I was introduced to Michael Mortiz only once many years ago during a visit to Sequoia. I know of him only through stories told by others, his writing and what I have read in the press. His accomplishments are impressive, as is his insight on topics like the venture capital business.
1. “When we help organize one of these companies at the beginning, it never looks like the world’s greatest idea. I think it’s the marketing and PR department that rewrites history and tells you that it was always the world’s greatest idea. What they don’t say is that at the very beginning there was great uncertainty and a great lack of clarity.” “We just love … people who perhaps to others look unbackable. That has always been our leitmotif of doing business.” The best venture capitalists understand that success in the venture capital business is about buying mis-priced optionality. Something “not looking like the world’s greatest idea” is actually helpful since uncertainty is the friend of a wise venture capitalist. In other words, it is uncertainty that causes others to mis-price optionality. Without some elements which make the startup’s ambition seem audacious/crazy, the potential financial return is unlikely to be the 20-100X plus tape measure home run needed to make the VC fund a success. Typically it is one or three tape measure home runs that generate the necessary financial return for the venture capital fund. For this reason, the distribution of success within a venture firm’s portfolio will follow a power law.
2. “Every single time you write a check you expect, or pay depending on your inclination, for that investment to succeed.” In order to harvest optionality, the venture capitalist must believe that each swing of the bat may produce a tape measure home run – even though statistically about 50% of startups will fail outright and more will be poor outcomes. Many startups will nearly crash into the ground before they soar to become a success. Of course, others just crash into the ground. But in the beginning you must expect them all to succeed.
3. While there is danger in the venture business in getting too far away from the crowd, it can often pay to be unconventional. … Don Valentine, the founder of Sequoia Capital, told me to trust my instincts, which lets you avoid getting dragged into conventional thinking and trying to please others.” In order to outperform any given market, it is mathematically true that you must not essentially *be* that market. In other words, a venture capitalist can’t outperform other venture capitalist if they act just like them. This may seem like common sense but you would be surprised how much herding happens anyway, since many people would rather fail conventionally than succeed unconventionally.
4. “If you have been around the start of success it is far easier to recognize it again.” Venture capitalist Bruce Dunlevie of Benchmark Capital said to me once: “pattern recognition is an essential skill in venture capital.” While the elements of success in the venture business do not repeat themselves precisely, they often rhyme. In evaluating companies, the successful VC will often see something that reminds them of patterns they have seen before. It might be the style, chemistry or composition of the team or the nature of the business plan. Some things will be fundamentally different but other things may be familiar. While the pattern will be similar, something in what the team is doing will seem to break a rule. Part of the pattern that is being recognized is a rule breaking innovation of some kind which drives new value.
5. “There’s nothing more invigorating than being deeply involved with a small company and … everybody’s betting against us.” Great venture capitalists love the process of creating companies and more importantly creating customer value. Venture capital is a service business. Making others successful is the driving activity in the work. Finding vicarious joy in the success of others is essential.
6. “The very best companies are the ones where founders build the companies and stay with the companies for a very long time.” The most successful founders have a passion for building a business. This passion is highly correlated with a desire not to flip the business for a quick financial profit.
7. “The venture capital partnership that invests small amounts of money judiciously is almost always going to outperform the venture capital partnership that tries, to use an ugly phrase in the business, ‘to put a lot of money to work.’” The size of a fund at a point works against performance. Emotional errors kick in when people have more more to spend than they have ideas. Even worse, they can end up investing too many times which can lead to a lack of focus. A top 5% venture capital firm may hear thousands of pitches and invest in only 8 to ten new companies each year (depending on the firm). A few outlier venture capital firms may invest in 20 new startups each year at a series A stage, but that is not the norm.
8. “Five-year plans aren’t worth the ink cartridge they’re printed with.” Great teams are able to respond to a world which changes in ways which cannot be foreseen. This is why venture capitalists spend so much on the people employed by the startup. A strong team of people means the startup itself has optionality. The ability to “steer” as conditions change is more valuable than the ability to create medium- and long-term plans.
9. “It takes a tremendously long time to build a company of value. In many cases, the best venture returns don’t happen in the private phase of the company; they happen in the time that the company is public… “It takes a long time for sales to grow and it takes a long time for true value to be achieved.” “People would be staggered at the length of time that we hold investments. It’s not uncommon for us to hold investments for 10 years or more. It’s certainly not uncommon for the partners at Sequoia to own stock for 15 or 20 years.” Most outsiders underestimate the importance of patience in venture capital. Building great companies takes time. A few stories about relative short term payoffs from someone selling out for a big return warp the view of many people about the time required to find success in the venture business.
10. “A downturn can be a very good time to build a company. The parvenus and the pretenders are gone. The only people who want to start a company in a time like this are the ones with the greatest conviction.” … it gets rid of all the riffraff. There isn’t as much chaff in the air. There is more time to be thoughtful. You don’t spend your day reacting to all sorts of fruitless entreaties. So to some extent it is easier. It is easier to hire and find places to locate companies and in some respects also it is easier to get customers. Oddly enough in recessionary times, customers are prepared to take more risk with a young company if they believe that that company offers them a tremendous advantage that will help them become more efficient or lower their costs.” As Howard Marks likes to say, business cycles are inevitable. The best time to be planting seeds is often when others are in a panic and depressed. Thinking counter-cyclically pays big dividends in business and not just in venture capital. People see the recent past and then extrapolate it into the future. Volatility is actually the friend of the investor with control of their emotions.
11. “[Venture capital] is a business that’s always had the investment returns concentrated in very few hands.” Path dependence is a huge element in the venture capital business. In short, early luck and skill lead to more success and more skill as a number of factors feed back on themselves in a positive way. This results in two power law distributions: (1) returns within a venture capitalist’s portfolio; and (2) relative returns of venture capital firms in the industry.
12. “I know there are millions of people around the world have worked as hard and diligently as I have and weirdly enough, like [former US President] Jimmy Carter said years and years ago, ‘life’s unfair’. I just happen to have been very fortunate.” “A chimpanzee could have been a successful Silicon Valley venture capitalist in 1986.” Luck has way more to do with outcomes in life than most people care to admit. The benefits of luck compound and because successful people attract successful people. Adding to the bounty is that fact that being around other successful and skilled people makes you more skillful. If you happened to be lucky enough to be working as a venture capitalist in 1986 somewhere near Stanford you very likely were the benefit of a massive tailwind that not only make people richers but more skilled. If you were that lucky and are not humble, you have not been paying attention. Are these people more skilled too? Yes, because being lucky puts you in situations in which you acquire new skills. Luck not only feeds back on itself to create more luck, but also more skill.
P.S., As an aside, what I know about the venture capital business I learned from many people, most notably my friend Bill Gurley of Benchmark Capital. The post I wrote on Bill Gurley is one of the most insightful in this “Dozen Things” series, in my view. His interviews with GigaOm and PandoDaily are as good an explanation of the venture business as exists anywhere.
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For interviews of Michael Moritz see: