1. “When a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens.” “If you address a market that really wants your product, if the dogs are eating the dog food, you can screw up everything in the company and you will succeed. Conversely, if you’re really good at execution but the dogs don’t want to eat the dog food, you have no chance of winning.” A great product in a great market can make an executive look great, regardless of skill. Similarly, when a talented executive tries to achieve success with an offering that is lousy or the market is lousy, the result is inevitably lousy. Warren Buffet has expressed a similar thought: “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Andy wants great management and a great market when he invests. One big difference between Andy Rachleff and Warren Buffett is that as a venture capitalist and entrepreneur, Andy builds new moats. Warren Buffett and Charlie Munger make it clear that they only buy existing moats. Building new moats and buying existing moats are very different objectives, involving very different skills and talents.
2. “A disruptive product addresses a market that previously couldn’t be served — a new-market disruption — or it offers a simpler, cheaper or more convenient alternative to an existing product – a low-end disruption. …Silicon Valley was built on a culture of designing products that are “better, cheaper, faster,” but that does not mean they are disruptive.” Wealthfront, which Andy founded, is an example of a company providing people with services which could not have been offered before the software-based innovations that are robo-advising. In other words, small accounts served by Wealthfront could not previously have been served by traditional advisors without higher fees, loads and costs. The lower fees are enabled by technology and new sales channels. One thing I love about Andy making this set of statements about disruption, is that he said publicly that he did not really understand disruption fully until he founded Wealthfront. That sort of intellectual honesty is what makes people succeed in life. Charlie Munger likes to say that if he does not destroy one of his most cherished ideas every year, it is a wasted year.
3. “Instead of starting with the market and then finding the product, the really big winners start with a product and find a market.” Finding a product or service that delivers a 10-2,000X financial return happen much more often when the entrepreneur is harvesting something that is nonlinear, and that comes from a technology rather than something that is just marginally cheaper. Discovering really big new markets can be especially profitable. Andy’s friend Bill Gurley has a masterful essay on total addressable market definition here.
4. “It’s very difficult to manufacture innovation.” “Great entrepreneurs are far more missionaries than mercenaries. The missionaries are true to their insight, and the money is secondary to it. Mercenaries, whose primary goal is money, fall somewhere on the middle of the entrepreneur bell curve. They seldom have the desire to change the world that is required for a really big outcome, or the patience to see their idea through. I don’t begrudge them their early payouts. They’re just not the best entrepreneurs.” Since only ~15 tape measure home runs a year are what drive venture capital returns, the odds that the same person will get lighting in a bottle at that level multiple times are small. A given person hitting more than one of those home runs is possible, but that ~15 number is a top down constraint on the total number of people who succeed at that level. People who flip the business early or midstream usually don’t last long enough to do this. Experience has shown that it is very likely to be genuine passion and domain knowledge, and not what Andy called “manufacturing innovation,” which produces those ~15 tape measure home runs.
5. “We never meet with companies that aren’t referred or where we don’t know the entrepreneurs.” “It’s sort of a test, if you can’t get an introduction [to the venture capitalist] you are unlikely to succeed in selling the other constituencies.” Being an entrepreneur requires effective selling in the broadest sense of the word. The entrepreneur must sell ideas, prospective employees on jobs, products and services, partners, investors, the media, etc.
6. “[Venture capital is] a very cyclical business. So there was a cycle from 1980-1983 that looked a lot like 1996-1999. Only an order of magnitude smaller on every dimension.” “I don’t think a bubble is an environment where things are valued highly, I think it’s an environment where crappy companies are valued highly.” Andy Rachleff, Bill Gurley and many other investors are fans of Howard Marks like I am. Howard is fond of pointing out that business cycles will always exist and the best approach is to expect their inevitable and unpredictable changes. All markets are cyclical and always will be. Venture capital is no exception, and is in fact more cyclical that many other markets. The timing of business cycles in different industries and sectors is often not synchronized. As Bill Gurley has pointed out,“venture capital has long been a trailing indicator to the NASDAQ.”
7. “All our advice on Silicon Valley careers is based on a simple idea: that your choice of company trumps everything else. It’s more important than your job title, your pay or your responsibilities.” Feedback is what’s driving returns today in markets, and as Reid Hoffman has said, what company you work for and who you learn from matters more than ever. Networking “early and often” is an excellent approach to business and life especially in a digital world.
8. “Human beings want returns, but they don’t like risk.” Most people talk a good game about risk and uncertainty but will typically back off when it comes time to actually do anything. Some of these people are your really smart classmates who have never gone anywhere financially in life. People who are comfortable with risk earn a premium as a result of the risk aversion of other people. Ironically, people who are oblivious to risk sometimes also get lucky and earn that same premium (even a blind squirrel finds a nut once in a while).
9. “It doesn’t matter how many losers you have, all that matters is how big your winners are.” “You can only lose 1X your money [as a venture capitalist]. “[As a venture capitalist] you make bets and you have to be willing to be wrong a lot…. It’s one of the few industries I know of where you can be wrong 70% of the time and be brilliant.” If you have been reading this series you recognize that Andy is talking about what I have called “harvesting optionality.” A tape measure home run hitter can strike out a lot and still be great. It is magnitude of success and not frequency of success that matters most for an investor.
10. “When it comes to investing in venture capital I would follow the old Groucho Marx dictum about ‘never joining a club that would have you as a member.'” The very best venture capital firms and startups don’t need your money. This fact is a byproduct of cumulative advantage and is reflected in the power laws that drive venture capital returns. Andy Rachleff writes: “only about 20 firms – or about 3 percent of the universe of venture capital firms – generate 95 percent of the industry’s returns, and the composition of the top 3 percent doesn’t change very much over time.”
11. “Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. … Now obviously if you’re wrong you don’t make money. What most people don’t realize is if you’re right and consensus you don’t make money. The returns get arbitraged away. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.” All the investors in this series on my blog understand that you cannot outperform a crowd unless you are sometimes contrarian, and right enough times when you decide to be a contrarian. Many people first heard this idea from Howard Marks, but if you trace the idea back even further it leads to Ben Graham and before him John Maynard Keynes.
12. “Other than my wife, Bruce Dunlevie is the most influential person in my life. His advice was to always put the gun in the other person’s hand. In other words, if you are in negotiations with someone, you tell them to tell you what they think is fair, and then you do it. It’s a much better way to live to give trust first, rather than to make someone prove he is trustworthy.” Bruce Dunlevie is someone I have learned a lot from, especially about being a thoughtful, well-rounded and trustworthy human being. Having a colleague who has these qualities is a fine thing to have in life. As a bonus, when you develop a network of high quality people who you can trust, you have what Charlie Munger calls a “seamless web of deserved trust” – which enables efficiency and better financial returns. But that should not distract anyone from the fact that being a good person is its own reward.
Notes: PandoDaily – What makes for a great entrepreneur?
TechCrunch – The Truth About Disruption
This WeekIn Startups – Andy Rachleff, CEO Wealthfront
Stanford Graduate School of Business – Andy Rachleff: How To Meet VCs
Wealthfront blog – Demystifying Venture Capital Economics
SiliconMBA – Deep Thoughts From Andy Rachleff