Navigating the Known Unknowns of Venture Capital
A year ago, I had doubts about the existence of venture capital alpha. I came to VC from Bridgewater Associates, a macro shop with a highly systematic philosophy, where things that couldn’t be measured and backtested — like intuitions and judgments — were not front and center.
Venture capital alpha is one such thing; it is difficult to quantitatively substantiate and, thus, to quantitatively replicate. The relative infrequency of venture deals, their long gestation period, and their heterogeneity means it would take (possibly) hundreds of years to demonstrate that any given VC has a statistically-significant edge.
And alpha, or outperformance, can come from a variety of factors. For example, the most successful venture capital firms may reap cascading benefits from early wins in the form of buoyed reputations, stronger networks and, thus, better deal flow. This virtuous loop likely amplifies their returns from good decisions made early on, which are challenging to attribute with certainty.
For somebody starting out in venture, mastering the art of investment decision-making is critical. But one also needs to consider structure, size, and strategy and reputation as important factors that affect the outcomes related to a sound investment decision-making process. You need, at a minimum, to be in a position to make investment decisions that could generate alpha. If your deal flow is very limited, for example, this will be much more difficult; saying “no” to a hundred deals doesn’t necessarily get you very far. Or, for instance, if your strategy is tied to exit timelines derived from fund life, you may not be in a position to buy, hold, and reap compounded returns from a long-term winner (for this latter reason, I believe that having a permanent capital structure which allows for long compounding is an advantage for my current firm, Cue Ball Capital).
So unlocking the code of investment performance in venture may, in itself, be more art than science. In fact, the limits of quantitative knowability in venture capital were part of what drew me to it in the first place. Systematic thinking remains essential within those limits, as no amount of judgment can help you if you don’t have the right grasp on the structural questions at hand. But outside of them I see space in which an understanding of humanity and progress — an intuition for what we want and feel and strive for — could play a defining role in making investment decisions.
To that end, about a year ago I worked towards complementing my Bridgewater-learned systematic investment instincts with developing some of the more amorphous qualities that make one a top-notch venture capital investor.
This, as I have learned, is more difficult than one might think.
The first step in evaluating an idea starts with distilling a narrative into its component parts and identifying the “hinge questions” which most drive the eventual outcome. Determining what to do with that knowledge — and even whether or not it is reliable — is tricker, and more experience-based. Recently, I was wrestling with questions on a prospective investment and connected with an industry veteran (one of our partner’s contacts) for perspective. The response was a recommendation not to invest, but with the caveat that he would have said the same thing about another, ultimately very successful company in the same industry when it was at that growth stage. Learning how to make good bets in venture capital (i.e., the part that is not modeling) is more or less the same thing as learning what to make of that kind of information.
Over the past year, it’s been the culture side of my Bridgewater training (and the patience and candor of my new colleagues) that has proven invaluable for learning how to walk the fine line between having so much confidence that my beliefs blind me and so little that I don’t act on them at all.
Bridgewater is famous (infamous?) for being a community built on “radical transparency”, which fuels an “idea meritocracy”. In practice, this means that people are open and honest with their feedback and opinions to a degree I have not seen in even the most candid conversations at other firms. They then apply this lens to themselves, setting ego aside (or trying to) and figuring out how to confront their weaknesses productively.
Moving from a culture which takes no-holds-barred debate to an extreme to a startup world where entrepreneurial spin is ubiquitous and relationships themselves are essential created some growing pains. The first time I shared a negative view on a portfolio company, I learned quickly that the degree of bluntness I had been used to is not the sole path to productive discourse, but also that the substance of my views would always be appreciated. In that first foray into sharing my thoughts, I was more wrong than right (both in my thinking and in my ability to read the (virtual) room). Yet the experience was ultimately quite positive; I got a greater volume of thoughtful feedback on my transparently-communicated view than on anything else I had done up to that point. I recalibrated the amount of bluntness needed relative to how strongly I felt about something and soon found my colleagues to be great sparring partners, strategic advisors, and sounding boards on many different topics. Importantly, though, I didn’t let being wrong stop me from continuing to put my thoughts out there. In fact, the willingness to take a lot of swings and be (publicly) wrong is indispensable to someone who is starting a career as a venture capital investor, more so even than in other investment careers.
This willingness — desire, really — to be wrong, and wrong often, has been another indispensable skill. One of the pitfalls of joining an investment firm in the early stage of your career is the tendency to let doing a larger share of the analytical work make you into an analyst first and an investor second. Over time, this can make you care more about the “answer” and the analytical outputs than the hard work of making sense of ambiguity in the context of an investment decision. This makes it especially important to put your views out there often and have the humility to learn from your mistakes. I have learned a lot more from being wrong than right. At Bridgewater, this was known somewhat grotesquely as “putting your hand in the fan”. I am lucky enough to still work at a place where this is encouraged, and I am much better for it.
One natural result of taking a lot of swings and being willing to be wrong is that you learn a lot about yourself, good and bad, and can figure out what to do about it. In venture capital, so much of the information comes in narrative form; and, as somebody with capital to invest, you also meet a lot of people who have an incentive to get on your good side. As humans, we are predisposed to assimilate new information that reinforces our existing worldviews (which include our egos). It so happens that the very ability to identify moonshot-level VC bets — the ability to make human judgments predicated on a view of the world transformed — is also one of the most fallible to this confirmation bias. This makes self-reflection (in my opinion) one of the most valuable tools for venture capital investors, and only becomes more valuable the longer you have been a practitioner.
Surrounding yourself with colleagues who share these qualities also supercharges your investment discourse. Many of the rooms I’ve been in have been full of very smart people, much smarter than me. But when those people also happen to be open-minded and self-aware (qualities that are rarer than you might think among very smart people) their thinking is worth more than the sum of its parts. New ideas and questions can easily enter the fray and people give credence to the ones they know they are predisposed to miss while confronting those they feel confident align with their strengths. This, at both Bridgewater and at my current firm, Cue Ball Capital, forms the foundation of productive discourse. Realization of the power of well-considered disagreement among smart, self-reflective people is where I have found the most faith in making good decisions in venture capital. At the end of the day, those decisions must find a careful balance between relying on what you do know and respecting what you don’t, and productive discourse (tension, even) is the best way I’ve found to both do that and improve at it.
In the spirit of radical transparency and humility, I should note that I am just one person, with just one year under my belt in venture capital. I hope the impressions I’ve had as I wrestle with how to make investment decisions in what, to me, is a new paradigm prove helpful or, at least, entertaining.
