Sam Hinkie, VC?
As a Knicks fan, I couldn’t help myself but to read Sam Hinkie’s 13 page resignation letter from his post as President of Basketball Operations for the 76ers in its entirety. After all, after enduring ~15 years of losing basketball, I’ve been infatuated with the way that Hinkie attempted to rebuild the 76ers . Could the Knicks have traded in just 5 losing seasons for 10 full of prosperity if they just followed Hinkie’s blueprint?
The more I read though, the more I found myself drawing parallels between Hinkie’s view of how to build a basketball team and building a great VC firm. Both involve a delicate balance between taking the short and long term view due to luck and power laws.
Like basketball, VC is about your top performers. Without a superstar in the NBA (Steph Curry, Lebron James, Kawhi Leonard, Kevin Durant, Russell Westbrook, etc.) you can still be a good team that competes but becoming a championship team is almost impossible (there are a few exceptions a la the Pistons in 2004). In VC, power laws rule everything. It’s much harder to return 3–5x without investing in the best companies created during a fund’s lifecycle (Fred Wilson talks about the fact that there are 20–30 companies created each year that account for almost all venture returns). There are exceptions to this rule in both cases, but for the most part, you’re either great (win a championship) or you’re stuck in the middle in which case LP’s prefer to put their money into the top performing firms.
Both building a great basketball team and a great VC firm require making predictions about the future. Great VC firms do their best to invest in founders that they believe have a viewpoint on the future with a higher probability of occurrence relative to the risk/reward proposition involved. Maybe bitcoin or VR won’t ever reach the masses, but VC’s that invested early on in those companies will also have visibility into new opportunities and market adoption. In basketball, foresight is required in imagining which great players will shake free in the future and the assets it will take to get those players. Consider this quote from Hinkie’s letter:
Ask who wants to trade for an in-his-prime Kevin Garnett and 30 hands will go up. Ask who planned for it three or four years in advance and Danny Ainge is nearly alone. Same for Daryl Morey in Houston trading for James Harden. San Antonio’s Peter Holt said after signing LaMarcus Aldridge this summer, “R.C. [Buford] came to us with this plan three years ago, four years ago — seriously. And we’ve worked at it ever since.
As Peter Thiel has said, it’s not enough to be consensus and right, you need to hold a non-consensus viewpoint and also be right. While car companies scramble to acquire and develop technology to manage fleets of self-driving cars, Tesla is uniquely positioned to capitalize on this market opportunity due to how the company was built and run from day one. Many times, VC’s invest in new technologies or ideas with the idea that this may have a lower probability of working but if they do, the payoff will be tremendous (the Babe Ruth effect I’ve written about before). If the payoff of a $500,000 investment could be $100M and the probability of this occurring is 1%, there is high expected value. This concept transcends capital allocation and investing and applies to young NBA players as well:
Looking at a player with an estimated 10% or 20% chance of being a star over the next three or four years can’t be written to zero — that’s about as high as those odds ever get. That’s surely a very, very high number for any player that is ever available to you to be added to your team. Once you accept that, it becomes clear that shrinking the confidence interval around that estimate (and the estimates of the downside risk at the other end of the spectrum) becomes pretty darn important.
Jeff Bezos talks about this in his annual shareholder letter as well:
Given a ten percent chance of a 100 times payoff, you should take that bet every time. But you’re still going to be wrong nine times out of ten. We all know that if you swing for the fences, you’re going to strike out a lot, but you’re also going to hit some home runs.
Hinkie’s VR, bitcoin, drone, bot, etc (or in Amazon’s case, Alexa) investment was Joel Embiid. The reasons that companies succeed or fail oftentimes involves a lot of luck. We live in a world of complex adaptive systems with many potential points of failure ranging from team dynamics, market shifts (chaos theory), and sometimes just being on the wrong side of cumulative advantage. While mistakes are made, the very best firms make decisions for the right reasons, even if it results in a failed outcome. The situation is described here:
You can be wrong for the right reasons. This may well prove to be Joel Embiid. There is signal everywhere that Joel is unique, from the practice gyms in Lawrence, Kansas to Bala Cynwyd, Pennsylvania to Doha, Qatar where he does something awe inspiring far too regularly. We remain hopeful (and optimistic) about his long-term playing career, but we don’t yet know exactly how it will turn out. The decision to draft Joel third, though, still looks to me to be the correct one in hindsight given the underlying reasoning. But to call something that could be wrong (“failed draft pick”) right (“good decision”) makes all of our heads hurt, mine included.
This is why most investors take a portfolio approach versus making less, more concentrated investments similarly to the traditional private equity model. With so many outside factors and unknowns involved at the time of investment, VC’s look to make these same decisions for the right reasons enough times that the magnitude of those that do pan out become meaningful enough to cover the cost of their losses and then some. By cutting their losses earlier and accumulating more draft picks and salary cap space, the Hinkie’s goal was to create more and more optionality in the hopes that some of the young players on 76ers could become superstars. These quotes sums up his thought process:
We need to identify high potential prospects and find ways to add them to our program. Then we need to work with them on their game in a targeted way to maximize their performance, their impact on the floor, and their value. One way is to draft them and put them on our 15-man roster. We do that. Another is to draft them and hold their exclusive NBA rights while they play professionally in a league that doesn’t start with N and end with A. Now we do that. These players can develop under our guidance while not counting against our roster, giving us not just 15 opportunities at one time, but several more…
These sets of players are viable players for the Sixers and viable options to trade in the interim. The goal is simple — a larger quiver. This quiver will give us more options immediately and more options over time.
In many ways, this approach under Hinkie is similar to Dave McClure’s at 500 startups. Consider this quote from Dave (via 25iq):
We like to think of ourselves as lab scientists at a petri dish rather than gamblers at a roulette table. In the same way those MIT students gamed Vegas, we’re taking that strategy to the world of internet start-ups. It’s about predicting whether or not they’re fail.
Lastly, but likely most importantly, a great brand that players and founders are attracted to is of the utmost importance. This is why VC’s spend so much time creating content and making sure that founders have a good experience with the firm whether or not they choose to invest. Consider why so many great companies choose to partner with Sequoia or Benchmark or why LaMarcus Aldridge decided to sign with the Spurs this past summer.
At the same time, teams want to cultivate practical methods of helping these younger players to develop and succeed, similarly to how great VC firms help portfolio companies and founders to succeed in differentiated ways. It’s not a 1/1 comparison with VC given the different factors involved and varying aspects of experience and resources to help startups succeed, but the overall mentality is the same. Like startups, talented young NBA players can succeed or fail for a variety of reasons and both a great VC firm or NBA organization need to work tireless to provide the ecosystem that enables success. Here is Hinkie’s take on the subject:
We determined to play a faster style that recognizes the importance of speed in tomorrow’s NBA and one that quickly integrates young players. We set out to improve our shot selection toward high efficiency basketball. We also wanted to build a defensive identity that — in time — could thwart tomorrow’s high-efficiency offenses. Lastly, we needed to build a world-class training center, develop an ever-evolving player development program, and change the organization’s culture to one of innovation and a constant search for competitive edge.
In VC, this involves helping portfolio companies with recruiting, sales, vendors and more, while also anticipating market changes (like capital resources tightening up or expanding). In the NBA, this involves anticipating changes in style of play, rules, etc (like the proliferation of 3 point shooting and spacing).
It has become apparent that after several years of trial and error, the 76ers ownership became tired of losing and Hinkie wore out his welcome. Such is the case when choosing between succeeding with conventional wisdom or non-conventional wisdom. Luck is involved in both cases, but Hinkie attempted to increase his odds of future success with his methods by removing some of the ambiguity. While as of now, it looks as if he didn’t succeed, his other option was suffering the pitfall of the Knicks; bad luck and short term thinking that prolonged losing until you hit the jackpot (Porzingis, anyone?) which sounds to me like the plight of many unsuccessful and undifferentiated VC firms.
