In this podcast, Motley Fool host Ricky Mulvey talks with Ilya Strebulaev and Alex Dang, co-authors of The Venture Mindset: How to Make Smarter Bets and Achieve Extraordinary Growth, about:
- The benefits of building an “anti-portfolio.”
- Why it pays to get outside of your own four walls.
- Lessons from a piggy bank auction.
Strebulaev is the founder of the Venture Capital Initiative and a professor of private equity and finance at Stanford’s Graduate School of Business. Dang is a CEO, technology executive, and advisor who’s worked with Amazon, McKinsey, and across Silicon Valley.
To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on May 26, 2024.
Ilya Strebulaev: When everybody is running in the same place and you’re running faster, maybe you’re overestimating the fruits of Victory. In the piggy bank game, in the fear of missing out on the former and in the stock market, investing in general, the winner very often loses. It has a special name called winner’s curse.
Mary Long: I’m Mary Long and that’s Ilya Strebulaev. An economist and professor at the Stanford Graduate School of Business. He’s also the co-author of the new book, The Venture Mindset, which he wrote with Alex Dang, a technology executive who’s launched new ventures at Amazon and been an advisor for companies across Silicon Valley. Venture capitalists are looking for winners, a 100x winners. Stock investors certainly wouldn’t complain about those kinds of returns. What can we learn from the people who are analyzing and investing in early stage companies. Strebulaev and Dang joined my colleague, Ricky Mulvey, for a discussion about why A-List teams are the best bet. The good that can come from getting outside your own four walls and what investors can learn from a piggy bank.
Ricky Mulvey: Alex and Ilya, either one of you can take this, but for those with the venture mindset, why don’t they care about strikeouts? Why aren’t they worried about getting on base? Why are they only worried about home runs with the investments they make?
Ilya Strebulaev: The reason is very simple. If you look at a typical venture fund, then out of 20 investments, 15 or 16 fail. They’ll sell strikeouts. Then there’ll be a couple of more where you get 2-3x, which means for each dollar you’ll get maybe $2-3. You know what? If you are a very conservative investor, 2-3x is OK, but for venture investors, that’s a mediocre return. Why? Because it doesn’t cover all those losses. On average, my research shows only one out of 20 venture deals result in a home run. Where you get more than 100x or at least a 100x, which is $100 per each dollar of your return. If you think about venture investors, the only thing they really care about is what can they do to increase, even slightly so, the odds of hitting a home run. If they experience one more strikeout, even five more strike-outs, but then they have that 10,000x home run, nothing else matters. Ricky, I had an amazing experience once in my Stanford MBA classroom. I’ve been teaching for many years the venture capital class, as you can guess, very popular. I have a panel full of very successful VCs. One very famous VC and billionaire spoke to my students. A student asked him, what is your biggest regret as a venture capitalist in your entire life? The venture capitalist started telling a story, one day he came to a friend, and there were those two guys in the garage of a friend that were building a new search system. Well at the time there were 50 search systems, and he even refused to meet those two guys. They were founders of Google. This guy, he was in his mid-50s. Again, extremely successful guy, he’s starting telling the story about how he missed that biggest home run in his lifetime, and you know what? Tears started rolling down his cheeks. That’s how personal they take it. They care about home runs, and you know what? I’m pretty sure he couldn’t even mentioned, even if he could not remember any of his strikeouts from that period.
Ricky Mulvey: When you looked at a lot of these venture capital companies, many of them I think only invest in what four projects a year. Why not then, why not have a lower due diligence process, spread your bets out more, and then hope that more of those home runs come in?
Ilya Strebulaev: Well, mainly VC firms invest more than four, in fact, a year. It’s true that if you think about any partner in a venture capital firm, they might invest only in one or two per year, and that is true. At any point in time, a typical venture capital may be on 8-12 boards, so it’s a very limited number. Why then not to do spray and pray? That is how we call it. By the way, some angel investors are doing this. Here’s the reason. It’s because if you are doing just spray and pray it’s in fact, very unlikely that you either will hit a home-run because hitting home run requires a lot of due diligence, a lot of decision-making. But also it’s even less likely you will be able, if you hit randomly that home run, it will be less likely that you will be able to follow on. The trick with venture investors is that not only they hit a home run maybe one out of 20 times, but when they do so, they can invest in this home run again and again and again. It’s a meaningful bet. While you’re doing spray and pray, those bets are not meaningful.
Ricky Mulvey: Ricky, you mentioned so-called due diligence, and interestingly enough, but VCS call themselves risk reduction engineers. The reason for that term because they actually do due diligence. They not start with it. They filtered out many deals right to weigh. But they do want to know and understand what company they invest in or said differently, what kind of a team they bet on.
Ricky Mulvey: Alex or Ilya, when you hear about the red flags from the venture capitalists you study what are some common red flags? What are some common reasons that they immediately say, no, I’m not going to continue further research into this company?
Ilya Strebulaev: Ricky, it will vary. Some VCs will immediately ask what is the size of a market that you are addressing. If their total addressable market or TAM is not big enough, you’re done. That would not be of much interests, but there will be funds who would pretty much ignore the size of TAM. What they will pay more attention to would be, are you able as a company to be a semi-monopoly? What’s in this market? Peter Thiel’s fund is pretty well known. Founders Fund, it’s pretty well known for that feature. But Number 1 factor across all of the VCs, and that’s what Ilya’s survey and research demonstrates, it’s the key. It’s all about the jocking on the horse. It’s all about the team that plans to lead. There they will look at different characteristics from, are they great team members? Do they have enough skills to make it happen? It will not just be about the founders, but having been able to bring great talent to the team. That’s all going to be about the team. If you compare that to Angeles, Angeles may invest in the very early idea with maybe just a single two founders. At a VC level, they will look into the team. That’s actually such a big contrast. I used to work at Amazon, launch multiple businesses there wasn’t a McKinsey partner and trust me it [inaudible] larger works, companies pay way more attention to business plans, not teams. That what’s demonstrates the power of jockey versus horse. Jockeys, truly important for VCs.
Ilya Strebulaev: One of the Legendary VCs, Ricky George Dario said, I’d rather invest in an A little team pursuing a B-level lazier rather than invest in a B-level team pushing an A level idea. The reason is that the moment there is a great idea, there are many teams pursuing this right away. Let me give us quickly, one example. Some years ago when the first iPhone was just released, everybody was talking about file-sharing. File-sharing was not yet possible. Maybe, some of your audience, Ricky, still remember those USB drives, maybe floppy disks, etc. But everybody was talking about this. They’re actually more than 80 start-ups that were pursuing file-sharing. Partners at Sequoia and I’m sure many other venture capital firm thinking, oh, that’s a great vertical. Do you know that one of the partners, that sequate the time his name was Samir Gundy. He met with dozens and dozens of stops, and he did not invest in any of them because he did not believe that that team would execute. Then one day he met the two founders serendipitously. They didn’t have the money. I actually think they didn’t have the money to fly cross across the US. They took a Greyhound bus from Boston to Silicon Valley. He met them and I think half an hour, he said I’d love my partners to meet them. There’s Doug Leone, Mike Moritz, partners at Sequoia I met. I think in a couple of days they invested. Why?
Ilya Strebulaev: Because those founders knew exactly how they’re going to do it. They could describe, they could teach. Venture capitals could spend like six months preparing their mind how they’re going to do it. Sequoia ended up being the first institutional investor in what was to become Dropbox. I think one of the most successful investments they’ve made.
Ricky Mulvey: One of the investors in Dropbox as well, he was someone working at a rug store. Can you tell the story of how that happened?
Ilya Strebulaev: I think it really tells you a lot about venture capitalists getting outside of the four walls. I think it’s really important for all investors. You know what happened that this guy who was selling rugs in Iranian store in Palo Alto, his name is Pejman Nozad. Doug Leone, who’s a senior partner at Sequoia was his customer, was interested in rugs. They’re very beautiful by the way. One day, Pejman told Doug, you know what? I’m from Iran originally, so I have access to a lot of smart Iranian PG students. Do you want to meet some of them because I think they’re working on start-ups? Doug Leone was very famous, successful venture capitalist, like why would he need to meet this rug store dealer apart from buying rugs? Doug Leone’s reply was, yes. See you Monday at 7:00 AM in your office. He met and that was another connection that led to Dropbox and many other deals.
Ricky Mulvey: It’s very early meeting time. You’ve got to be able and willing to get there at 7:00 AM.
Ilya Strebulaev: Well, outside of your four walls every time 7:00 AM Or 7:00 PM.
Ricky Mulvey: The difference between an A level team and a B level team, for me at least seems difficult to find. I’m in Denver. We have the Denver nuggets out here, Nikola Jokić, it’s pretty easy to see that that’s an, a level player dominating on the court scoring 40 points last night at the time of this recording. Just schooling people. But how do you do that in the venture world? How do these venture capitalists know that they’re talking to an A level team. You mentioned Dropbox where were they had a clarity of vision and clarity of how they’re going to solve the problem. What are these venture capitalists looking for?
Ilya Strebulaev: Amazingly, in Africa, it’s not that different from sports in some ways. Here’s what venture capitalists look for. First, they look for charisma. Charisma is very difficult to define, but you know what, when you say charismatic founder, you know. The best way to think about charisma is the following. Is the founder able to convince other people to follow them? Here’s an example. I’m very lucky because I developed this venture capital class at Stanford. Over the years, I had more than 2000, almost 3,000 NBA students who took my class, MBA MSX students. There are a lot of charismatic students. I can give you actually many examples. We can definitely spend the next hour. Here’s one example. I had a student recently, his name is René Cassin. He is, I think it’s called maxillofacial surgeons. Originally from Canada. He came to Stanford and he decided to build a healthcare platform to help people with rare diseases. It’s an amazing idea, but it’s very tough. Every single time he would come to my office, talk to this idea. I’m advising many of my students every single day I was thinking about, gosh, I’d like to drop this being professor and join him as a team member. He convinced a lot of people, he convinced the best computer science of Stanford. He convinced amazing executives to drop what they do and join him. That is, I think, charisma that venture investors try to find out and then invest in those people. Second, passion. Passion, because the venture story is a long one. If you’re a successful founder of venture start-up, it can be round with the start-up for 10 plus years. If you are not passionate now, you’re definitely going to be passionate two years down the road. I think passion that you really care about, what you do is something that venture investors care about. Finally, is resilience. We love talking about successful stories, who doesn’t? But behind every single successful stories, there are a lot of near failure experiences and many of them. I think founders who are resilient, who are able to recover from inevitable negative situations, they’re much more likely to go into be successful.
Ricky Mulvey: Yes, Slack would be one of them, where it was originally a team of video game developers that had a video game that didn’t work out so well, but they had an internal messaging tool that did work out pretty well. Had a venture capitalists encouraging them along the journey and then incomes, Salesforce, buying it out for billions and billions of dollars. It’s one of the top dog messaging tools we use today.
Ilya Strebulaev: That’s exactly the case, Ricky. But what is even more important that the statement about that this is going to be a but on the team was written in the very first investment memo. I think this is the most important part of the story that, that was the but on the team. When the team actually faced challenges and they had to pivot and they fail, and they tried to find a new product, that’s when this whole trust, our VCs on that team played out. You have to make, from the very beginning you have, that’s why I’ve used the term risk reduction engineers. We have to identify, here’s the risks that I’m taking, but here’s the but that I’m making. In Slack example, and the company’s initial name was Tiny Speck with a game called Glitch. The Glitch was glitchy, but the initial but was on the team. That’s why it turned out to become Slack.
Ricky Mulvey: We’ve talked about the investment memo a little bit and the importance of it. Those who are listening right now we encourage them to write an investment thesis before they buy a stock. What does it take to write a good investment thesis, a good investment memo from those investors you’ve studied?
Ilya Strebulaev: That’s a great question, Ricky. You know what? Let’s step back and start with the strategy, which is why are you going to do this investment memo? It is in fact not just to make this specific decision. It’s also because you will be then able to go back after you made this decision. The decision could be to invest or not to invest, and to review. You will have an unbiased record of what your decision was. For example, what many VCs do they use the autonomous memos later on to form their anti-portfolio. Anti-portfolio is something that I think is extremely useful to any investor, even though I haven’t seen it implemented much outside of the venture world. This is one of the tricks of the trade. Anti-portfolio are those companies that you met, that you likely investigated, that you likely wrote an investor memo and decided not to invest. Ricky, how many of our audience decides not to invest in the stock and then continued to follow the stock maybe for months? Just think about this. What venture investors do like Bessemer Venture Partners, famous VC firm, and the value they actually published this anti-portfolio on their website. Now, most other VC firms don’t publicize their anti-portfolio, but they observe. Here’s a trick. If your anti-portfolio is more successful than your portfolio, it’s time to make changes to your decisions. Therefore, these investor memos are really way more useful, you just need to find other ways to use those investor memos. Now how to write those investor memos. I think first of all, follow the pattern, set up really good procedural rules. Think about that you write investor memo, even if you’re making your own decision, think about it as though you’re writing that memo for a committee, for others. By the way, recommendation that I’ve been told by some investors. Think about that you’re writing to the top VC investors in the world. Now, if you’re a stock investor, think about that you’re writing universe investor memo for Warren Buffett. Warren Buffett may never see your investor memo. But once you think about, I’m going to write this investor memo for Warren Buffett, you’ll put much more effort. You mentioned the clarity Ricky, earlier. Investor memo must be very clear. It should identify strengths and weaknesses. It should identify what is known and what is unknown.
