Venture and Value Investing
Alchemists Visit the Gold Mining Convention
Warren Buffett and Charlie Munger have built an enduring firm in Berkshire Hathaway by focusing on investing in enduring companies. Ultimately, that’s what we want to do at Initialized Capital.
That’s why my Initialized General Partners and I made the trek to Omaha this past month.
Buffett and Munger were remarkably plainspoken— no-nonsense and very matter of fact. From what we could tell, most everything having to do with Berkshire Hathaway was steeped in Midwestern plainspokenness. This really stood out to us as we sat in a room full of tens of thousands of people who came from all around the world. It was a packed crowd.
We felt like alchemists at the gold miner’s convention.
Many folks were surprised when they heard a Silicon Valley venture capital firm went to a value investing conference. Tech and value investing seem like different planets. Silicon Valley sure does spend a lot of time talking about what the future is supposed to be, in high-fallutin’ terms that make it sound basically like magic.
Great pitches aren’t magic though. The most powerful pitches I’ve ever heard are always incredibly simple concepts that, when linked together, point to something very big. What made Uber a great idea wasn’t that it was a “realtime local mobile ridesharing platform.” It was that you could get around a lot easier because there were lots of cars that you couldn’t ride in previously.
The best startups are simple and real
Instacart had a real working app when we funded it. That was what really set the founder Apoorva Mehta apart from all the other people who wanted to do it. A real app with thousands of items and two drivers hired from Craigslist to deliver to the first hundred alpha users.
Coinbase founder Brian Armstrong built and hardened the first online wallets himself. He went to people he knew and gave them their first bitcoin held on a secure Coinbase account.
The Initialized team doesn’t always need such things for us to fund a company, but to be frank, it sure helps.
Pragmatism is a commitment to reality
Being plainspoken lets you be pragmatic. Every truly great founder I can think of has this trait.
What does pragmatic actually mean? Dealing with things sensibly and realistically in a way that is based on practical rather than theoretical considerations.
In the short term, a fancy pitch can make something seem popular and therefore likely in the eyes of investors. When smart people start talking about a particular buzzword (kind of like the buzzword realtime in 2009 or artificial intelligence in 2016… or blockchain now) then it can be really easy for people to bandwagon. More investment and attention begets more attention and investment. This is what people call reflexivity. Humans are still simians, afterall. FOMO (fear of missing out) is a powerful emotion.
In the long term, people expect companies to exist that drive real revenue and grow fast. That’s where being realistic and sensible is really important. You can’t bullshit customers, and sooner or later these things turn into weighing machines.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” — Benjamin Graham
If that’s true, then you can hide for a few rounds, but you can’t hide for long.
Years ago one of my friends quietly told us Theranos probably wasn’t legit, well before the WSJ takedown piece finally got them. How did he know it was a scam so early? He had read about the one-drop technology and that it was being deployed to Walgreens. He went down to the local one in Palo Alto and tried to order some tests. They were all standard full-blood-draw tests, and none of them were using the new technology. It was impossible to order the tests that the press releases said were magical and available now. Hundreds of millions of investment dollars piled in after that press release.
Legend has it that the Theranos data room only contained a myriad of PDFs of press from all the biggest media outlets.
All the press in the world doesn’t make up for a blood test that doesn’t work. When the voting machine becomes a weighing machine, the outcome can be dramatic.
Great pitches are audacious but pragmatic
Remember when I said great pitches aren’t magic? Well, that’s not exactly right. They do have to hit a magical middle ground: audacious enough to be something meaningful, but pragmatic enough to be within the realm of achievable.
This is a hard line to walk. You do need a reality distortion field, but everyone only makes money when the reality gets manifest.
One thing I heard about Theranos engineers and scientists (especially those that quit over the Walgreens press release) was that management constantly insisted that they implement what they basically said was impossible. Not listening to your own engineers and scientists isn’t audacious, but horribly unpragmatic and foolhardy.
What tech can learn from value investing
It turns out, we can learn a lot. The best startups an early stage investor can invest in are still the ones that make a lot of sense from the beginning.
Here are a bunch of Berkshire Hathaway-isms that I find pretty valuable:
- “Never invest in a business you can’t understand.”
In cryptocurrencies, we call this one “Do Your Own Research.” Relying on social proof is a sure way to get caught. As investors, we’ve found that if the founder can’t teach us their business in an hour or less, it’s not clear they will ever be able to convince future customers or employees either. - “Our favorite holding period is forever.”
Venture capital as an asset class actually exists because large institutions and professional family offices are generally willing to take illiquidity in exchange for a excess return. We’re not in it for the quick flips. Nobody makes money on the fast 2X return— those can’t move the needle on the fund so that can’t be what we are looking for. - “Time is the friend of the wonderful company, the enemy of the mediocre.”
Most startups die of suicide, not homicide. Keep taking care of your customers and team, and if the underlying fundamentals are there, the score usually takes care of itself. - “You only have to do a very few things right in your life so long as you don’t do too many things wrong.”
The power law applies in tech in very extreme ways, so if anything VCs must focus what’s going right a lot more than how they go wrong. A false negative can cost you a multiple of your fund. That’s why fear of missing out is so strong.
Alchemy doesn’t exist
Remember when I compared early stage tech to alchemy? Well, alchemy doesn’t exist.
A startup is a business like any other. The mechanics are the same: moving dirt, rock, rubble to find gold. The difference is that we are mining in places where they didn’t think to mine— new islands and continents recently discovered.
We’re also trying to find and fund them when it’s one or two people with a shovel in a field, and the first nugget hasn’t been dug out of the ground yet.
It looks like alchemy, but it’s still gold mining. That’s why value and venture investing aren’t that different after all.
Thanks to Alexis Ohanian, Vincent Chu, Kim-Mai Cutler, and Joe Bryant for reading drafts of this.
