“Arthur Rock was one of America’s first venture capitalists. He played a key role in launching Fairchild Semiconductor, Teledyne, Intel, Apple, and many other high-tech companies. Following an early career on Wall Street in investment banking, Arthur started his first venture capital partnership with Tommy Davis. Between 1961 and 1968, Davis & Rock invested $3 million and returned $100 million to their investors.”
1. “What attracted me first, I got this letter from Gene Kleiner when I was in New York, actually written by his wife, suggesting that seven of the scientists at Shockley were not happy there and could I find them a job together…”
“The problem at Fairchild Semiconductor had to do with incentives. The whole idea of giving people incentives was something foreign to most companies.” “…employees like to feel they own part of the company, no matter how little.”
Seven scientists who were very unhappy with the management style of William Shockley left Shockley Semiconductor with Bob Noyce to become the famous “traitorous eight.” The capital these scientists needed after leaving Shockley was supplied by Arthur Rock’s investment firm Hayden Stone. Each of the eight scientists received 10 percent of the equity and Hayden Stone received 20%. The incentive created by that 10% ownership interest was important in motivating these people to create one of history’s greatest businesses (Fairchild Semiconductor).
Therese Poletti once wrote about this group: “It is estimated by some that more than 400 companies can trace their roots to those “Fairchild Eight” … the most famous being Robert Noyce and Gordon Moore, who left to co-found Intel in 1968. Other famous “Fairchildren” include Jerry Sanders, a sales star at Fairchild, who left with a group of engineers to co-found Advanced Micro Devices in 1969. ‘This was the first company to spin off engineers starting something new,’ said Moore. “By luck, we caught up with some financing and got to start our own company.” But it wasn’t easy, the group approached 35 companies with the help of a young Harvard MBA named Arthur Rock.”
2. “I get my kicks out of building companies…” “[Early venture capitalists] were all company builders. And people entering the business in the late 1990’s were promoters. They’re always promoting their companies and promoting their deals.”
“You know, a lot of people are just interested in building a company so they can make money and get out. That doesn’t interest me at all. Usually it’s not a successful way anyway…”
The venture capitalists I admire most like to spend their time and effort building real businesses. They almost always understand finance deeply, but for them, finance is an enabler of what they most love to do. One of the ironies of venture capital is that the best way to be financially successful is to pay less attention to finance and more attention to building a business. The right financial structure doesn’t mean anything if all it does is guarantee you a high percentage of nothing.
3. “We spent a lot of time with our companies... [sometimes] if you divide up the number of companies they’re invested in by the number of partners, you find that the partners haven’t got ten minutes for any one company.”
Time is the scarcest resource that any venture capitalist has to offer any business in their portfolio. A founder or business is not going to get much time from the venture capitalist if that venture capitalist is investing in too many businesses. This is part of the reason why the venture capital business does not scale well. You can’t automate the work that a great venture capitalist does in helping grow a business.
4. “I was more interested in people, in figuring out whether the people are good people without knowing exactly what it is they are going to do technically.”
Many people in this series on my blog have pointed out that the success of a business is fundamentally tied to its people. The company you build is the people you hire. Arthur Rock himself is not a technologist, but he is an excellent judge of people. Finding the right people is fundamental to the success of a startup. Great people create optionality for the business since they are more able to adapt to an uncertain future.
5. “Good ideas and good products are a dime a dozen. Good execution and good management—in a word, good people—are rare.” “The lesson from Intel? The necessity of having great management.”
Almost everyone has good ideas once in a while. There is a light year of difference between “I thought of that” and “I built that.” Arthur Rock’s comment on the importance of management also reminds me of the posts I did on “Coach” Bill Campbell, Jim Barksdale, and Sheryl Sandberg. Strong technical skills are not enough to create a successful business, and strong management skills aren’t enough either. The rarity of “good management and good people” is another reason why venture capital does not scale well as an industry.
6. “I am especially interested in what kind of financial people they intend to recruit. So many entrepreneurial companies make mistakes in the accounting end of the business. Many start shipping products before confirming that the orders are good, or that the customers will take the product, or that the accounts are collectible. Such endeavors are more concerned about making a short-term sales quota than about maximizing the long-term revenue stream.”
Accounting revenue is an opinion and real cash flow is a fact. A startup focused on fake metrics will eventually pay the price. The first and second rules of finance are: pay attention to cash and pay attention to cash. When the business has found product/market fit and the task at hand is more focused on scaling the business, if the focus of the sales team is to create faux success by using misleading metrics that is potentially a huge problem. The easiest person to fool is yourself.
7. “I look for people who [are] honest. They have fire in their belly. They’re intellectually honest meaning that they see things as they are, not the way they want them to be and, and have priorities and know where they’re going and know how they’re going to get there.”
Confirmation bias and other dysfunctional heuristics drive people to see what they want to see. This gets in the way of the intellectual honesty Arthur Rock seeks. Psychological denial is a powerful and often dysfunctional force in the world of failure. In this interview Arthur Rock is also pointing out that he is trying to sort out whether someone “is a good person.” Whether someone is a good person is a highly underrated success indicator. Not only is it the right thing to do and the most pleasant thing to do, it is the most profitable thing to do. People who deal with each other via what Charlie Munger calls a “seamless web of deserved trust” because they are good people, get more things done quickly and efficiently.
8. “When they have their five-year plan and they come down to net profits, that’s okay. But then when they tell you how much your earnings per share is going to be and what the dilution is going to be and then how much, at what price earnings ratio the stock is going to sell at and then they tell you, well, you know if you invest it today you would make twenty times or a hundred times or something on your money, at that point I don’t want to talk to them anymore. Very nice to have met you. Goodbye. Good luck.”
This is such a great statement since the “tell’ Arthur Rock describes reveals so much. First, people who think they can predict the future with sufficient accuracy to create a detailed five-year plan have a lousy understanding of how business works and have not been paying attention to life. A spreadsheet is only as good as your assumptions and when you put garbage into a spreadsheet garbage comes out. Second and even more importantly, entrepreneurs like Arthur Rock described are not sufficiently focused on solving real customer problems – a precondition for creating a valuable business.
9. “One thing that probably has not changed is the need to be a good listener.”
In deciding which venture capitalist to select, Chris Sacca has suggested the founder ask: “Who’s gonna listen?” Mark Suster has similarly said: “There are a lot of people with big mouths and small ears. They do a lot of talking; they only stop to listen to figure out the next time they can talk.”
This list of people recommending listening is long. Larry King: “I remind myself every morning: Nothing I say this day will teach me anything. So if I’m going to learn, I must do it by listening.”
It is not just important that you listen to your venture capitalist or your founder – any successful business must listen to its customers, suppliers and employees. Arthur Rock also pointed out in this same interview that whether someone is a good listener is best judged over time, since in the first meeting they may be on their best behavior.
10. “Fred Terman was head of the engineering school at Stanford, and he encouraged his students, especially the doctoral and postdoctoral students, to form companies and continue to teach at Stanford.”
“It is entirely possible that there would be no silicon in Silicon Valley if Fairchild Semiconductor had not been established.”
The positive feedback loop that Stanford has created is powerful. The formula is simple: allow professors and students to be entrepreneurial and give them access to great facilities and other resources. Teach them to be empathetic, ethical and thoughtful. These professors and students will build valuable businesses and will eventually be philanthropic toward the university, which creates a source of funds that can be re-invested in students, professors and infrastructure and other resources in a way that grows over time [repeat indefinitely]. That William Shockley was born south of San Francisco area was a lucky break for the San Francisco area just as Bill Gates being born in Seattle as a lucky break for the Seattle area. If you look at which areas of the world are economically successful, you inevitably see major research universities. If the research university has archaic rules about conflicts of interest the universities suffer, and so does the surrounding area’s economic environment.
11. “Over the past 30 years, I estimate that I’ve looked at an average of one business plan per day, or about 300 a year, in addition to the large numbers of phone calls and business plans that simply are not appropriate. Of the 300 likely plans, I may invest in only one or two a year; and even among those carefully chosen few, I’d say that a good half fail to perform up to expectations.”
This fundamental aspect of venture capital investing – the power law distribution of financial returns – has not changed and will not change. The combination of (1) the optionality discovery process inherent in venture capital and (2) the top down constraint an economy puts on income for any given business/all business collectively, means that the power law is here to stay. To find the one unicorn that drives financial returns in the venture capital industry requires that the venture capitalist look at a lot of prospects before finding an opportunity that may be mispriced. And even after carefully examining hundreds of opportunities, half of all venture opportunities will fail outright and most of the rest will mostly be “meh” results.
12. “Success breeds success.”
This is a simple statement of one of the most powerful forces operating in the world today. The more technical term to describe the phenomenon is “cumulative advantage.” Columbia University’s Duncan Watts puts it this way:
“The reason is that when people tend to like what other people like, differences in popularity are subject to what is called “cumulative advantage,” or the “rich get richer” effect. This means that if one object happens to be slightly more popular than another at just the right point, it will tend to become more popular still. As a result, even tiny, random fluctuations can blow up, generating potentially enormous long-run differences among even indistinguishable competitors — a phenomenon that is similar in some ways to the famous “butterfly effect” from chaos theory.”
“…hindsight isn’t 20/20; it’s reductive and unreliable. In a section on the Mona Lisa, for example (see excerpt), he discusses how the painting languished in relative obscurity for centuries, only becoming world famous after it was stolen from the Louvre in the early 1900s—but since the idea of its greatness owing to a fluke is so inherently unsatisfying, people ascribe post-facto “common sense” explanations. (It’s the smile! It’s the fantastical background! It’s the genius of Leonardo da Vinci!) “Common sense is the mythology—the religion—of the social world,” Watts says. “It’s the simple answer that maps directly onto our experience, the explanation we need to make things make sense. So we hear thunder and say, ‘The gods are fighting.’ That’s something we understand; people get angry and throw things. Common sense is socially adaptive. If we constantly had to grapple with the complexity of the world, we wouldn’t be able to get out of bed in the morning.”… if an answer and its opposite can seem equally obvious through the right mental gymnastics, there’s something wrong with the idea of “obviousness” in the first place. “We make this mistake so often, and it really hurts us,” Watts says. “We can’t understand the social world just by telling a bunch of cute stories. You need theories, experiments, data. It’s tricky and counterintuitive, and everything is more complicated than you think it is. Your intuition is always misleading you into thinking you understand things that you don’t.”
Descriptions of this so-called “Matthew effect” (the rich get richer) are old enough that the source of its name is the bible. What is new is that digital systems are accelerants of the Matthew effect. The rich are getting even richer since cumulative advantage scales even better when the phenomenon is digital. As Nassim Taleb has pointed out, more and more of the world is Extremistan. Taleb gives the example of the recording device as a contributor to Extremistan results:
“Our ability to reproduce and repeat performances allows me to listen to hours of background music of the pianist Vladimir Horowitz (now extremely dead) performing Rachmaninoff’s Preludes, instead of to the local Russian émigré musician (still living), who is now reduced to giving piano lessons to generally untalented children for close to minimum wage. Horowitz, though dead, is putting the poor man out of business. I would rather listen to Horowitz for $10.99 a CD than pay $9.99 for one by some unknown (but very talented) graduate of the Julliard School. If you ask me why I select Horowitz, I will answer that it is because of the order, rhythm or passion, when in fact there are probably a legion of people I have never heard about, and will never hear about – those who did not make it to the stage, but who might play just as well.”