Or…How to Invest in the Not So Obvious Next Big Thing
It’s been 10 years since the book The Big Short by Michael Lewis came out, and 5 years since the release of the movie.
Both are valuable (and wildly entertaining) to re-visit for perspective (and the identifiable parallels to today) as we unwind from another bubble — the bubble in later stage venture investing.
Note: For a complete review of the mortgage/CDS/CDO/derivatives bubble and how it was actually predicted, covered up/denied, and subsequently mis-handled, watch, in order:
- The Warning — a Frontline documentary on Brooksley Born’s attempt to regulate the derivatives in the mid-’90s, before they became a systemic threat.
- Too Big To Fail — a movie adaptation of Andrew Sorkin’s book, with an inside view of how it was handled by our ‘leaders’.
- The Big Short — at least you can end a depressing journey on an entertaining note.
Nobody Saw It Coming
As with the narrative during and since the crisis of ’08, the narrative for the current state of the venture funding model is following suit.
There has been ample research and observations drawing parallel conclusions regarding the unsustainable nature of the venture (or entrepreneurial) funding model — a model that has had little innovation since the first fund was launched in 1958:
- Perverse incentives of the sponsors/GPs
- Opaque structures, fees & processes
- Social capital & social signals fueling groupthink and/or FOMO behavior among the fund managers and investors
- Concentrate bets on overpriced assets (FOMO again)
- Lack of accountability for bad outcomes
History Doesn’t Repeat Itself, But It Rhymes
How can those investors that recognize the rhyme (or echo) from the prior venture and mortgage/derivative speculative bubble, navigate these times?
Especially when there seems no ‘rhyme nor reason’ (metaphor belaboring alert) for some of funding activity (Theranos, WeWork, Uber’s last couple of funding rounds, Hollar, ScaleFactor, shall I go on?) undertaken by the purported ‘smart money’?
As it has been said about the voting practices in Chicago, ‘invest early and often’.
Or, as the title suggests…..bet on the ‘Small Long’.
And why wouldn’t you? Scout funds are where the better investors are looking now.
Let me explain how….
Mange Risk First
It’s no secret the two principal risks of investing in startups are timing risk (systematic risk) and company risk (non-systematic risk )— in that order. It is also critical to manage the hidden risk — decision process risk.
You can pick the perfect company, in a big market, staffed by a quality team doing disruptive things, with lots of money in the bank…and be dead wrong on the timing.
Or, you can time the sector/industry right with room for lots of winners, an obvious path to disruption across lots of industries (the internet in ’98, blockchain today), then arrogantly place too few of bets on ‘the obvious winners’.
The more prudent way to invest would be to manage those specific risks via:
- Multiple funding rounds (see HERE for good research) in..
- Properly diversified portfolios (see HERE for good research)
For the CFAs/RIAs/portfolio managers out there, this is DUH!
But how many vcs are even educated on portfolio management? Non-systematic risk? Dollar cost averaging?
Smartest Guy In The Room
Enron, Tyco, Lehman Bros., Goldman, and now Sand Hill Road. All taking great risk with other people’s money, socializing losses while privatizing profits. How?
- Perverse incentives of the sponsors/managers/senior management of firms
- Opaque structure & fees & processes
- Social capital & signals fueling groupthink and/or FOMO behavior among the fund managers and investors (and the management of the corporations)
- Concentrate bets on overpriced assets (or strategies, or trades)
- Lack of accountability for bad outcomes
As history has shown, bet against this behavior, tactics or strategies.
The Cheapest Asset On The Planet — Early Stage Entrepreneurs
Over the next 10 to 20 years, the cheapest asset on the planet is where the Masters of the Universe aren’t — early stage startups.
Partly due to the fact that the big dollars can’t flow there efficiently, and partly due to the absence of good information.
Both of these have been solved already.
Full disclosure; I’m now ‘talking up my own book’. We built the platform to solve for the inefficiencies of early stage funding/investing, simply designing in and deploying via a licensable ‘Venture Turnkey Asset Management Platform’ the tested tools of standardized reporting/analytics, portfolio diversification/monitoring/management, etc.
Invest small, early, diversified, often, and over multiple rounds as the data confirms the ‘trade’.
Support a more diverse profile of entrepreneurs, across more regions outside the ‘crowded trades’ of Silicon Valley, NYC, Boston and maybe LA.
Don’t do what everybody is doing, because everybody is doing it.
Think. Read. Listen.
Play the long game.
Invest in things that actually matter. That add value or improve the human condition.
But even if you don’t do that, make sure you watch The Big Short.
You will be entertained, probably a bit saddened, and you will recognize the rhymes in today’s headlines…
Note: For more of Michael Lewis’ brilliance, see the Dec. 7th, 2019 interview in The Guardian. Remarkably prescient in predicting a pandemic, and optimistic at the same time.