Why Playing Poker Helped Me to Become A Better Startup Investor
Following the enormous MasterClass funding news last week and since Daniel Negreanu has made this great teaser video, it gave me an idea. For the past 10 years, I’ve been playing poker.. a lot. The thing I learned is that the same way poker is a game, life and investing in early-stage startups are also games. I mean from a strict gaming theory point of view: It involves an environment where players compete and fight for a defined goal, respecting a set of rules. I won’t explain why life is a game and how it relates to poker as well because I want to you read Olivier Emberton’s strategy guide for that. It’s one of the best articles I’ve ever read.
Instead, I want to unpack 5 mental models that I learned along the way and that I also found in venture capital last year. I hope this will be useful and fun.
1. Expected value (EV)
The expected value is the weighted-average value for a distribution of outcomes. Given possible outcomes, it’s basically, the sum of the different values associated with the outcomes multiplied by the probability of the outcome to happen. If the EV of possible decision A (the sum of all weighted outcomes related to decision A) is superior to those of decision B. Chose A. Decision making 101.
In Poker: EV is at the heart of every move. For instance, considering my hand and the cards on the already visible on the flop, should i call or fold? What should be my decision? What is the EV of Outcome A “a heart is shown on the flop” versus Outcome B “no heart is shown”? Well. Of course, if you think that a heart will give you the best hand then you should calculate the EV of those two outcomes before making a decision.
- The EV, in this case, is: The value you will gain in A x the probability of A to happen + the value you’ll lose in B x probability of B to happen.
- If EV>0, you should call. It doesn’t mean you will win but statistically speaking, you will if you play a sufficient number of times. Of course, poker is not a nash game theory problem, you have to make decisions with partial information (since you don’t know the opponents’ cards) so the EV will be the best estimation you can make of it. You can also add the probability of your opponents bluffing, the odds your opponents will fall if you bluff even if he has the best hand and make it even more accurate… But it’s also a matter of perception and psychology.
In VC: I can think of two ways EV is used.
- The first obvious one is actual startup valuation: EV/revenues multiple is used to create an EV of the investment based on past acquisitions or investments. You can even possible exit scenarios like in the i-angel valuation method
- The other one is when we calculate the TRI of a given portfolio. That’s why to mitigate the risk, diversification is key.
2. Power law — Pareto principle (the 80–20 rule)
In simple words, Pareto states that 80% of outcomes will come from 20% of the incomes. It follows a power law distribution.
- 80% of your gains will come from 20% of hands
- 80% of your loss will come from 20% of your hands
That’s the reason the most important skills in poker are patience and learn to “rob value” by maximizing huge hands.
- 80% of the TRI will come from 20% of your investments
- 80% of your deal flow will come from 20% of your network
- 80% of your startup’s revenues will come from 20% of the sales actions
- 80% of the work will be done by 20% of the team resources’
- 80% of a deal’s work will take 20% of a deal’s time
That’s the reason VC seek for “go big or go home” startups. It’s the babe ruth effect. The EV of a power law distribution (VC returns) wants to chase unicorns because not only it will cover your actual losses but it will cover the future loses as well. That’s also why volume and diversification are key. It’s still better to make 200x — 1% of the time than 2x — 99% times… You need to win sure, but you need to win big.
3. Compound interest and network effects
Compound interest is basically reinvesting your gain resources to produce more outcome.
- The more money you make, the more hands you’ll play, the more knowledge you’ll have to make decisions, the more experienced you’ll get, the more money you’ll make.
- The more hands you’ll play, the more good hands you’ll maximize, the more money you’ll make, the more hands you’ll play.
Compound interest and network effects are the reason why I think VC both is a taught market with actually strong barriers to entry and why VC do become platforms.
VC is a taught market because even if it’s fragmented, there are actual home runners like Andreessen Horowitz, Sequoia and Benchmark in the US, Accel and Balderton in London, Idinvest in France. More money pouring into the VC industry doesn’t mean market efficiency for others.
I like to see it that way: Home runners have a track record of home runs. Track record leads to raising more funds and brand recognition for entrepreneurs. Money and brand recognition lead to better resources and to better home runner hunters in the fund’s team. This lead to both bigger networks and an actual incredible deal flow. Incredible deal flow leads to more frequent home runs with higher magnitudes. Loop is done.
You will tell me that’s why disruption exists. Wallmart had those network effects before Amazon came out. But VCs are in the business of investing in disruption. The only way to make a place is then to create a strong differentiator to make home runners go with you in the first place. Even if the market is inefficient and the information is partial, I don’t think there is room for more VCs out there…
4. Confirmation bias
Confirmation bias is when people are interpreting facts to confirm their actual’s opinion.
This tends to happen when you really don’t want to fold a hand because you’ve invested too much, you will start to search for an explanation about your opponents’ behavior that confirms you’re ahead.
- You’ll look out for markets info that confirms your idea on the project
- You’ll interpret certain behaviors to accept or reject an entrepreneur because you want it in the first place
- You’ll interpret execution mistakes of entrepreneur you really like external forces when there are actual honest mistakes.
5. Play the man
Don’t play the odds, play the man means to act in the reaction of your perception of the opponents and of your opponent’s perception of you instead of just facts.
That’s when bluff comes in.
Play the founder. As I like to put it :
Founder > Market > Idea => A good founder in a good market with a bad idea is better than a good founder with a good idea in a bad market.
Even more :
Founder > Market + Idea => A good founder in a bad market with a bad idea is better than a regular founder in a good market with a good idea.
Ideas pivot, markets evolve but people stay the same even if they learn. It doesn’t necessarily mean the same thing in my case but I interpret it as I want :).
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