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Good morning 👋
Last week I shared the Q1 letter for Outlaw. If you haven’t checked it out yet, let me know what you think.
This is the latest installment of me sharing the things that changed my thinking over the past month on the job (the others can be found here).
If anything in here is interesting, I’d love to hear your thoughts.
Investing notes
Questions that lead to partnership
80/20 thinking
Venture talent
Early hedge fund traders came from esoteric backgrounds and usually had no formal training - gunslingers like Paul Tudor Jones and Stan Druckenmiller traded on intuition and exploited arbitrages everywhere; when Henry Kravis invented the LBO at Bear Stearns in the 70s, they were known within the firm as the esoteric group running “bootstrapped investments”; for a few decades, all six venture capitalists in the world met each week for lunch on Sand Hill Road to discuss deals. The commonality between these asset classes is that they have all swelled significantly in size and professionalization in the last few decades. However, while hedge fund and private equity investors today undergo rigorous recruiting, training, and career progression systems, venture capital stands alone in its informal curation of talent.
Questions on AI
Is copper mispriced?
Is coal mispriced?
If globalization is the metaphor, and the thing can just write all software, is SF the new Detroit?
If it does become an energy game, what's the trade?
What nations win and lose?
What is the euclidean distance of reskilling in prior revolutions, and how does AGI compare? The typist became an EA, can the software engineer become a machinist?
Electrification and assembly lines lead to high unemployment and the New Deal, including the Works Progress Administration, a federal project that employed 8.5m Americans with a tremendous budget… does that repeat?
Is lifelong learning worth investing in? Something worth doing beyond the economic value of mastering the task?
If AI is truly deflationary, how would we know? What chart or metric would show that first?
How should one think of deflation if demand for intellectual goods continues to grow as production costs go down?
Creating an edge as a buyer
Can deliver speed and certainty to a seller who needs it.
Participates in a complex corporate carveout that achieves an important goal for the seller.
Partners with a former employee to buy an asset from his/her former employer.
Purchases from a government entity where maximizing value is not the only objective.
Buys from feuding owners.
Has a special bond with the seller or management team.
Solves a headline reputational issue for the seller.
Purchases growth assets in the secondary market (e.g. employee shares at demonstrable discount).
Engages with the seller right after another deal falls through.
Agrees to a term proposed by the sponsor or seller that others would not agree to for irrational reasons (e.g. above-market fees for an extraordinary deal).
Brings value-add on day one (e.g. buying a building with a tenant in hand).
Purchases a small option to later make a large favorable investment (e.g. buying an option on a piece of land that can be built upon once a tenant is secured).
The seller is earning a high multiple upon exit (since they tend to be less sensitive to price).
Can finance in a different market than the seller (e.g. replace a high yield loan with a CMBS loan).
Sees an opportunity to sell in a different category in the future (e.g. buy from private equity and sell to an infrastructure fund or REIT).
Venture 50 years ago
Fighting against wetting cement
Venture is an asset class where the asset has to choose the investor, thus luck compounds, and winning begets winning. Because of this, the venture industry structure is like wet cement, and with each passing year, the structural delta decreases.
Downsides of large investment teams
various studies have shown that investment teams larger than a dozen begin to correlate with poor returns
there are 28 total possible relationships in a group of 8, 66 in a group of 12, and 190 in a group of 20
as a result, internal politics problems scale superlinearly with headcount; talent adverse selection becomes a problem with a large team, as ambitious and intelligent up-and-comers want some balance of mentorship, range of motion, upward mobility, and exclusivity
there exists less trust in bigger teams leading to intel silos, relationship hoarding, and horsetrading; it’s hard to keep the bar high with more people, and B players slip in
we are instinctively afraid of speaking up against majority consensus, thus the firm is more prone to homogeneous thinking
it’s hard to give junior investors enough attention and career development with more people; sector coverages inevitably collide leading to conflict
geographical divide starts to feel more visceral
management overhead is distracting
Investor personas
The cycle of returns
The history of the investing world is a cycle of new alpha sources → temporary superior returns → market saturation → diminishing returns → new alpha sources.
Hierarchy of BS
On the ability to recognize outliers
Venture capital rewards outliers; outliers are best recognised by outlier minds, and outlier minds, by definition, do not survive consensus. The same is true for any pursuit of alpha.
The current non-consensus buy according to TB
What game are you actually playing?
Investment firms make money in three ways:
Fee-related earnings (management fees)
Performance-related earnings (carry)
EV
Some are good at playing the fee-maximization game by maximizing AUM and multiplying by 2%.
Some are good at playing the PRE game by keeping fund size consistent and improving execution ability with each fund cycle (USV, Mucker, Benchmark).
Some are good at looking at the firm as the business and maximizing their stake in the EV (KKR, Apollo, Blackstone).
After studying hundreds of firms, the majority of wealth for larger firms has come through maximization of EV + excess management fees (not through carry).
Fund updates
Chief capitalist to out-of-distribution individuals.
I’m nearing the end of fundraising for fund I, and I am relieved to be spending the next several months focused on deployment instead of fundraising.
My next (probably final) close date will be May 31.
I will be sending out more info to a few people who have been closer to the process over the past several months. If you are interested in getting more involved, you can find time with me here or move to next steps through the link below.
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