Y Combinator Startup Investor School, Day 1, Session 1 — Sam Altman
What does that have to do with brand?
Investing, is really about the appropriate allocation of capital, whether that capital be time, money or another resource. So, if it is investing in your own brand or investing in a new brand, there is a lot that can be learned from some of the best startup investors in the world and the principles that they use to think about allocating their capital. As such, I will be publishing my notes from the Y Combinator startup investor school and continuing with ‘Brand, business and the biological system afterwards’.
The only caveat is that the mindset of investing in venture is largely centered around “home runs” or 100–1000x potentials returns and likely losing 1x your invested capital 95% of the time. High risk, high reward. When thinking about these principles in the context of investing in your brand, it would be best to think of this as “investing in innovation”, something akin to highly convex scientific experiments for your brands future.
With out further a due, here are my notes from Y Combinator Startup Investor School, Sam Altman Day 1, Session 1.
Why Should You Invest In Startups? (and innovation?)
To some this may sound counter intuitive but it is essential, to me this speaks to the intrinsic motivations behind investing and innovation. Exploring the future is like having the opportunity to be a grown up little kid, curiously exploring the world. For an investor the motivation should not be purely financial, for a company the motivation should be tethered to your “north star.”
The point about energy was also something that I found fascinating because it also a key trait that Warren Buffet looks for in people he surrounds himself with and invests in.
But, what are the other reasons that you would want to invest in startups/innovation? Well…
Help shape the future: There is a great Steve J. quote that goes something like “everything around you was built by people no smarter than you” No better way to live that quote than to help build the future.
Sometimes you make a ridiculous return: Investing in startups is antifragile, it is losing 1x (capping the downside) with an infinite and unknown upside. It is of a high likelihood you will lose the time/money that you put into it, but if you don’t the emergent phenomena in terms of money, connections, or ideas is infinite and unknown. Nassim Nicholas Taleb would love investing in startups.
The people you’re around: To continue with the Nassim Nicholas Taleb loves -founders, early employees, and other investors all have skin in the game, maybe even their soul in the game. These people are giving their all to shape the future. Its kind of similar to being on an NBA team — everyone is giving all they have to actualize their potential and win the (self defined) ‘championship’.
Humbling!: Its not easy, Sam Altman speaks about writing the level of conviction he had about a company on the back of stock certificates. Simply, you will often be wrong.
How? What are the fundamental principles?
Sam takes a page out of the Charlie Munger playbook here and focuses on explaining his mistakes, and what investors should avoid, invert! always invert!.
1. Don’t Overweight The Opinion Of Other (Previously Succesfull Investors)
“80% of investors out source 80% of their investing decisions”
I was somewhat surprised to hear Sam Altman say that his biggest mistake was overweighing the opinion of other investors he respected. But, anyone familiar with the work of Daniel Kahenman and Avos Tvresky will know that expert intuition can not alway be trusted. While Sam articulates the problem of over weighting other investors opinions, he does not provide a solution.
The question then becomes how can we evaluate the validity of experts (other investors opinions and decisions)?
The simple heuristic is this: Intuition cannot be trusted in the absence of stable regularities in the environment. This is to say, if you are piggy backing off of other investors, they should have a lot of experience and a key insight into the unchanging parts of the market.
2. POWER LAW! POWER LAW! POWER LAW!
A power law distribution is not how we humans think about the world, and thus it is incredibly counter intuitive. In terms of investing this means thats your best investment will be worth more to you than all of your other investments combined, and your second best investment will be worth more than all of your investments 3 through infinity combined. — Sam Altman
Practically, this means that generally speaking everyone invests in startups the wrong way. Most investors look for minimal but compounding returns. Lots of singles. Which may work in the public markets across a long time horizon, but this does not work in the high risk high reward landscape of start up investing. The key here is that it is about the magnitude of your biggest win, it is not about your failure rate. The right question to frame and anchor your thinking around is:
After answering this question you can think about what could go wrong, which, if the growth of the market is sufficiently large, will be emergent and unpredictable anyway.
Ultimatley, this is important because the ideas that often work and are huge, sound like bad ideas but are actually good ideas .
How To Get Deal Flow
It might seem like all the same people get the best deals, or that you have to be incredibly well connected to meet the best founders. Although, I was surprised to hear Sam say that in reality most great founders are “out of network”.
Practically, just be useful and full of integrity, likely echoing Adam Grants thesis on being a giver not a taker and the word of mouth between founders will be good to you.
On Good Terms & Advisor Shares
Again, this is counter intuitive because in value investing, the first principle is to find a margin of safety (buy things on sale). So, for an angel investor thinking in terms of ‘advisor shares’ and a great deal on a term sheet might actually not work in your favor.
Specifically from Sams experience he has found that terms in good deals have been either:
A) He is willing to over pay and it works out because it a just a great founder with a great team in a great market.
B) There is no competition and he gets a great deal anyway because he has a secret that no one else knows about.
Sam’s Rules For Picking Investments
Rule 1.
Could this be worth over 10 Billion dollars. Any stage. Any sector.
Its a simple algorithmic if statement. If Market Share > 10Bn, then (consider) Investing. The rational here is that the companies that will take advantage and win in the game of power laws are so rare that you must optimize for (potential) size.
That is worth repeating.
The companies that will take advantage and win in the game of power laws are so rare that you must optimize for (potential) size.
Okay, so far, we have seen that (1) Ideas that sound bad but are good are the ones to look for (2) Those ideas need to be able to hit at least $10bn of intrinsic value. But, then what? If these were the only two filters you would likely be writing way more checks than you care to. There is many more check points that Sam is screening for before deploying capital.
Rule 2.
Founders.
Start with Character. Sam has found that the best founders are obsessive, focused, frugal and in love with (I would assume the mission).
My interpretation of the canonical founder is Elon Musk. Lets look at his 10/10 criteria as a best in class.
Elon Obsession: The founder is willing to sacrifice all of their personal comfort for the product the company is creating.
Elon Focus: I would also call this mission part one, as focus is highly tethered to the founders ability to stay on track in the face of short term gratification at the sacrifice of long term accomplishment of the mission.
Elon Frugality: No fund raising parties.
Elon Love: This is mission part two, the founder is so in love and so clear about how the world will look and feel when the mission is complete.
How to parse the crazy from the competent?
The above character traits, when coupled with an idea that sound bad but is actually good is hard to distinguish from someone who might just be delusional. Thus, Sam talks about the successful skills that founders also seem to have.
- Intelligence
They can think for themselves and see problems in creative new ways. They are likely very high in openness on the big 5 personality scale.
2. Communication
By definition, the idea will sound bad but be good. This means the founder or one of the founders has to be able to galvanize the crowd. They have to be able to evangelize the team. This is hugely important and likely be tethered to a strong sense of knowing their why and north star.
3. Execution Speed
Incredibly correlated with success. Heuristic? Talk to users change the product and fast.
4. Founders who improve over time
They constantly get better, Reid Hoffman has dubbed the term “Infinite Learners”
Rule 3.
Growth RATE of the market.
In public market equities, and the idea of investing with a margin of safety, the TAM or total addressable market is a important metric. But, when thinking about investing in startups a large TAM is not a good sign. Again, counter intuitive. Why? because a large TAM either means that (a) the space is ripe with competition or (b) their is an incumbent(s) that could just crush or copy you. Thus, you should be more concerned with the size of the market in 10 years. Its far better, but more difficult if you can find the next rapidly growing market and invest there.
This is echoed in Peter Thiel’s book Zero to One. We tend to idealize competition, but in reality you don’t want to compete at all. The heuristic here is to have a sufficiently large or monopolistic hold on a niche (but exponentially growing market). For example, what was FBs TAM when it started? What was Aribnb’s TAM? not very big, but exponentially growing.
The middle brow thing to do at this point would be to just use all the previous rules and optimize for every buzzword, which is currently {insert company name} in Blockchain, AI, AR, VR, BIG DATA and Autonomous Vehicles.
With all the buzz and hype it becomes imperative to be able to parse the signal from the noise with the next rule.
Rule 4.
Real Trends vs Fake Trends
Real trend: A small amount of people use the platform ALOT, maybe obsessively, and always tell their friends how great it is. (A small amount of people first used Iphones but they were absolutely obsessed with it and told all their friends — then mobile became a real trend)
Fake trend: ? — The inverse. Not many people using the platform and not telling their friends about it(Like VR).
Rule 5.
Great Products. Great Products. Great Products.
The simple heuristic here is:
Rule 6.
Bigger.Better.Stronger.
Sam likes to see that the bigger companies get, the stronger and less fragile they become because all the value of your investment will be created in years 10,11 & 12.
As they get bigger their moat increases in the form of:
- Increasing pricing power
- Harder to compete with (entry or mobility barriers)
- Easier to get users
If you really want to go deep on this I recommend Michael Porter and Michael Mauboussin
Rule 7.
What’s your advantage?
Maybe its subtle and nuanced, maybe its explicit and technical — what ever it is you have to bring an advantage to the table when investing.
Sam phrases this as a simple question:
Again echoing Thiel: what’s your secret
What do you know about the laws of nature or the mis information of society that others don’t?
Thanks to Y Combinator and Sam Altman for sharing. More to come!
