge. Right? I mean, it was like the revenge of the nerds. I think it’s possible, but it’s rare.
Patrick: Curious who some of the other investors are that you’ve learned the most from.
Josh: It’s pretty rangy. My best learnings have been on boards and seeing how people behave. These are typically older, so it’s why I generally believe for entrepreneurs, experience is overrated. Everybody’s like, “Get experience.” You look at some of the most amazing entrepreneurs in history, they had no experience doing what they did when they started. None. Right? They were either pioneering some field, or … But they had the gusto, and they often knew to surround themselves with good people. On the investor side, there’s a guy, Leighton Read, a long-time venture guy. I’ve been on a few boards with him. He had a style of equanimity and professionalism. He could get to the 90/10 of what mattered. He was able to drop his voice a little bit an octave or two to command a baritone attention when you needed it. He would support the entrepreneur and developed a trusting relationship with him. There was another guy, Chris Brody, who, a long-time VC, Warburg Pincus, also like very fastidious when it came to the analytics and KPIs for business and would hold people really accountable, so he was another one.
There’s somebody else that was just super inspiring as a coach for entrepreneurs, so they never really beat him up in the board meeting, but they were always really inspiring, and they always brought out the very best in them. By the way, Bill Gates, in a boardroom with the CEO, you’d think he’s beating him up and he’s going to be the smartest guy, and if somebody else is beating up the CEO, he’s the first one to defend him and be, “I actually think he’s doing an amazing job.” He’s able to step back and be like, “Okay, this is the one thing that really matters.”
I find that super impressive, but our number one job on the board is making sure that she or he, whoever is running the company, are doing a good job, and if they are, I basically view it as, we work for them, and if they’re not, then we have to replace them. That’s the hard thing, and you can never do that too soon.
Patrick: How do you think about investing outside of your particular comfort zone or asset class? I’m going to start asking people this question more and more, because it’s a question I’m asking myself. The vast, vast majority of my invested net worth is in public markets, quantitative equity strategies, and I think that will always be the case, because that’s what I know. That’s what I can have the discipline to stick with because I know it so deeply, but I want to explore, and obviously the podcast is good evidence of this, other areas. I’m curious how you think about that. Leverage buyouts or public equities, or credit, or things that are not what you do in your day job, how do you think about those not only as the potential to learn about them, do you spend time on them, and you do personally allocate capital to them?
Josh: I do personally allocate capital, and my wife is an activist, public market investor.
Josh: She does the public stuff, and I do the private stuff. I will say, I’m more a student of business and history and human nature, and so where that affects asset classes, I get it. Credit is a little bit harder for me. It’s more structured. It’s more finance. It’s less about the human psychology. Real estate is totally uninteresting to me, although we have some personal investments, but I’m more interested, public and private markets, because on the one hand you have true businesses that you can understand, and then you have human psychology. You can look at everything from, and I’m obsessed with the rational capital allocators, whether that’s the Rales brothers, or Buffett, and Malone, or Bezos.
People talk about, in technology, Amazon and Jeff Bezos, and Elon Musk and Tesla in the same breath. If you follow me on Twitter, you know I’m crazy about this. Elon is a brilliant guy. SpaceX, incredible company. Tesla, not so much, and it’s like heresy in the venture world for me to say that. Jeff Bezos raised money in an IPO, never raised additional capital-
Josh: … and people say, “Well, he had no profits, and well, where did all that value come from?” It came from cash generated in the business in the same way John Malone did. He didn’t report profits, so having an understanding of business and understanding accounting and understanding human nature and good capital allocation, I don’t think it matters whether there’s liquidity, which is to say whether they’re private or public businesses, but businesses, people that are corralling capital, producing a product, serving a market, to me is just endlessly fascinating. I also have a penchant which is my personality for identifying fads and frauds and technological obsolescence, and I am part of a sort of private group of people that are always looking for great short ideas.
It’s interesting, because Lux is fundamentally shaped like a call option. The stuff we do are low probability, potentially high magnitude outcomes. There’s a few ways to cut a venture fund, but on average, 30-year companies are going to be total zeros. You don’t know which, a priori. A third you might make your money back, and a third maybe you get 10X, you end up with a 3X cash-on-cash fund. Another way to look at it is, maybe you have one or two companies that return the entire fund once. Maybe two to five next companies return at another time, and everything else combined return a third, you get 3X in 10 years, but that’s a call option like payoff, and I look at this and say, “Okay, the put option like payoff, we’re betting on the future, but maybe there’s an opportunity to bet against the past.”
That’s an area that I’m interested in increasingly of saying, “You know who these fads, you know who the frauds, you know who the crappy companies that your venture peers have taken public. You know the bad operators,” and just being students of business and markets, and again, that curiosity, which is the same curiosity you have, to talk to interesting people and learn about different asset classes, can help get you there.
Patrick: You mentioned your partner was the optimist. You’re the one focused on kind of the downside and risk, so let’s use that to talk about the short idea, the put option part a little bit more. Don’t necessarily have to name individual shorts or whatever, but I’m curious about the process behind this and how that maybe small group, that private small group, was sort of cultivated. What are you looking for? What’s kind of the inverse of what you look for on the call side, on the put side?
Josh: It’s just really bad businesses.
Patrick: Identified how, I guess that’s the question.
Josh: Terrible unit economics, massive amount of leverage, and particularly run by people which are horribly promotional and dishonest, because I think sort of those things like if you lie to people and the public, you’re going to lie to yourself in private. I grew up in Coney Island. There were carnie barkers, and hustlers, and con men, and so I always grew up-
Patrick: You’ve seen it.
Josh: You just grow up skeptical, right? You’re like, you don’t make eye contact, and if you do, it’s sort of like half-squinted like, “What’s that guy’s agenda? What’s the game he’s running?” I’m generally skeptical of people and more distrusting. Thankfully, there are people here who are more trusting and open and haven’t had the same kind of life experiences, but you can see it. You can see these hustlers, and you just want to avoid them. On the short side, I’m fascinated by these crazy promoters which, by the way, it’s really dangerous, because one of the greatest assets, and we talked about this before about on the venture side-
Josh: Fundraising, and so if somebody, I would never short a religion, and some of these people are like the Joel Osteens of public markets. Right? It’s just like they get out there, they can promote, they’re selling. Like I always say, Elon doesn’t sell cars. He sells a future, and he does an amazing, admirable, enviable job that people should take note of, but the fundamental is that business are just not good. It’s not a good business.
Patrick: You said SpaceX is a good business, so maybe contrast SpaceX and Tesla. I’d be curious about your opinion here.
Josh: It’s interesting, because I don’t actually know if it’s a good business, but what it lacks is the need to publicly promote to raise money in the same way that is needed amongst management with Tesla. I’m in continued awe that SpaceX keeps low expectations. You’ll even hear Elon sort of tempering like, “Look, this thing might blow up. Right? It might be a total disaster.” Then he creates awe and amazement. I have a crazy speculative theory, and it’s a complete speculation, and you can discount it. It’s totally absurd, but I’m convinced that Tesla and SpaceX will actually end up merging, that the narrative, it’s a beautiful simple narrative which is, from space and back to space. You’ve got from the sun, which goes down to SolarCity, and then terrestrial, and you’ve got The Boring Company, and you’ve got Tesla, and then back up to space through SpaceX. It’ll just be called X, and if you look a year or two ago, he bought that domain name, X.com. I think that that is the ultimate way.
Now, the cynic would say, “Maybe there’s financial obfuscation and it’s easy to do the same sort of thing you did with SolarCity. It’s a little bit of a magic trick.” The optimist would say like, “What better way to attract capital and some of the brightest minds for the future of humanity?”
If you have a true moat of whatever kind, an unfair source of supply, something on a brand, the ability to get scale where a competitor can’t, a technological innovation that somebody literally can’t access and they look at that and say, “It’s not fair. I can’t make that,” that is a beautiful thing. From that, you have a moat. From moat, you have pricing power, you have monopsony, like pricing leverage with suppliers. I just, I think everything flows from competitive advantage.
Patrick: This topic of unit economics has come up quite a bit, and one of the topics I’ve been spending some time on privately is just sort of the evolution of business models and business in general, like going back to like Coase’s theory of the firm, and the platform business model we’ve spent a lot of time on on the podcast as well. I’m curious how you think about approaching the quality of a business. This unit economics way of doing it has become very popular, boiling things down into very simple terms. Maybe you could describe that process, and more generally I’m just curious on your take on the evolution of business models and what matters in business. I’m really excited for Albert Wegener’s new book. I think it’s called World Without Capital, or Beyond Capital, something like that, where he mentions the scarce resource used to be capital. Now it’s attention. That may change business models. I’m curious, your take on that.
Josh: Well, I actually think capital will become scarce again, but Albert and I are in a few investments on some boards together, and he’s wonderful, by the way. I think the most important thing in business, and it’s interesting, because everybody at Lux has a different lens that they look at these things through, and I always tell entrepreneurs when we’re sort of asking them questions, most of my questions, most lens, and after we make an investment, I insist that they start answering these questions, but I am psychotic about competitive advantage. What can you do, or what can you assert that you can do that will scare competitors that nobody else can do? From that flows good unit economics.
If you have a true moat of whatever kind, an unfair source of supply, something on a brand, the ability to get scale where a competitor can’t, a technological innovation that somebody literally can’t access and they look at that and say, “It’s not fair. I can’t make that,” that is a beautiful thing. From that, you have a moat. From moat, you have pricing power, you have monopsony, like pricing leverage with suppliers. I just, I think everything flows from competitive advantage.
Patrick: When you’re doing the venture side of things and you’re thinking about that as part of the assessment, how do you evaluate that? How do you evaluate the potential for a moat? Obviously in many cases, it’s not there yet.
Josh: Well, the first thing that you can see is how many possible entrants are there in a space. In fact, the scariest thing that I think people make the biggest mistake on is, they look at the trajectories of, “Such and such market by 2020-whatever is going to be this billion dollars,” and they’re always hockey sticks. That is never predictive of returns, ever. What is predictive of returns is how much capital is going into the sector. The more capital that’s going into the sector, that is the greater measure, the worse your returns are going to be.
I mentioned before, I like to go where there’s these five things and you have scarcity, if there’s 5,000 global competitors to Groupon, you are spraying and praying, you have no idea. Forget about 5,000. If there’s 500 or 50, how are you picking a winner? I think you have to go where there’s five or less companies, and the conditions for those, those sort of barriers to entry, are the critical things, because otherwise, those guys are going to be competing for talent. They’re going to be competing for attention. They’re going to be competing for capital. They’re going to be competing for customer interest, and the worst thing you can have is not a bad product, a bad competitor, because if you’re going to a customer and then you knock on the door and you get access to them, and then somebody else was just there a week before and they were a really crappy competitor, they’ve just completely ruined the opportunity for, they’re like, “You know what? We’re good. We don’t need to look at this market right now.” I really think it all flows from competitive advantage.
Patrick: What would be your assessment of where we are in the venture capital landscape, broadly speaking? This is a question about cycles, and I think venture capital results tend to be quite cyclical, but just generally your assessment of the industry, whether it’s doing the right things, whether it’s structured the right way, any problems that you see with the venture capital business.
Josh: I’ll tell you that the average short seller, who I think is right, is always wrong on timing, and my views have so far been wrong on timing, but I think that they are fundamentally right. They were inspired, actually, by something that I was studying at Santa Fe Institute, which was the slime mold. Slime mold was this single-cellular organism that sort of becomes this superorganism. When the environment is resource-rich, the slime mold spawns off and tries every experiment, and then when the proverbial stuff hits the fan, it recongeals into this mothership waiting to spore off again. The analogy is when there’s a widespread availability of capital, every experiment is being tried. In fact, people have asked me, “Is it better for innovation and venture capital when the cost of capital is high or low?” My answer is yes. It doesn’t really matter. When the cost of capital is low, you get what you have now, which is the slime mold expanding, every experiment being tried.
Evidence for this are the WeWorks. The abundance of WeWork, and I was saying this two years ago, which means I was wrong because I was early, meant that every mom in Tribeca and every guy in SoHo is starting a business, going into a WeWork. They have friends and family that maybe feel wealthy from stock gains or maybe there’s just bank money available, and they’re starting companies. The slime mold is expanding out, and every experiment’s being tried. All the kind of stuff is being thrown up against the wall. Now, for society, 99% of the those things are going to fail, go out of business, die, but the detritus that ends up falling on the floor from the wall becomes the combinatorial fodder for the next thing. That happened in the internet boom. It happened in every boom in history. That’s the good news.
Conversely, if you had back like in the ’70s 15% interest rates, then capital is super scarce, only the very best people and very best projects get funded. That was a time when you had FedEx and Microsoft and other companies that emerged that became these timeless entities, and their necessity is the mother of invention, capital is scarce, and so I don’t think it matters. The current environment, cash is abundant. It is everywhere. Corporate VCs, so here are signs. I started this little neologism on Twitter I called nottom, as in not a bottom. Signs of excess that are worth taking note, because you should be scared. I can tell you that our pace of investing is way slower today than it was two years ago, and it’s slower because prices are crazy in markets.
I worry that the amount of capital that’s out there is not only raising valuations, but the speed at which people are putting it out and the expectation that they’re going to be able to raise a subsequent fund. The LP illiquidity, something that we never asked in our second fund or our third fund, which we asked explicitly in our fourth or fifth fund, was to LPs, “How much money do you have targeted for the asset class, and how much do you actually have invested?” If somebody was like, “We have a 4% target for venture capital out of the 8% target of PE, and we’re 12% allocated,” we would say, “Thank you very much. It’s great to meet you,” we would not take their money. Why? I don’t want my name ending up on a secondary list because they’ve got some denominator effect in two years, and we have to deal with their liquidity. In the early days, we’d be delighted to raise money from whoever we can. Now we’re really judicious both about the mission that they’re fulfilling, but also their own liquidity.
Venture, way too much money, prices way too high. I think the natural corrective to that is eventually failure, but the problem with venture is, you have 10-year asset class where people can sort of fake it and keep these things going for a very long time. The other natural corrective is doing NewCos. I don’t like golf. I like basketball, growing up in Brooklyn, and the ability to have ball control. The way you have ball control is, you start a company. You control the price. You control who you’re letting into the syndicate, and so we’re going to be doing a lot of those over the next few years. Then I think also something that we haven’t been doing over the past few years, but we did post ’08 crisis, were special situations. When the cost of capital is low or negative, as it is essentially globally, and now may be starting to tick up, every company is special, because they’ve got tons of money, but once you hear that sucking sound, to me that’s a whistle. “Pay attention.”
Wherever capital is starting to get scarce, you’re going to have … You don’t want to catch falling knives. There’s going to be a lot of companies that just end up going out of business, but there are going to be some great teams with great balance sheets but really impaired cap tables. If you can find those impaired cap tables where there’s corporate VCs, record levels of investment, always a contrarian indicator. They’re always investing at the top of cycles. People on the LP side, which is a little bit concerning, that historically were doing just LP allocations now have direct programs. Individuals are starting VC firms at record rates. People are leaving the McKinseys and the Goldmans and opening up shop and starting venture, and some of them will get lucky and persist, and the vast majority won’t. That’s the beauty of markets. Right? It’s messy. It’s not predictable, but I think it would be irresponsible to not see it and just be really cautious.
Patrick: How does that opinion affect how you run Lux as a business?
Josh: Some of it is the pace of investing. Some of it is making sure that we are good stewards not only of our capital, but good partners to other people. We have syndicates that we’ve sort of come up in the business with who we like, we reciprocate. There’s a lot of chit trading, both reputationally and amongst deals. Being good actors, because I think the capital will come and go, but your reputation, and I’ve seen just people with horrible reputations that made a ton of money, and they’re blown out of the industry. Just being good actors, being thoughtful, being methodical, being wary of risk and not caught up in this hype, because I think just so many sectors right now are just totally overdone.
I think that there’s a lot of lying. I think there’s fraudulent companies. I think … I mean, it’s amazing you see these companies. “Everything’s great. Everything’s great. Everything’s great,” and then it’s like turkey before Thanksgiving. Then they’re out. They’re dead. It’s like, “Well, what happened? That was a quick phase transition. Where … “ It’s because they couldn’t go to the market and be like, “We’re having trouble.” You’re seeing these, some of these unicorns that are just going to zero, and there’s no, there’s total discontinuity between the last round and then just going bankrupt.
Patrick: Interesting side story that’s happening is the cryptocurrency crash right now, where talk about abundance of capital, right? Like ridiculous amounts of money being raised to effectively, on a whitepaper, oftentimes fraudulently. Curious, your take on crypto as an idea, maybe as an asset class, whether you consider it an asset class. Just your general thoughts.
Josh: My view is, you have to understand both sides of it. Right? I understand the view that this is a tulip bubble. It is the measure, as money itself is, of people’s belief that … You mentioned Sapiens before, so if you think about, you’ve got objective, subjective, and intersubjective reality, money doesn’t really exist but for the fact that I believe that you believe ad infinitum. I can’t give you Monopoly dollar and get that cup of coffee from you. I can’t give you Bitcoin because you believe that somebody else believes that … As an intersubjective belief, it’s real because people believe in it, and everybody says, “Well, blockchain is going to be super interesting.” I think people are starting to see, “Well, wait a second. What are the actual incarnations of this?”
My view is that this will probably be more akin to that combinatorial fodder that comes from the detritus and mass failures that somebody then picks up the pieces in the same way that happened post-internet where what got laid and lit were all these fiber optic cables that begot the internet 2.0 and the Facebooks and the YouTubes and all the stuff that didn’t exist in the first boom. Something will come from that. Anyway, so that’s the first view, which is approximating everything of the bubble. You see the curve now with the crash.
The other view, and you have interesting people, like Murray Stahl from Horizon Kinetics has a really interesting take on it. Bill Miller, obviously, he admits that it was a speculative investment, and they’ve sort of parsed that off. There’s just really rational people that have said, “I’m speculating basically on the belief of what it might be.” I do accept that in extremis, if you … What’s the value of Bitcoin? I used to ask people this, and they never had a good answer, and I actually worked and did calculation with people, and it’s like, “Okay, if you took the sum total of all the currency in the world, and you divide it by some money multiplier and you assume that you had, forgetting about the unlimited forking and unlimited production of other cryptos, but just Bitcoin, that you would have a value.”
The reason that that would never be realized is because you have people, specifically people who run countries, and those people want to be able to issue debt and inflate their currency and control their people, and so as long as that exists … I mean, the great irony was, the reason that people were embracing this was that it was a rejoinder to sovereign control over a currency, and so people in Argentina or Venezuela that were trying to get money out, that was one case of actual use, but then South Korea says, “We’re going to ban it,” and then it crashes 10 or 15% that day. I just think that this is going to be a messy thing. Nobody actually knows what’s going to happen. The high confidence thing I have is that something great will come of it, and I have no idea what, but it’s not what everybody is talking about today.
Patrick: Talk a bit about Santa Fe Institute. We haven’t talked on the air yet about that, your experience with it. Maybe for those unfamiliar, just describe what it is.
Josh: It is the birthplace of complexity science. It is looking at emerging phenomenon, and it is looking them across disciplines. You will have people that study geology and earthquakes, people that study ant colonies, people that study disease and epidemic progression inside of populations, people that study stock markets, people that look at mating calls of birds and compare that to the frequency modulation inside of spectrum auctions of countries. I got introduced to it through Michael Mauboussin, who is a brilliant strategist and a voracious reader and a dear friend, and another friend, Bill Miller. Bill is one of these guys who, to me, as a philosopher, like your background, really interested in non-obvious ideas, and could you go into other people’s domains, sort of like a Charlie Munger, and pull out really big ideas and then apply them to an investing process?
He did that very early on, became chairman, recruited Michael. Michael became chairman. Michael recruited me. I become chair of the nominating committee. We’ve brought on some amazing people, most recently Bill Gurley and Jim Pallotta and some others to join, and it’s this collection of scientific minds and curious people, and there’s no direction. They get to choose what they want to focus on, but they’re inspired to really go after really big things. The guy that runs it is this guy, David Krakauer, who is the prodigal son who was sort of asked to leave, maybe, like years ago, because he was too disruptive, and he comes back to run it. He’s like the Steve Jobsian figure. He’s got a cool British accent, and he’s this champion of science, but total champion of rebels. He wants the scientists to go and think big, crazy, non-practical ideas, and they come up with all kinds of crazy stuff.
I get inspired by it, because it’s either an idea that I can pull that might affect one of our companies, or it’s a way that process-wise we can forge for new ideas or a way to organize and think about our time, but it’s just really this intellectual smorgasbord, and I just, I love it. It’s just an amazing place.
Patrick: Makes me jealous that I’ve never experienced it yet. Maybe someday.
Josh: Oh, we got to get you there.
Patrick: What is the most memorable conversation that you’ve ever heard?
Josh: Oh, that’s a great question. I’ll give you the pedestrian one. The salience of memory is coupled to the emotional response you have. The most important conversation, the most memorable, was when we went to Bill Conway of Carlyle, and I was talking about all these crazy areas of emergent tech, and I said, “I want to put our money where our mouth is now in this space, and actually I want to put your money where our mouth is.” Whatever it was that day, I got lucky. Right? I mean, Mauboussin is a big student of skill versus luck, but whatever the circumstances, he had a good day. Maybe he made money for his LPs. Maybe the firm was going good. Maybe somebody just complimented him. Maybe his team just … I don’t know what it was, but that day he said, look to me, he said, “I hope you make a billion,” and he backed us. I mean, it was like the most fortunate day of my life. I never forget that, because I’m going to hopefully make that mark on somebody else, but that, to me, was hugely memorable.
Second one, by the way, I remember first board meeting for Kymeta. We’re in Bill Gates’ office, and you think billionaire, richest man in the world, you’re going to have chefs and people waiting on you, and four-course meal and this kind of thing. I remember at that meeting sitting down for lunch, calling my wife afterward excitedly, because I have a very pedestrian palate. I mean, Coney Island hot dogs, Nathan’s, and I’m like, “You’re never going to guess what we had for lunch.” She’s like, “What? Filet mignon?” I’m like, “California Pizza Kitchen.” It was just, to me, it’s just like they’re regular people, and the circumstances and the fame and all this, but it’s just regular people.
But the best advice I ever got was Jim Watson, who co-discovered DNA. Jim is brilliant, and as many brilliant people are a little bit crazy, and Jim has this admonishment which is double meaning, three words, “Avoid boring people.” I love it, because what he’s saying is, “Stay away from people who are not interesting,” avoid boring people, and, “Avoid boring people. Don’t be boring to people. Be interesting.” I have information anxiety, because I need to know and want to know something about everything, whether that’s poetry, or literature, or science, or sports, or whatever it is, I need to know something so that I’m never in a conversation and be like, “Oh, okay. Yeah,” nodding my head. I want to be able to converse about everything.
Patrick: I’ve seen you talk about entropy before. Obviously, you have informational FOMO, and you’re doing a lot. What is your objective function? Like what are you optimizing for? Did you even think about it like that? In the long run, as Keynes said, we’re all dead, and you’re an atheist, or not religious, I should say.
Josh: I am an atheist. I-
Patrick: How do you think about that? This is a big philosophical question, but-
Josh: Well, okay-
Patrick: … it seems appropriate.
Josh: … so entropy, to me, I think is one of the not widely understood and most important concepts, because I think it is one of these universal Santa Fe-like phenomenon that pervades everything. Your room is a mess unless you put energy into the system. Right? It trends towards disorder. The universe itself, life is a fight against heat death and entropy, so your metabolism and consuming food and structure and order and muscle building and all of that, and sleep, everything is to fight entropy. Businesses will trend towards disorder. By the way, I would trend towards disorder if I didn’t have the entropy of a partnership and people that would keep me focused on certain things and be like, “Come out of that rabbit hole.” Right? “Here’s disconfirming evidence.” I think it’s a really useful function, because you can see it in cities. You can see it in organisms. You can see it in businesses. You can see it in markets. Any time that there’s massive disorder, there’s an opportunity for energy to come in and organize, and that includes ideas.
When you see something in our world that sucks and you say, “Well, that’s chaotic. I mean, we’re sitting here in a conference room. This sucks. The conference equipment, there is not a person listening right now that has not become accustomed to and accepted that conference calls never start on time, that they don’t work, that videoconferencing sucks, that you all have the same crappy Polycom system,” etc., that’s an opportunity for somebody to organize all the disorder in a market. Anyway, so objective function number one is, don’t die. Right?
Josh: Make good decisions. Avoid making bad decisions. I do, and sort of inspired by Charlie Munger, keep records of people that have made really bad decisions, because through them, right … People can always celebrate, and I’ve debated this with Peter Thiel where he’s like, you only want to focus on people that have been really successful, and I totally disagree, because a lot of that has been luck, but I think if you focus on people that have really screwed up because they’ve made bad choices, that’s something to avoid.
Survive is number one. Having children and, you’ve got two? I’ve got three. To me, it is the most important thing in life. Some people don’t want to have kids, and some, but I just, to me it’s everything. Aside from the biological function, the role model that I can be for them, the optionality that I can create for them, and by the way, making sure that I don’t screw things up by giving them too good of a life that they lack the very thing that I had, which was this adversity and not having money and all that. I haven’t figured it out, but that to me is the objective function, is …
By the way, happiness is not that. Right? I don’t believe that you can achieve the state of permanent happiness. I don’t believe it’s in the human condition. I think you can have punctuated periods of sort of cultivated happiness. You can have perspective that gives it to you, but I think we need dissatisfaction for continued progress, and I have to be dissatisfied that my kids have not achieved enough, or I’ve not achieved enough, or we don’t have enough, or we’re not giving back enough, or whatever it is that just keeps you going.
Patrick: You’ve talked a lot about being a contrarian or thinking in contrarian terms. Is there a person or people that you disagree with, but deeply respect?
Josh: I mean, the number one would probably be Bill Conway, in that I respect him and enormously credit my entire business success to this man believing, and he is a deeply religious guy, and I respect him, and I respect that. I think his morals and ethics come from it. I think he never … It didn’t matter what the deal documents said or legal documents said. He would do the right thing, and I think that comes from a profound religious belief, and I respect that, but I totally disagree with him. I mean, I have a very scientific worldview. In the absence of evidence, there is a high bar for me to believe something. I’m an empiricist, but that would be probably the great example of somebody who I ad hominem have huge respect for but fundamentally disagree with what they believe.
Patrick: My closing question for everybody is for the kindest thing that anyone’s ever done for you.
Josh: Again, I mean, and it may be recency bias here, but Bill putting us in business.
Patrick: What’s number two?
Josh: My wife saying yes. I don’t know. I mean, I think there are amazing acts of kindness. This one’s going to sound a little bit negative, but one of the happiest moments of my life … If you remember, I like people that sort of come from broken backgrounds and have something, but my father was not a significant part of my life. There was a lot of animosity between him and my mother, and divorce, and custody battles, and all kinds of crazy stuff, and there was a moment a few years into Lux when I was speaking to my father, and he told me a story that somebody heard his name and said, “Wait a second. You’re Josh Wolfe’s father?” That was like a really proud moment for me. I don’t know. That always has and will stick with me.
Patrick: Well, what’ll stick with me from this conversation is to be absolutely relentless and insatiably curious. I’ve learned a tremendous amount today, so thank you for your time.
Josh: I love listening to you, so I’m really honored to be here.
In each episode of the Invest Like the Best Podcast, I speak with the most interesting people I can find, whose stories will help you better invest your time and your money, and teach you how to play with boundaries in your own life.
While many guests are professional investors (portfolio managers, venture capitalists, researchers, authors), I will also speak with many people outsideof the investing business whose insight and experience can entertain and inform.
ILTB has been downloaded more than 2,000,000 times and was chosen as one of five podcasts to listen to by the Wall Street Journal
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