Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: I want to go to the situation where I'm a person, I have an idea, something I want to do. It requires capital or resources of some kind. What people should understand about that starting state that you've learned, and where people then tend to fall down. I think one of the interesting messages that you and I have talked about before is — of course a good idea is important, a good product, the thing you're trying to build or sell or what have you, but that people maybe underestimate the role that capital can play in making that thing happen. And therefore, this skill that you've learned a lot about and done a lot of is just unbelievably valuable, but no one really knows how to do it beyond the idea. At the very beginning, orient us around that combination of idea plus capital and the importance of the relationship.
· John Kim
[00:00:00] S1: First, you have to look and say, okay, who are the people who trust you? This is why they call it friends and family. What is friends and family? High trust. I don't think it's totally true that friends and family are people who will give you money — they're not afraid to lose it. Their tolerance for loss actually may be much, much worse than an institution. That's, I think, an urban myth that, oh, go to friends and family because they'll give you the money as charity. I think the most expensive money is borrowing money from your friends because if you don't give the money back, your friendship is not the same anymore, but they trust you and they want to see you do well. And their desire minus fear, which is, we talk about persuasion, their fear of losing money is subordinate to their desire for you to do well. And they know that in order for you to do well, you need resources you don't have. So as an individual, first you need to find out who trusts you. Who are the people who desire your success more than they fear, or they trust you're going to make money for them? They desire to make money and they don't fear that you're going to lose it because they've seen you in action in other places. So that's where you have to start. Politicians call this the hard reelect number. The hard reelect number is some base number where no matter what you do, they still will vote for you. So you first have to figure out naturally who would give money. And then from there you sort of multiply it. You say, well, if I think that my friends and family are going to give me, let's say, $1 million, then maybe my goal should raise $2 or $3 million because from their trust, I can leverage their trust to seed. Now, maybe you could do better than that, but you have to start from there. You're not going to raise $100 million off of friends and family of $1 million. But you should do better than $500,000. By the way, that tends to be my experience. If your first close is $1 billion, you tend to tap out at $2 billion because your first close almost always is your hard reelect number. That has been my experience. First, find out how much money do I really think trusts me already? And then from there, let's build on it with a campaign. And then we could talk about the actual mechanics of doing a campaign.
· Patrick O'Shaughnessy
[00:00:00] S0: Before we do that, I'd love you to dig deeper into this very simple idea of persuasion equals desire minus fear. It's an incredibly simplifying, elegant way of thinking about this. Why is that the reduction that you've arrived at versus some other one?
· John Kim
[00:00:00] S1: This is only a decade ago, I was talking to one of the masters of the universe and I was talking about, well, I think it's desire minus fear. And thanks, Mr. Obvious. Everything's greed and fear. And I looked and I said, wow, that's actually not true. The simplicity of it isn't the wisdom of the phrase. It's the nature of desire. It's the nature of the positive side. It's the invitation to say that people can be inspired by something that is not just self-serving. Greed is self-serving. The human condition has so many things it desires. The ego has so many things it desires. Otherwise, we would never give money away. Otherwise, we would never do things that are generous for people. Otherwise, we wouldn't care about the environment, care about our children, care about desire. So when you are talking to somebody and trying to persuade them, too many people — and this is maybe one of the most important lessons that people seldom get right when they first start fundraising. In the alternatives world, an investing professional talks to somebody on the other side — they're called limited partners. And they just are so passionate about how much money they're going to make for them and the returns, because the more money they make, the bigger the plane or whatever it is, because they're motivated that way. And of course, as a fiduciary, you're saying, well, this has to be what you care about. But the dirty secret to the relationship is that very few — some do — very few limited partners are actually compensated on the returns that the general partner makes. Very few are. Some are, some are compensated on IRR. And it's hard, right? Because the alternatives business, you have to wait for ten years to see if something's good or bad. So it's really kind of an awkward alignment of interest. Say, okay, I'm going to pay you on an IRR, but we don't really know if this is really good. So I could pay you a ton of money, and the general partner could be tricking up the IRR, and there are lots of great tools to do that these days. That's a misalignment of interest if I'm giving you my money to actually manage. So therefore, there are a lot of people who just simply don't make money if you make money. So in other words, there is no greed. So there's got to be some other motivation.
· John Kim
So when you're trying to raise money, look for that motivation that they have because they're in that spot for some reason. The fear piece is also really important, and fear might as well be another word of saying trust. It's the anti-trust. The way to inoculate yourself against fear is trust. In fact, the more fearful somebody is and the more trust you can develop, the less desire they need. If they just trust me absolutely, then everything else will pale in comparison. If they have no fear — in other words, it's riskless — they will do it And this is one of the things that ties into — so many hedge fund professionals that appear on your podcast as well will talk about risk-loving, risk-aversion. I think that's kind of bullshit. I don't really think there's such a thing as risk-loving, risk-aversion. I think that there are only people who perceive there's no risk. I think that no one actually really invests with a lot of risk. I think that people actually convince themselves that the risk is far less than what it really is in order to justify the risk they're taking so they can receive the reward. And where do we see this? Gambling, right? The casino. It's part of the human condition that we rationalize away the risk. And so if somebody says, I'm risk-loving — no you're not. You're just really good at rationalizing away the risk. And not to zero, but if you know your outcome is gigantic, you just have to rationalize the risk to half of what it really is, and you'll say yes. And that's where a lot of cognitive mistakes are made in investing for sure.
· Patrick O'Shaughnessy
[00:00:00] S0: A lot of this equation is — you've talked about applying it early to get going. I'm also very curious about applying some of these ideas much later on. So if I think about your time at General Catalyst — you're on fund 8 or whatever, you're established, people know who you are. There's somewhere in the book you said the path of least resistance is often that money goes to stuff already in motion. Fund 8, let's say, or Series D, you're already in motion. What have you learned about doing a really great job at that stage? What happens there that's distinct from just the early stuff of total uncertainty? We don't even know if you're any good. How would you do that even? I'm even thinking literally about you sitting down like, okay, we're going to go raise this thing.