On Hype And Hot Air

Introducing Retrospection Into The Hype Cycle

May 20, 2023

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If you haven’t watched Breaking Bad, or the prequel show, Better Call Saul, then you should. They're both exceptional shows, one exploring an apparent good guy, who is actually bad. And an obvious bad guy, who underneath is just trying to be good.

In one episode of Better Call Saul, you see one character asking a number of key characters throughout the show what they would do if they had a time machine. Each of them talk mostly about regrets; things they would change. The final conversation ends with this line: "If you don't like where you're heading, there's no shame in going back and changing your path."

For most people, reflecting on the past only really invokes pride, or pain. One of my least favorite genres of clickbait is what I sometimes call "regret porn." It's this almost self-inflicted regret of "what if you had done this? What if you had done that?"

But as powerful as the pain or pride that reflection can cause you, it is almost never coupled with instruction. Investing is meant to be one of the most learning-heavy disciplines precisely because we don't have a time machine. We can't live the same markets or opportunities over again, so all we can do is learn from it. But investing is so often mired in rewritten history and unlearned lessons.

The Lessons To Learn, And The Lessons To Leave

When I turned 19, my brother gave me a printed and bound copy of a book of quotes he had collected in his life. For some reason, one Mark Twain quote has always stuck with me and seems to crop in the unlikeliest of places in my life:

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and that is well but also she will never sit down on a cold one anymore.”

Reflecting back on history is not meant to teach you the lesson "if only I had put $1,000 in Amazon!" It's meant to teach you, "what made Amazon so special that putting in just $1,000 would have been such a boon?"

I've written before about an exercise called a post-mortem. In that post, I made this specific post about when things go wrong in investing:

"The less time people spend with failure the less comfortable with it they become. They develop an aversion to the very concept of correction. Acknowledging that something went wrong is to acknowledge that there is blame to be dished out. Particularly in investing there is a lack of easy attribution, both for success and failure, and careers are made or broken based on an investor's ability to take credit for success and avoid association with failure."

For most investors and firms, there is so much hanging on that last idea. As a VC, your job is to associate yourself with as much success as possible (even if you had nothing to do with it) and to avoid failure like the plague (even if it was 100% your fault). Why?

Venture funds, contrary to the marketing framework they like to reinforce, are not long-term thinkers. They’re a collection of short-term careerists focused on maximizing the amount of success they’re associated with. As an individual investor, your economic interests are not as easily connected to long-term success, but instead short-term performance.

I've heard a half dozen stories of younger partners who will make a bet on a company, and senior partners will take them aside and give the same general advice (if you can call it that). "This deal had better work out, or you're through."

What about 10 year funds? What about long-term partners? What about the power law? And portfolio theory? One deal could make or break you? That's right. It could make or break you. Not necessarily your entire firm. But venture partnerships are incentivized to not let dead weight continue to suck up their economics.

So where's the opportunity for learning?

Failure By Association

This week I've seen the desire for retrospection come up several times. The first was from Sar Haribhakti. In addition to being the inspiration for my writing this week, the comments on this post are also where I got the title for this week's piece from Tom White.

Next, I saw a similar sentiment from Michael Dempsey at Compound. Side note: Compound is a firm I have huge respect for because they tout themselves specifically as a "thesis-driven, research-centric investment firm." They do a good job of putting their thinking on the line, and letting the chips fall where they may.

Both of these requests are slightly different, but the core is the same: "I wish more VCs would articulate what they thought was right, why they got it wrong, and what they learned from it." There are certainly isolated instances where a VC might reflect on something in a blog post. But there is rarely an entire overview, and certainly not when the VC is still invested in companies that were the result of that thesis.

Some people point to LP's who incentivize transparency as a potential driving force. But that isn't really a thing. LPs might say they like transparency, but often their behavior is similar to the short-termism that VCs themselves employ. I guarantee you there were funds rewarded by LPs for getting "access" to FTX before it blew up. Performance didn't matter. It was access, and clout, and signal.

Other people pointed to resources like Bessemer's Anti-Portfolio where they "honor the companies we missed." Certainly an interesting collection, but it has elements of reverse-pride. "Look at all the great companies we saw, even though we missed them."

To acknowledge fault of action vs. fault of omission takes a lot more gumption. And one question is: does anyone do this? Are there capital allocators that can comfortably step back and say what they got wrong?

Transparency Is A Long-Term Game

As most often do when they start talking about long-term investing, we can turn to the 92-year old Oracle of Omaha for guidance. Let us commune with the commodore of Coke and candy.

When I first started thinking about an example of Warren Buffett acknowledging, "I got that wrong," I thought about his admission of the weakness of the textiles business. Or short-term corrections in insurance markets. But what I didn't realize was how often Buffett is acknowledging his mistakes.

One really interesting analysis from Justin Fox at Bloomberg looked at all the times in all of Buffett's annual letters he had used the word "mistake." You can almost see a statistical correlation between how often he's admitting mistakes and his investment performance.

One of the best introductions to Buffett's philosophy on mistakes comes from the 1985 Berkshire Hathaway annual letter:

"Our Vice Chairman, Charlie Munger, has always emphasized the study of mistakes rather than successes, both in business and other aspects of life. He does so in the spirit of the man who said: “All I want to know is where I’m going to die so I’ll never go there.” You’ll immediately see why we make a good team: Charlie likes to study errors and I have generated ample material for him, particularly in our textile and insurance businesses."

So how is it that Warren Buffett can acknowledge he's made a mistake 100+ times in 46 years? Mistakes like selling McDonald's in the late 90's, getting into textiles or the shoe business (especially when he bought the failing shoe business with Berkshire stock), or turning down a $35M NBC station that ended up being worth $800M. Meanwhile, every VC can say 2021 got crazy but can rarely say "we made a mistake investing in that company at a $2B valuation for $3M of revenue, or even other world-class capital allocators, like Jeff Bezos, who only ever really acknowledged he made a mistake 3 times in 24 years.

I've written before about the power of Buffett's brand of marketing. I've never heard it summed up better than by Morgan Housel in an interview wit David Perrell:

"I think Warren Buffett and Howard Marks were really the forerunners for all of this. They were not just giving their investors more information, but they were using their ability to communicate as a bridge towards trust. And that’s really what it was.

So many investors will say 'Oh I went back and read Warren Buffet’s letters to shareholders and they’re so enlightening.' I think, for the most part, there’s actually not that much technical information in there that most people didn’t already know. If you have a finance background, you understand a free cash flow and value and margin of safety. You get all of that. But Buffett’s letters instilled the sense of like subconscious trust. The way Buffett describes things gives you this view of: 'Hey, you’re not trying to screw me.' Buffett and Marks more or less had permanent capital because their investors trusted them. And because of that trust, all these other hedge fund managers and private equity managers that during a bear market, their investors would have said, “I don’t trust you anymore. I’m out of here. Give me my money back.”

But investors didn’t do that for Buffett or Marks, and that’s a massive competitive advantage right there. So put all that together. Buffett and Marks used content to instill trust, trust gave them permanent capital, and permanent capital gave them a massive financial advantage over other investors."

In short: Communication + Transparency = Trust; Trust + Permanent Capital = Ability To Compound Long-Term.

You might think about venture capital as long-term capital. But again, just because venture funds have 10-year lifecycles, most investors are battling the trust of their colleagues more than the longer-term view of their funds or LPs. If your partners don't trust you, then you won't stick around to take advantage of long-term compounding.

And most VC partners are making decisions, not based on long-term performance, but on short-term activity. As a result, that makes it very difficult to acknowledge mistakes without damaging one individual career.

A Prepared Mind

One of the most powerful benefits of building retrospection into your process is the ability to develop a more "prepared mind." This concept is common, but one venture firm really focused on building it into their process: Accel.

In the book "The Power Law," there is a great explanation of Accel's approach to developing a prepared mind:

"Accel embraced an approach that it came to call 'the prepared mind.' Rather than looking anywhere and everywhere for the next big thing, the partnership carried out management-consultant-style studies on the technologies and business models that seemed to hold promise.

[Arthur Patterson] read widely, theorized fluently, and wrote a series of internal papers codifying the Accel approach. It was he who had come up with the Accel watchword, 'prepared mind,' having borrowed it from the nineteenth-century father of microbiology, Louis Pasteur. 'Chance favors only the prepared mind,' Pasteur had observed sagely."

The best illustration of the prepared mind at Accel being honed and fine-tuned came in the age of Internet 2.0 alongside social media. One of Accel's partners got super excited about Skype, but for a number of reasons the investment was considered "too weird" for them to pull the trigger. Pretty soon they were looking at a missed 100x return.

"'There were some colleagues who said we should have locked the Skype guys in a room and not let them out until they signed. There was a lot of frustration within the partnership.' But the good news was that Accel’s distinctive culture gave it a way of processing its miss. It could build on the prepared-mind exercise."

That willingness to be frustrated and reflective on the Skype miss led to Accel's "prepared mind" going into a conversation with a then-upstart social network: Thefacebook.

"Relative to the traditional user benchmarks he remembered from those days, the engagement that Thefacebook claimed was astonishing. Moreover, everything about this meeting followed the script laid out in the prepared-mind exercises of the past two years. Thefacebook’s founders were unorthodox and elusive... But if you ignored their conduct and focused instead on their data, Thefacebook was a can’t-miss opportunity."

Accel invested $10M in Facebook at an $80M valuation. When Facebook went public in 2012, Accel saw a $12B return. You could argue that missing out on the Skype investment was a capital cost to develop the prepared mind necessary for investing in Facebook.

What Does This Mean For Venture Capital?

I don't have a great answer to this question this time. There are a number of implications. I've written before about the business model and incentive systems of venture capital that cause some of these allergies to reflection.

There are some micro implications. The first is that everyone, in every job, should strive to find a way to learn from past mistakes. I've been in firms that had passed on Coinbase, Airbnb, Spotify, Atlassian, Snowflake, and Datadog, but would rather avoid talking about those things than reflect on them. That leads to a propped up mind, not a prepared mind. Each firm can choose to be different.

On the macro, though, its a much more complex question. Venture capital, as currently constituted, is a very difficult organism to establish with legitimate long-term focus. Berkshire Hathaway is a perfect alignment of incentives. Warren Buffett's salary has been $100K for 40 years—no bonus, and no stock awards. Buffett's $100B+ net worth is almost entirely made up of the appreciation of his Berkshire Hathaway stock that he has purchased.

Models that rely heavily on the interplay between a limited number of trusted partners, like Benchmark, is maybe one way to come close to avoiding the perverse incentives of hyperactivity. But it's quite difficult in venture capital to be open and honest about the mistakes you make. Part of that is a function of private companies being (obviously) private about their trajectory and traction. VCs can't talk as openly about buys and sales the same way public investors can.

But regardless of the economic arrangement you find yourself in, every investor should be actively looking for ways to better reflect on the lessons worth learning from the experience they've lived.

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