1. “I’ve learned that when the pessimism is high, dial up the investment pace. When the optimism is high, take a breather.” This is a version of Warren Buffett’s admonition that investors “should try to be fearful when others are greedy and greedy when others are fearful.” This is easy to say but hard to do, especially since the desire to run with the crowd can be so strong in humans. Most investment mistakes are based on emotional and psychological errors but so are most investment opportunities since it is when others make mistakes that mispriced assets become available. In short, being contrarian based on the bi-polar actions of the mob can generate market beating investment returns. To Jim Breyer’s credit, he was very cautionary prior to the pop of the Internet bubble, and took a lot of heat as a result. He was wrong in his prediction until he was eventually right. Jim Breyer recalls that in: “March  — which actually was the precise market top — Whoopi Goldberg was a dinner speaker. And the fact that Whoopi was coming up and talking about how wealthy these Silicon Valley entrepreneurs and venture capitalists were and what a great life it was (and she had some ideas as well) – that to me was a sure sign the end was pretty darn close. But she was a great speaker, by the way..”
2. “Investing is very psychological, whether you’re Warren Buffett, whether you’re early-stage technology venture capitalists, psychology plays such a central role.” All successful investing styles and systems share certain common fundamental elements (buy at a bargain, discover value rather than predict it, be contrarian to beat the market, etc.). But the most common element of all is that the hardest part about investing is keeping control of your emotions and other psychological factors. As Warren Buffett has said: “Investing is simple, but not easy.” Jim Breyer is saying that what is not “easy” is investor psychology.
3. “There’s a pattern recognition and real-time knowledge that comes with investing and building companies from the earliest stages over a long period of time.” Becoming a successful venture capitalist takes time, since pattern recognition comes from making a range of mistakes that help one acquire good judgment. One key to this process is avoiding certain mistakes that fall into what Daniel Kahneman calls “System 1.” Michael Mauboussin describes the two types of thinking as follows: “System 1 is your experiential system. It’s fast. It’s quick. It’s automatic and really difficult to control. System 2 is your analytical system: slow, purposeful, deliberate, but malleable.” Mauboussin provides the right cautionary note: “for System 1 to work effectively, you need to deal with situations that are linear and consistent. If you’re dealing with decisions in a realm where the outcomes are nonlinear or the statistical properties change over time, intuition will fail because your System 1 doesn’t know what’s going on.”
Investing decisions are best made as System 2 decisions since the complex adaptive systems involved are nonlinear. When you use System 2 in the right way, the power of counter-intuition can be a big source of investing opportunities. Using System 2 properly requires training so that investors have the right “muscle memory” when a decision needs to be made.
4. “We like to think that we will make a mistake only once and learn from it. We also are humbled every day by a new mistake.” If you are making the same mistakes more than once something in your investment process is broken. For example, as I noted above, one important set of problems arises due to unthoughtful reliance on System 1 thinking. By becoming more aware of the investment decision making process one can work to shift thinking from System 1 to System 2 when it is appropriate. To acquire the right decision-making muscle memory it is important to rub your nose in mistakes when you make them or shortly thereafter. The natural human tendency is to gloss mistakes over with psychological denial. By celebrating rather than burying mistakes, you learn faster.
5. “The investment and venture capital cycle is continuously changing, and one of the most fascinating internal discussions is often around where we are in the cycle.” “We will have many booms and busts forever in Silicon Valley.” All markets are cyclical. Venture capital is more cyclical than other markets, not less. One of the most talked about tells for a change coming in the business cycle is when people start to talk about there being no cycle. People don’t make decisions independently, and when one person moves people tend to follow other people until they unpredictably don’t. The idea that the sequence of behaviors that make up a business cycle is precisely predictable, given that a nest of complex adaptive systems is involved, is folly. One can at best hope to make general forecasts about the probability of a shift in the business cycle, which can help with investing.
6. “The dangers of over-capitalization are, in many cases, even higher and more grave than under-capitalization.” “We’ve always said was that risk reduction is all about, in the first 12 months, take out the technical risk; in year two, take out sales and marketing risk; in year three, build for working capital and international distribution; year four, take the company public. That’s a classic venture model in terms of how we stage investment. But, in fact, [during the Internet bubble] there was no staging. There was no risk reduction that was occurring, because the capital was so free, the companies could raise it all at once, and were simultaneously trying to address all these issues.” Biggie Smalls put it best: “Mo Money Mo Problems.” Too much money at a startup can cause a range of problems including a lack of focus and a failure to innovate. Too much money can also wreck a capitalization table, make later financing rounds hard to achieve and a down round inevitable.
7. “We look for a business plan that demonstrates differential insight.” If you are not searching for ways to be contrarian and right about that contrarian view, you are not going to outperform markets as a investor. This applies at many levels and domains in investing, including the process of defining a target market for a start up. Startups that chase the tail pipes of other startups and companies are less likely to be a success.
8. “Most of the best businesses in Silicon Valley started with a very simple concept and extended into adjacent market segments as well as into global markets.” Focus matters, especially in the early months of a startup. It is also helpful for a startup to be in a market in which there is not a lot of competition, until the business generates a strong base from which to build into adjacent markets.
9. “We are always looking for fit between people, opportunity, ideas.” “The balance between optimism, candidness, intellectual honesty, and integrity results in a virtuous set of characteristics that are shared by all exceptional entrepreneurs.” Michael Porter is a big advocate of including fit as an objective in creating a company strategy and in assembling a moat for a business: “Fit drives both competitive advantage and sustainability: when activities mutually reinforce each other, competitors can’t easily imitate them. Fit is leveraging what is different to be more different.” This brings to mind the Charlie Munger idea of a lollapalooza. Munger has pointed out that that the impact of a lollapalooza involves vastly more than simple addition of the components which are interacting.
10. “The history of technology businesses, as well as many others, suggests that it’s very often the case that the second or third mover ends up winning … Sometimes it really pays to let someone else create a market and be the second or third entrant. That’s true in the spreadsheet business with Lotus. That was true in the personal computing business with Dell; true in the router business with Cisco; true in the operating system business with Microsoft.” Markets “tip” later than many people imagine, and sustainable competitive advantage (moats) can also end up being far more brittle than people imagine. My friend Craig McCaw has said to me many times that “sometimes pioneers get an arrow in the back for their efforts.” I also recently quoted Peter Thiel on this topic: “More important than being the first mover is the last mover.”
11. “In every deal I can think of, there’s a dark day when board members sit around the table and simply wonder how we can dig ourselves out of the hole we’re in.” Many very successful startups nearly expire in the early months and years of building the business. Successful venture capitalists know this and don’t easily give up. Knowing when it is really over for a startup vs. when it is time to fight on is a skill acquired with time and experience (and the right sort of System 2 analysis).
12. “Some people get real lucky….But that’s no way over a long period of time to operate a venture capital firm or an investment business. It sure helps to get lucky, but you can’t count on it.” To count on luck bringing you success or to discount the role of luck in your success is just plain dumb. If you are not thankful for your luck, and not more humble as you grow older, you have not been paying attention. As always, Michael Mauboussin is preeminent on this topic of luck vs. skill in a recent interview.
Notes on Breyer: