-
Notifications
You must be signed in to change notification settings - Fork 0
/
How to Angel Invest, Part 2.html
1092 lines (1092 loc) · 52.2 KB
/
How to Angel Invest, Part 2.html
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
120
121
122
123
124
125
126
127
128
129
130
131
132
133
134
135
136
137
138
139
140
141
142
143
144
145
146
147
148
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
178
179
180
181
182
183
184
185
186
187
188
189
190
191
192
193
194
195
196
197
198
199
200
201
202
203
204
205
206
207
208
209
210
211
212
213
214
215
216
217
218
219
220
221
222
223
224
225
226
227
228
229
230
231
232
233
234
235
236
237
238
239
240
241
242
243
244
245
246
247
248
249
250
251
252
253
254
255
256
257
258
259
260
261
262
263
264
265
266
267
268
269
270
271
272
273
274
275
276
277
278
279
280
281
282
283
284
285
286
287
288
289
290
291
292
293
294
295
296
297
298
299
300
301
302
303
304
305
306
307
308
309
310
311
312
313
314
315
316
317
318
319
320
321
322
323
324
325
326
327
328
329
330
331
332
333
334
335
336
337
338
339
340
341
342
343
344
345
346
347
348
349
350
351
352
353
354
355
356
357
358
359
360
361
362
363
364
365
366
367
368
369
370
371
372
373
374
375
376
377
378
379
380
381
382
383
384
385
386
387
388
389
390
391
392
393
394
395
396
397
398
399
400
401
402
403
404
405
406
407
408
409
410
411
412
413
414
415
416
417
418
419
420
421
422
423
424
425
426
427
428
429
430
431
432
433
434
435
436
437
438
439
440
441
442
443
444
445
446
447
448
449
450
451
452
453
454
455
456
457
458
459
460
461
462
463
464
465
466
467
468
469
470
471
472
473
474
475
476
477
478
479
480
481
482
483
484
485
486
487
488
489
490
491
492
493
494
495
496
497
498
499
500
501
502
503
504
505
506
507
508
509
510
511
512
513
514
515
516
517
518
519
520
521
522
523
524
525
526
527
528
529
530
531
532
533
534
535
536
537
538
539
540
541
542
543
544
545
546
547
548
549
550
551
552
553
554
555
556
557
558
559
560
561
562
563
564
565
566
567
568
569
570
571
572
573
574
575
576
577
578
579
580
581
582
583
584
585
586
587
588
589
590
591
592
593
594
595
596
597
598
599
600
601
602
603
604
605
606
607
608
609
610
611
612
613
614
615
616
617
618
619
620
621
622
623
624
625
626
627
628
629
630
631
632
633
634
635
636
637
638
639
640
641
642
643
644
645
646
647
648
649
650
651
652
653
654
655
656
657
658
659
660
661
662
663
664
665
666
667
668
669
670
671
672
673
674
675
676
677
678
679
680
681
682
683
684
685
686
687
688
689
690
691
692
693
694
695
696
697
698
699
700
701
702
703
704
705
706
707
708
709
710
711
712
713
714
715
716
717
718
719
720
721
722
723
724
725
726
727
728
729
730
731
732
733
734
735
736
737
738
739
740
741
742
743
744
745
746
747
748
749
750
751
752
753
754
755
756
757
758
759
760
761
762
763
764
765
766
767
768
769
770
771
772
773
774
775
776
777
778
779
780
781
782
783
784
785
786
787
788
789
790
791
792
793
794
795
796
797
798
799
800
801
802
803
804
805
806
807
808
809
810
811
812
813
814
815
816
817
818
819
820
821
822
823
824
825
826
827
828
829
830
831
832
833
834
835
836
837
838
839
840
841
842
843
844
845
846
847
848
849
850
851
852
853
854
855
856
857
858
859
860
861
862
863
864
865
866
867
868
869
870
871
872
873
874
875
876
877
878
879
880
881
882
883
884
885
886
887
888
889
890
891
892
893
894
895
896
897
898
899
900
901
902
903
904
905
906
907
908
909
910
911
912
913
914
915
916
917
918
919
920
921
922
923
924
925
926
927
928
929
930
931
932
933
934
935
936
937
938
939
940
941
942
943
944
945
946
947
948
949
950
951
952
953
954
955
956
957
958
959
960
961
962
963
964
965
966
967
968
969
970
971
972
973
974
975
976
977
978
979
980
981
982
983
984
985
986
987
988
989
990
991
992
993
994
995
996
997
998
999
1000
<html>
<head>
<link rel="stylesheet" href="styles2.css" />
</head>
<body>
<p>![[Naval-Ep69.mp3]]</p>
<h2>Everybody Thinks They Already Have Good Judgment</h2>
<p><em>It takes years to know if you have good judgment</em></p>
<p>
<strong>Nivi:</strong> For the past few episodes, we talked about why you
should angel invest and how to get proprietary dealflow by building a
brand. Now let’s talk about judgment: how important it is and how to
develop it.
</p>
<p>
<strong
>Good entrepreneurs don’t want to be associated with bad
judgment</strong
>
</p>
<p>
<strong>Naval:</strong> In the long-term, having good judgment is
critical. Without it, you’ll end up with a bad portfolio; other investors
won’t back you; you’ll lose your money; and your brand will suffer. Good
entrepreneurs don’t want to be associated with bad judgment.
</p>
<p>
At the end of the day, judgment is the single most important thing. It’s
more important than access to deals and access to capital.
</p>
<p><strong>If you have poor judgment, you won’t know it</strong></p>
<p>
The problem with judgment: Everybody thinks they already have it. That’s
because your ability to assess your own judgment is subject to your level
of judgment.
</p>
<p>
If you have poor judgment, you won’t know it. This cognitive bias is
called the
<a
href="https://www.google.com/search?q=Dunning-Kruger+effect&rlz=1C1CHBF_enUS795US795&oq=Dunning-Kruger+effect&aqs=chrome..69i57.1403j0j7&sourceid=chrome&ie=UTF-8"
>Dunning-Kruger effect</a
>
after psychologists who popularized the idea. It’s also common sense.
People who are not that intelligent usually don’t know it. It’s partly an
ego defense mechanism.
</p>
<p>
<strong
>It takes five to 15 years to know if you have good judgment</strong
>
</p>
<p>
Furthermore, you might have good judgment in certain areas and poor
judgment in others. You might have good people judgment but lack market
judgment. The only way to know is to look over a long period of time.
Unfortunately, in early-stage investing it takes five to 15 years to
figure out if you have good judgment.
</p>
<p>
The first thing to do is be honest with yourself about your own judgment.
We’ll walk through a plan to calibrate and improve your judgment over the
long-term.
</p>
<h2>Judgment Gives You the Winning Lottery Numbers in Advance</h2>
<p><em>But you still need a portfolio effect to be successful</em></p>
<p>
<strong>Naval:</strong> At the seed stage, judgment is much more about
people judgment, product potential and market potential than your ability
to size up cashflows, customer acquisition costs or virality
metrics—because you don’t have much data.
</p>
<p><strong>Diversification is a hedge against lack of knowledge</strong></p>
<p>
When you have less data, you need a more diversified portfolio. In some
sense, diversification is a hedge against the lack of knowledge.
</p>
<p>
Warren Buffett can examine in detail a company that’s been around for 20
years. Judgment still applies, but he can pick one deal after doing
diligence on many. With seed-stage startups, you have very little data.
You might have to rely on other people’s judgment, which is why social
proof plays such a big role.
</p>
<p>
<strong
>Nobody has enough data to have high conviction at the
seed-stage</strong
>
</p>
<p>
To be successful in early-stage investing, you’re going to have to build a
portfolio, because nobody has enough data to have high conviction or
fool-proof judgment early on.
</p>
<p>
When he was posting as
<a href="https://twitter.com/startupljackson?lang=en">@StartupLJackson</a>
on Twitter,
<a
href="https://www.google.com/search?q=parker+thompson+investor&rlz=1C1CHBF_enUS795US795&oq=parker+thompson+investor&aqs=chrome..69i57.4094j0j4&sourceid=chrome&ie=UTF-8"
>Parker Thompson</a
>
wrote: “Everyone who invests after me is a spreadsheet jockey, and
everyone who invests before me is a dart-throwing monkey.” I thought that
was very appropriate.
</p>
<p>
Later-stage investors look at seed investors as making wild guesses. And
seed investors look at later-stage investors as spreadsheet jockeys.
</p>
<p>
But they’re just applying different levels and types of judgment, because
they have different data available to them. They’re going to have
different size portfolios and conviction because of the judgment they can
apply.
</p>
<p>
<strong>Judgment gives you the winning lottery numbers in advance</strong>
</p>
<p>
<strong>Nivi:</strong> Given the amount of luck involved at the seed
stage, how important is judgment?
</p>
<p>
<strong>Naval:</strong> Investing at the seed stage is like playing the
lottery—except that you can use your access and judgment to get some of
the winning numbers in advance. The better your judgment, the more numbers
you know in advance. This increases your odds, but you still need a
portfolio effect to be successful.
</p>
<p>
So it’s crucial to cultivate and hone your judgment. This is a long-term
game that will be played out over dozens—and eventually hundreds—of
investments.
</p>
<h2>Judgment Is the Work You Do Before a Deal Arrives</h2>
<p><em>Over time you’ll need less data to assess a deal</em></p>
<p>
<strong>Nivi:</strong> Given how quickly deals move, how much time do I
really have to apply judgment? Won’t I miss out if I take time to think
things through?
</p>
<p>
<strong>Naval:</strong> Judgment isn’t necessarily due diligence or even
thinking. Judgment is the preparation you do before a deal arrives so that
your subconscious can process it quickly.
</p>
<p>
<strong
>Early-stage investing is more about gut feel than due diligence</strong
>
</p>
<p>
Judgment for early-stage investing doesn’t involve extensive due
diligence. Yes, it’s smart to check references, talk to other people and
think it through. But that takes days, not weeks. Over time you will build
up a gut instinct, and you will require less and less data to assess a
deal.
</p>
<p>
You’ll know if a founder is credible by listening to them. You’ll know if
they come from a credible network, which means you can spend less
time checking references. You’ll know how customers in the space think and
you’ll develop a gut feel for what founders can sell them.
</p>
<p><strong>The best investors are immune to FOMO</strong></p>
<p>
Startups are now trained to run a tight, fast fundraising process. This is
especially true for startups coming out of accelerators. Some of them
pressure you hard to make a decision.
</p>
<p>
The best investors are immune to the
<a
href="https://www.google.com/search?q=FOMO+effect&rlz=1C1CHBF_enUS795US795&oq=FOMO+effect&aqs=chrome..69i57.424j0j7&sourceid=chrome&ie=UTF-8"
>FOMO</a
>
effect. If you push them to decide within 48 hours, they’ll say, “Well, I
don’t decide within 48 hours, so it’s not a fit for me.” They won’t look
at it, even if it’s a hot deal.
</p>
<p>
FOMO works on many investors—up to a point. I employ a 24-hour cooling off
period for deals I consider. Even after I decide to invest, I force myself
to wait 24 hours before moving forward.
</p>
<h2>Pivots Mean Your People Judgment Really Matters</h2>
<p><em>Bets on seed-stage startups are bets on founders</em></p>
<p>
<strong>Nivi:</strong> How is an investor supposed to know which companies
to invest in, given how much they can pivot?
</p>
<p>
<strong>Naval:</strong> Since companies often pivot, your people judgment
really matters. A pivot means keeping one leg in place and moving the
other one around. It’s not a jump or a leap into a completely different
industry.
</p>
<p>
Oftentimes a company pivots into an adjacent space, so it’s still
operating within the broader market. In that case, you’ll give more weight
to evaluating the team and execution and give less weight to the exact
product approach, assuming the market has enough room to pivot around.
</p>
<p>
The valuation should reflect that the company might go through pivots, and
the company’s cash burn and cash planning should, too.
</p>
<p>
<strong>Nivi:</strong> Here are some examples of soft and hard pivots:
Twitter started off as
<a
href="https://www.google.com/search?q=Odeo+twitter&rlz=1C1CHBF_enUS795US795&oq=Odeo+twitter&aqs=chrome..69i57.1887j0j7&sourceid=chrome&ie=UTF-8"
>Odeo</a
>; Instagram was
<a
href="https://www.google.com/search?q=insagram+burbn&rlz=1C1CHBF_enUS795US795&oq=insagram+burbn&aqs=chrome..69i57.2041j0j9&sourceid=chrome&ie=UTF-8"
>Burbn</a
>; Slack was
<a href="https://mashable.com/article/slack-glitch">Glitch</a>; and Lyft
was
<a
href="https://www.google.com/search?q=lyft+Zimride&rlz=1C1CHBF_enUS795US795&oq=lyft+Zimride&aqs=chrome..69i57.1783j0j7&sourceid=chrome&ie=UTF-8"
>Zimride</a
>. Uber started off with just black cars.
</p>
<p>
<strong>Naval:</strong> Uber’s move from black cars to shared rides wasn’t
a pivot; it was an extension. Zimride’s move from long-range shared rides
to short-range shared rides also was an extension—and a brilliant
innovation on their part.
</p>
<p>
Odeo to Twitter was a pivot, but it wasn’t a jump. It was a pivot from
podcasting to micro-blogging by the person who popularized blogging as we
know it,
<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&biw=849&bih=443&sxsrf=ALeKk03qGnRKPkq5VzFi-UL9NgzmK52xDA%253A1582846866334&ei=klNYXtmIFJL7-gSJxIPICw&q=Evan+Williams+twitter&oq=Evan+Williams+twitter&gs_l=psy-ab.3..0l6j0i22i30l4.3245.4318..4628...0.0..0.459.2648.0j3j5j0j2......0....1..gws-wiz.......0i67.zgfglNdlArs&ved=0ahUKEwjZmc6J9PLnAhWSvZ4KHQniALkQ4dUDCAs&uact=5"
>Evan Williams</a
>. It was a bet on a great individual who was staying within his space.
</p>
<p>
Burbn to Instagram was barely a pivot; it was more of a step. Now,
<a href="https://www.geni.com/">Geni</a> to
<a href="http://yammer.com/">Yammer</a> was a jump.
<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&sxsrf=ALeKk03woN4IpH3_oDeeBGZ6ubp28qUclw%253A1582835571084&ei=cydYXuHUBNfh-gTriIS4Dw&q=David+Sacks+&oq=David+Sacks+&gs_l=psy-ab.3..0l10.4440.4637..4950...0.0..0.149.439.2j2......0....1..gws-wiz.......33i299j33i160.iCHeOUmpJC0&ved=0ahUKEwih2s7_yfLnAhXXsJ4KHWsEAfcQ4dUDCAs&uact=5"
>David Sacks</a
>
is one of the greatest product designers we’ve ever seen. He was early at
<a href="https://www.paypal.com/">PayPal</a>, pivoted Geni into Yammer,
and ran <a href="https://www.zenefits.com/">Zenefits</a>. He was an early
investor in some of the greatest hits out there. Geni was a David bet,
similar to an Elon Musk bet. The people who bet on David would bet on him
all day long.
</p>
<p>
Glitch to Slack was another jump. Glitch was a gaming company, but
<a
href="https://www.google.com/search?q=Stewart+Butterfield&rlz=1C1CHBF_enUS795US795&oq=Stewart+Butterfield&aqs=chrome..69i57.325j0j7&sourceid=chrome&ie=UTF-8"
>Stewart Butterfield</a
>
had done something similar before. if I remember correctly. Even his first
hit, <a href="https://www.flickr.com/">Flickr</a>, had also been a jump of
sorts. People were investing in Stewart and hoping for the best—and he
delivered.
</p>
<p>But for every one of those, there’s 10 failures.</p>
<h2>Are Good Investors Piling in the Round with You?</h2>
<p>
<em
>It’s a sign of good judgment when proven investors pile into the
round</em
>
</p>
<p>
<strong>Naval:</strong> When you want to develop your judgment, the first
step is to calibrate it: Do I have good judgment or not?
</p>
<p>
It would be great if you could look at the results of your investments and
see if you were correct. But you won’t know for 10 or 15 years, and the
industry will have changed by then because it evolves and adapts quickly.
</p>
<p><strong>Look at markups in subsequent rounds</strong></p>
<p>
You can look at intermediate markups, noting when
<a href="https://www.sequoiacap.com/">Sequoia</a>,
<a href="https://a16z.com/">Andreessen</a> or
<a href="http://twitter.com/benchmark">Benchmark</a> invest in subsequent
rounds and pay higher prices. That’s an interesting metric, although it
really indicates your taste in what other tastes makers like.
</p>
<p>
It’s a
<a href="https://en.wikipedia.org/wiki/Keynesian_beauty_contest"
>Keynesian beauty contest</a
>
where each judge is rewarded based on what the judge in the next round
thinks. If your deals are marked up, it means you’re becoming a good
arbiter of future taste.
</p>
<p>
That kind of judgment is a <em>people proxy</em> mechanism; it’s not
really a way to build and calibrate your own judgment. Though it does have
value: If you can predict what VCs will fund, your companies have a better
chance of getting funded, which gives them a competitive advantage.
</p>
<p>
But being an arbiter of investor taste won’t help you with a deal like
Bitcoin, where it’s incredibly strange, nobody understands it and there’s
no subsequent round of VC funding to bet on. You have to make the decision
yourself.
</p>
<p><strong>Are good investors piling in the round with you?</strong></p>
<p>
You can also look at which investors follow you in the same round. If they
commit before you, it’s not a reflection of your judgement because you’re
probably keying off of them. But if good investors with proven judgment
pile into the same round after you, that is a reasonable indication of
good judgment.
</p>
<p><strong>Ask people about your weaknesses</strong></p>
<p>
Finally, you can ask people. Don’t ask them if you have good judgment or
not, because polite people will always tell you yes. Rather, ask them
about your weaknesses. Of course, only ask people if they have good
judgment themselves.
</p>
<h2>Judgment Requires a Willingness to Be Unpopular</h2>
<p><em>Groupthink leads to poor judgment</em></p>
<p>
<strong>Naval:</strong> People with good judgment tend to demonstrate it
in all aspects of life.
</p>
<p>
They are well read, think critically and hold a broad range of ideas and
opinions, including conflicting ones. People with good judgement are
humble and have a relatively low ego, so they don’t get too attached to
earlier decisions. They constantly question themselves.
</p>
<p>
Often, they have scientific or other technical training and work in
industries where they deal with real-world, consequential feedback and not
just what people think of them.
</p>
<p><strong>Groupthink leads to poor judgement</strong></p>
<p>
People with good judgement are willing to be unpopular. The clearest
thinkers work from the ground up and use first principles in their
reasoning. They end up relying on their own authority.
</p>
<p>
Things that lead to poor judgment: groupthink, over-socialization of
judgment and picking things because they are politically or socially
popular. Lots of people lose money in this business chasing things they
wish were true, as opposed to what actually turns out to be true.
</p>
<p>
The “<a
href="https://www.google.com/search?q=paypal+mafia&rlz=1C1CHBF_enUS795US795&oq=paypal+mafia&aqs=chrome..69i57.2126j0j7&sourceid=chrome&ie=UTF-8"
>PayPal mafia</a
>” is famous for being insular. They all have good judgment, they’re all
strange and politically incorrect—and they’re all brilliant. They’re not
afraid to hold unpopular views, and they value each other’s insights and
judgment.
</p>
<p>
Whatever people say about
<a
href="https://www.google.com/search?q=Peter+Thiel+investor&rlz=1C1CHBF_enUS795US795&oq=Peter+Thiel+investor&aqs=chrome..69i57.2502j0j7&sourceid=chrome&ie=UTF-8"
>Peter Thiel</a
>, no one wants to go head-to-head with him in a debate because he’s
brilliant and a contrary thinker. He’s a first principles thinker from the
ground up.
</p>
<p>
If you surround yourself with brilliant, contrary and first principles
thinkers, you will develop extremely good judgment; however, you may not
end up very popular.
</p>
<h2>The Best Deals Look Weird</h2>
<p><em>You want to be right when everybody else is wrong</em></p>
<p>
<strong>Naval:</strong> In investing, you want to be
<a href="https://spearhead.co/non-consensus">non-consensus right</a>. You
want to be right when everybody else is wrong. If you’re right when
everybody else is right, you won’t make enough of a return. If you’re
wrong, you won’t make any return.
</p>
<p>
<strong
>The best deals have something broken, strange or different</strong
>
</p>
<p>
The best deals are weird. They always have something broken, strange or
different about them.
</p>
<p>
They’re socially unacceptable, outside the norms of venture capital or too
niche to be interesting. The founder doesn’t fit the normal mold, or
they’re in the wrong city. Or they have a cap table problem. And so on.
</p>
<p>
That doesn’t mean you should only invest in weird deals. It’s like the old
saying, “<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&sxsrf=ALeKk02aRt6ofKE8B7EQYM-X4UNoE92soA%253A1583343567877&ei=z-dfXub8NNSxtQbVub7QDA&q=There%25E2%2580%2599s+a+fine+line+between+genius+and+madness&oq=There%25E2%2580%2599s+a+fine+line+between+genius+and+madness&gs_l=psy-ab.3...47204.50244..50589...0.2..0.169.887.3j5......0....1..gws-wiz.......0i71j33i160j0i22i30.xM5b_gkxOs4&ved=0ahUKEwimoK63roHoAhXUWM0KHdWcD8oQ4dUDCAs&uact=5"
>There’s a fine line between genius and madness.</a
>” The genius and madman both seem crazy until the genius is validated.
One out of 100 turns out to be a genius; the other 99 turn out to be
crazy.
</p>
<p>
You have to be iconoclastic enough to recognize genius founders without
being so low in judgment that you let in all the crazy ones too.
</p>
<p><strong>Patri Friedman is making weird investments</strong></p>
<p>
The way portfolios are constructed, you may be better off investing in a
lot of crazy deals than a lot of decent looking deals.
</p>
<p>
To give a recent example:
<a href="https://twitter.com/patrissimo">Patri Friedman</a> started a fund
called <a href="https://www.pronomos.vc/">Promonos Capital</a>. He’s
investing in experiments in governance: new city states, towns and
localities. These are places where people are taking local government into
their own hands and doing experiments in governance.
</p>
<p>
This seems impossibly difficult to do. The history with
<a
href="https://www.google.com/search?q=Seasteading&rlz=1C1CHBF_enUS795US795&oq=Seasteading&aqs=chrome..69i57.594j0j7&sourceid=chrome&ie=UTF-8"
>seasteading</a
>
in Honduras doesn’t look great. But all you have to do is stumble into the
next Singapore or Hong Kong—whether it’s virtual or physical—and you have
something that can create trillions of dollars in wealth and change the
way people live.
</p>
<p>
Promons benefits from two things. First, they have a unique brand because
nobody else is doing that. Everybody interested in this space knows to go
to them. Second, the vast majority of their investments are going to look
mad—but the few genius outliers should have huge returns because they’re
non-consensus investments.
</p>
<p>
Similarly, <a href="https://foundersfund.com/">Founders Fund</a>,
<a href="https://twitter.com/FutureJurvetson">Steve Jurvetson</a> and a
variety of other people built their brands by being willing to fund weird
deals long before anybody else.
</p>
<h2>You Can Give Every Deal One Fatal Flaw</h2>
<p><em>A startup that breaks all the rules won’t get anywhere</em></p>
<p>
<strong>Naval:</strong> You can give every deal one fatal flaw: the thing
that traditional venture capitalists will use as their excuse to pass on
the deal. If there’s more than one flaw, you have to worry.
</p>
<p>
<strong>A startup that breaks all the rules won’t get anywhere</strong>
</p>
<p>
Startups are rewarded for innovating on something new. If you invest in a
startup that’s trying to innovate on things that already work—such as team
structure or founder mentality—you’re just taking on additional risk.
</p>
<p>
You have to use your judgment to figure out when a startup can break the
rules and when they can’t. A startup that follows all the rules probably
won’t be interesting. A startup that breaks all the rules won’t get
anywhere, because they have to reinvent everything from scratch.
</p>
<p>
Uber was strange when it first came along, because investors considered it
a taxi business and they didn’t invest in offline industries back then.
</p>
<p>
To them it looked like the app was 5% of it and the other 95%
was people driving cars—and they were correct. The question, though,
is how much leverage accrues to the company that owns the app and how much
can they expand the market with the app by introducing new products,
attracting new customers and creating convenience.
</p>
<p>
Google was strange because everyone thought the search wars had already
been won by the time they showed up.
</p>
<p>
<strong
>Breaking the rules is easier when you understand technology</strong
>
</p>
<p>
To know which rules to break, it helps to understand technology. As an
investor, the best position is this: Others pass on a deal because they
don’t understand the technology, and you have enough technical insight to
know it’s feasible. Then, you have to make sure you can get it funded to
the point where it’s obvious to everybody.
</p>
<p>
The value comes in breaking the “rule” that you know isn’t a rule, while
everyone else thinks it is.
</p>
<h2>You’ll Get Less Money in Your Winners</h2>
<p><em>Always try to get your standard bite-size in a deal</em></p>
<p>
<strong>Naval:</strong> It’s easy to overestimate your own judgment. It’s
perfectly OK to say, “I don’t know.” That should be your answer most of
the time.
</p>
<p>
There’s only a few deals where you should say, “I have conviction.” And,
even then, be careful how much conviction you have.
</p>
<p>
At the seed stage, if you put a lot of money into one company and very
little into another, that begs the question: “Do you really have
conviction, or do you simply have better access to one deal?”
</p>
<p>Generally, the better the deal, the less access you’ll have.</p>
<p><strong>Always try to get your standard bite-size</strong></p>
<p>
If you put a lot of money into a few deals and little money into many
others, you’ll find that your winners tend to come disproportionately out
of the deals with little money invested. And that will hurt your portfolio
return.
</p>
<p>
Once you have conviction, always try to get your standard bite into that
deal. If a deal has too much space for you, that means: Either you should
invest more in other deals or less in this one, or you should get rewarded
with a lower valuation because you’re creating the signal that the company
will use to raise the bulk of the money.
</p>
<p><strong>Anyone chasing hot markets gets killed</strong></p>
<p>Anyone in this business who’s chasing hot markets gets killed.</p>
<p>
If you started seed investing when the consumer social market was hot, the
market was done by the time your investments matured.
</p>
<p>
If you invested in the masses of food delivery companies that showed up
once it became obvious Uber was winning—if you invested in companies five
through 50—you lost your money.
</p>
<p>
If you invested in crypto in 2017, you hit the tail end of the market; the
early side was 2009 to 2015.
</p>
<p>
Today, SaaS is hot. It’s a proven moneymaker. Let’s see how it plays out.
When current seed-stage SaaS investments mature in five to 10 years, you
may find the returns are a lot lower than they are today. It’s good to be
at the beginning of a market—not at the tail end. By the time you see
conferences about it and read <em>TechCrunch</em> articles about it, it’s
probably too late.
</p>
<h2>Don’t Fantasize About What You Would Do If You Were the Founder</h2>
<p><em>You’re not running the company—you’re betting on the founder</em></p>
<p>
<strong>Naval:</strong> A common trap for investors—especially if you’re
an entrepreneur—is to fantasize about the things you could do with the
company if <em>you</em> were the founder. You’ll learn the painful lesson
that it’s actually the entrepreneur who’s running the company.
</p>
<p>
It’s important to listen carefully and take the founder at their word
about what they plan to do. Don’t get caught up in the idea that somebody
else is going to run the company.
</p>
<p>
Angel investing is the opposite of value investing. Warren Buffett says,
“<a href="https://quoteinvestigator.com/2010/05/31/any-idiot-can-run/"
>Buy into a business that’s doing so well an idiot could run it, because
sooner or later, one will</a
>.” That’s not the case with startups.
</p>
<p>
With most startups, almost all the value creation happens while the
founder is intimately involved. So you’re betting on the founder.
</p>
<p>
If you bet on a founder you’re not excited about even though you’re
excited about the market or product, often the founder will fumble the
company or a competitor will come along with a much better founder. When
that happens, either you’ll be conflicted from investing in the new
company or the new founder won’t want to talk to you because you invested
in a competitor.
</p>
<h2>Invest in the Smartest Scientists in a New Field</h2>
<p>
<em
>You’re not going to become a great tech investor by reading
TechCrunch</em
>
</p>
<p>
<strong>Naval:</strong> There are many ways to build good judgment. The
timeless kind of judgment—good decision-making and the ability to size
people up—comes with experience. You can develop it by reading great works
at the intersection of science, business and philosophy. Read books that
cover how smart people think. Build so-called “<a
href="https://fs.blog/mental-models"
>mental models</a
>” and develop an understanding of microeconomics, mathematics and game
theory.
</p>
<p>
<strong
>You’re not going to become a great investor by reading
TechCrunch</strong
>
</p>
<p>
You can build <a href="https://nav.al/finding-time">timely</a> specific
knowledge in a field by diving in and learning everything you can about
it, as quickly as possible.
</p>
<p>
You won’t become a great tech investor by reading about technology on
<em>TechCrunch</em> or <em>Bloomberg News</em>. You have to go to the
source. You shouldn’t hesitate to read scientific papers and journals. You
should brush up on your mathematics. You should genuinely enjoy the act of
learning science and technology. After all, technology is applied science.
</p>
<p><strong>Invest in the smartest scientists in a new field</strong></p>
<p>
You can also develop good judgment by investing in the smartest scientists
and technologists in the space. Even if they don’t make you money, they
can perform due diligence for you on deals. They can validate and
calibrate deals for you, and they can send other great scientists your
way. Perhaps you’ll make them advisors to your fund, give them a piece of
your carry, or let them invest with you.
</p>
<p>
I did this early on, when I invested in cryptocurrency companies. I became
friends with
<a
href="https://twitter.com/zooko?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Zooko Wilcox-O’Hearn</a
>, who started <a href="https://z.cash/">Zcash</a>;
<a
href="https://twitter.com/juanbenet?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Juan Benet</a
>, who started <a href="https://filecoin.io/">Filecoin</a>;
<a
href="https://twitter.com/ryaneshea?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Ryan Shea</a
>
and
<a
href="https://twitter.com/muneeb/status/1238266251438407680?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Etweet"
>Muneeb Ali</a
>, who started <a href="https://blockstack.org/">Blockstack</a> together;
<a href="https://twitter.com/bramcohen?lang=en">Bram Cohen</a>, who
started <a href="https://www.bittorrent.com/">BitTorrent</a>;
<a href="https://twitter.com/elibensasson?lang=en">Eli Ben-Sasson</a>; and
<a
href="https://twitter.com/socrates1024?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Andrew Miller</a
>. They became my go-to people for vetting and validating deals. They told
me which technologies were real and which ones weren’t; and which
scientists were credible and which ones weren’t.
</p>
<p><strong>Scientists and technologists are a secret weapon</strong></p>
<p>
If you surround yourself with top scientists and technologists, they will
become your secret weapon. They tend to be no bullshit—they’ll tell you
exactly what they think of a new technology. And they’ll refer you to
their networks.
</p>
<p>
You’ll need to use your own judgment to decide when they’re being
unnecessarily negative or jealous, because that’s human nature. Overall,
very technical people tend to be extremely objective. They’re used to
corresponding with the real world and scientific results, rather than
people who are influenced by subjectivity.
</p>
<p>
If you can find a group of painfully honest and distinguished scientists
and technologists, that will be a secret weapon throughout your investing
career.
</p>
<h2>Invest Only in Technical Teams</h2>
<p>
<em>If there’s no technical team, you’re not investing in technology</em>
</p>
<p>
<strong>Nivi:</strong> Let’s discuss how judgment applies to evaluating
teams, product and market, traction, and social proof.
</p>
<p><strong>Every great founding team has a great technologist</strong></p>
<p>
<strong>Naval:</strong> This is the <em>technology</em> business; you want
to invest in <em>technology</em> teams. Every great tech startup is highly
likely to have a great technologist on its founding team. If they aren’t
the most important member of the team, the technologist must be
sufficiently compensated and motivated. Their name and accountability must
be critical to the project.
</p>
<p>
If there’s no strong technical person on the founding team, either it’s
not a technology business or the company has outsourced that
function—which is not just a yellow flag; it’s a red flag. For
example, I don’t consider
<a href="https://www.dollarshaveclub.com/">Dollar Shave Club</a> a
technology business.
</p>
<p>
Of course, you can make money investing in non-technology businesses like
Dollar Shave Club or Chipotle, but that’s not what we’re talking about
here.
</p>
<p><strong>If you’re not building, you’re selling</strong></p>
<p>
Anyone on the founding team who’s not highly technical should be great at
selling: to end users of the product; to investors while raising money;
and to potential employees to recruit talent.
</p>
<p>
A <em>community builder</em> is another character that can be incredibly
useful, though good ones are rare. They sell, too. Only, they’re good at
mass sales instead of one-on-one sales. Like growth hackers, they’re a
unique combination of building and selling.
</p>
<p>
Great community builders are high leverage, but they’re also extremely
difficult to find. They’re probably the rarest thing right now. Everyone
claims they’re good at community building, but you need to see the
results.
</p>
<h2>You’re Not Investing in Nice People</h2>
<p>
<em>Invest in people with high energy, intelligence and integrity</em>
</p>
<p>
<strong>Naval:</strong> I use Warren Buffett’s
<a href="https://nav.al/intelligence-energy-integrity">three-part test</a>
for qualities you want in a partner: high energy, high intelligence and
high integrity.
</p>
<p><strong>Startups are the Olympics of business</strong></p>
<p>
High energy is obvious. You have to work hard, because startups are the
Olympics of business and you’re competing against the best in the world.
To paraphrase “<a
href="https://en.wikipedia.org/wiki/Glengarry_Glen_Ross_(film)"
>Glengarry Glen Ross</a
>”: first prize gets a Cadillac Eldorado; second prize gets a set of steak
knives; and third place gets fired. If you’re going to win, you need
people who put in everything.
</p>
<p>
There’s a meme on Twitter that you should work 9 to 5 all the time, and
that’s work-life balance. That’s fine; not everybody should kill
themselves at work. But then I’d argue that you shouldn’t be an Olympic
athlete or a founder of a winner-take-all technology startup.
</p>
<p>
If you’re doing a startup, you and the rest of the core team will have to
work your tails off.
</p>
<p><strong>Be a snob about intelligence</strong></p>
<p>
High intelligence is important, because you need good decision-makers.
Intelligence isn’t just about broad judgment; it’s also about
moment-to-moment judgment.
</p>
<p>
If you invest in people who aren’t of the same intellectual caliber as
you, then you’re essentially investing down, talking down and thinking
down. You’re picking the wrong people.
</p>
<p><strong>Integrity gets tested when the stakes are high</strong></p>
<p>
High integrity is critical. If you don’t have that, you end up with a
smart and hardworking crook who can easily cheat you—and there’s so many
ways to get cheated in this business.
</p>
<p>
Integrity takes a long time to figure out. It’s hard to assess someone’s
integrity if you haven’t worked with them for a long time, which will be
the case with most founders. You can observe how they treat people around
them, including prospective investors~~,~~ co-founders and employees.
Someone who self-deals with others eventually will cross you.
</p>
<p>
Founders don’t necessarily need to be nice people. Niceness is a signal
that’s easily faked. It’s not enough of a filter. Technical people tend to
know that, so they don’t overemphasize niceness. It may be important to
you, because you’ve decided it’s more enjoyable to work with someone who’s
nice. But there are plenty of successful business people who are not nice.
</p>
<p>
Seek integrity over niceness. Integrity means living up to an internal
moral code of ethics. It’s being reliable and honest. Niceness often is
just politeness or someone sending off signals that they have integrity
when the stakes are low. Integrity gets tested when the stakes are high.
</p>
<h2>Coachability Is Overrated</h2>
<p>
<em>Great founders listen to lots of advice and follow little of it</em>
</p>
<p>
<strong>Naval:</strong> There’s a meme among venture
capitalists—especially inexperienced ones—that a good founder should be
coachable. These investors rely too much on their own abilities, thinking
they’re right and founders are wrong.
</p>
<p>
Inexperienced investors also rely too much on the idea that you can change
people in the short-term. Experienced investors know this isn’t the case.
</p>
<p>
In fact, great founders aren’t that coachable. They listen to lots of
advice, but they follow very little of it. They develop their own internal
compass. So I believe that coachability is an overrated metric.
</p>
<h2>Your Reputation Is Built by the Companies That Are Doing Poorly</h2>
<p>
<em
>Don’t invest so much that you’ll behave badly when things get rough</em
>
</p>
<p>
<strong>Naval:</strong> Angel investors tend to be on the tough side when
they get started, especially when investing a lot of their own money.
</p>
<p>
Generally, you don’t want to invest money that you’re not OK losing. If
you have too much at risk in any deal, you’ll engage in bad behavior when
things get rough. When the company performs poorly, you’ll behave poorly.
Emotionally, you won’t be able to help it, and it’ll damage your
reputation.
</p>
<p>
<strong
>Your reputation is built by the companies that are doing poorly</strong
>
</p>
<p>
Your reputation gets built in those moments. Your <em>returns</em> get
built by the companies that are doing well. Your <em>reputation</em> gets
built by the companies that are doing poorly.
</p>
<p>
In the long term, your returns also depend on your access. And your access
depends on how you behaved with founders when companies were doing poorly.
</p>
<p>
As a consequence, you never want to have too much at risk. So don’t put
down so much that you care.
</p>
<h2>Founders Almost Can’t Be Referenced</h2>
<p>
<em
>A founder who’s great for one business may be terrible for another</em
>
</p>
<p>
<strong>Naval:</strong> Some angels insist on checking references of
founders. This can work if you know what you’re doing, but reference
checking is an art that most people haven’t mastered.
</p>
<p>
Founding a startup is an act of creativity. If you think of the great
writers, philosophers and artists throughout history, honest references
would tell you they’re all crazy.
</p>
<p>
Founders are non-fungible; they’re irreplaceable. A founder who’s great
for one business may be terrible for another. The founder who can build
Craigslist—community-oriented, extremely patient and almost
anti-capitalistic—won’t work for a financial startup that’s racing to
raise and deploy lots of capital while pitching banks and regulators. So,
it’s the right founder for the right job.
</p>
<p>
References tend to be generic. They don’t work as well for assessing
founders as they do for hiring employees, where you’re looking for someone
to scale processes that already work.
</p>
<p><strong>I passed on Twilio because of a reference</strong></p>
<p>
I passed on <a href="https://www.twilio.com/">Twilio</a> in the seed round
because of a reference—big mistake. The reference came from somebody I
trusted who had good intentions. It was probably even accurate, but that
was beside the point. I should have gone with my gut feeling that
<a
href="https://twitter.com/jeffiel?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Jeff Lawson</a
>
was the right founder for the job.
</p>
<p>
I also passed on <a href="https://ethereum.org/">Ethereum</a> very early
because of a reference from a VC who was active in the space. The
reference dissuaded me in a way that it shouldn’t have—though I clued into
that one later.
</p>
<p><strong>References can devolve into checklists</strong></p>
<p>
References from VCs are among the worst type. For every deal a VC does,
other VCs passed on that very same deal.
<a href="https://www.sequoiacap.com/">Sequoia</a> does a lot of deals that
<a href="https://a16z.com/">Andreessen</a> has passed on, and vice versa.
This goes up and down the chain.
</p>
<p>
The best deals aren’t always chased by the best VCs. In this market,
everyone has their own unique point of view, and the good players have
<em>very</em> independent points of view.
</p>
<p>
References can devolve into checklists: “I better check the box that I’ve
done all these references.” Or, if you do listen, your point of view
becomes a smeared average, diluted by what other people think.
</p>
<h2>Avoid Teams That Would Sell Early</h2>
<p><em>Venture capital is a grand slam business</em></p>
<p>
<strong>Naval:</strong> Angel investing is a game of exceptional outcomes;
it’s not a game of averages. You’re better off with a portfolio in which
nine out of 10 investments go to zero and the 10th one goes 1,000x, than a
portfolio where all of them are 2x or 3x.
</p>
<p>
If a founding team hints, signals or even just <em>appears</em> likely to
sell the company early, it’s a strong negative indicator. Teams that are
overly financially motivated often will sell a company for $100M or
$200M. That’s a life-changing outcome for them; but it doesn’t
matter much to you because you own so little. It’s not going to move the
needle on your net worth.
</p>
<p>
As Bill Gurley famously said, “<a
href="https://www.google.com/search?client=safari&rls=en&q=%25E2%2580%259Cventure+capital+is+not+even+a+home-run+business;+it%25E2%2580%2599s+a+grand-slam+business.%25E2%2580%259D&ie=UTF-8&oe=UTF-8"
>Venture capital is not even a home run business. It’s a grand slam
business.</a
>” The smart VCs look for extreme outliers.
</p>
<p>
This is why smart VCs let founders sell
<a
href="https://medium.com/@rizstanford/secondary-sales-in-vc-backed-startups-a-quick-primer-for-entrepreneurs-bdc25ea7f39a"
>secondaries</a
>
early on. They take some money off the table in exchange for going for the
gold.
</p>
<p>
When you invest in a company that is going to sell early, you miss out on
compounding interest. Also, VCs downstream will read that signal and pass
on that deal, and the startup won’t be able to raise the cash they need to
become a big company.
</p>
<p>
It’s difficult to pull this signal out of founders, although sometimes
they offer it.
</p>
<h2>‘First-Time Founders’ Often Have Been Tinkering for Quite a While</h2>
<p><em>Their ‘first’ startup isn’t always their first startup</em></p>
<p>
<strong>Naval:</strong> There’s a running debate among investors about
which is best: first-time founders or repeat founders. There’s no hard and
fast answer.
</p>
<p>
I’d argue that most of the value in the industry is probably created by
first-time founders. Think of Jeff Bezos, Bill Gates, Larry Page and
Sergey Brin, and Mark Zuckerberg: Lightning strikes, things catch fire and
the company takes off.
</p>
<p><strong>‘First-time founder’ can be misleading</strong></p>
<p>
Though, the label “first-time founder” doesn’t really apply to some of
these. Zuckerberg had other projects before Facebook took off. Gates
founded
<a href="https://en.wikipedia.org/wiki/Traf-O-Data">Traf-O-Data</a> with
Paul Allen long before they did Microsoft. They measured traffic and sold
the data to cities.
</p>
<p>
Often, a so-called “first-time founder” has been tinkering for quite a
while.
</p>
<p><strong>Repeat founders tend to be better at execution</strong></p>
<p>
Repeat founders also can be extremely successful. Look at Uber, WhatsApp
and Zoom.
</p>
<p>
Repeat founders tend to be much better at execution. They’re good at
recruiting teams and generally more careful about what markets they enter.
Repeat founders also have better connections, which makes fundraising
easier.