Invest Like the Best with Patrick O'Shaughnessy
· Scott Nolan
[00:00:00] S1: For better or worse, they can draw you into a potentially brute force sort of approach. First few years at Founders Fund, I'm looking for great founders. I'm looking for underexplored ideas. It's just lots and lots of meetings. So from the investor perspective, unless you have things that you're into that you think are underappreciated by the world and you've maybe been really excited about them for a really long time, and why does no one think about this? And maybe it's this idea in your head that you just keep digging on and maybe someday you find a company that's actually an expression of that trade. Then it's just meeting a lot of people and trying to find what's interesting and what sounds really different and what makes sense. From the investor perspective, the attributes are something like, hey, you meet a founder. They seem really smart. They're talking about this thing no one's really talking about. They're telling you why everyone who's thought about this problem either thinks it's impossible or they're all going about it in the completely wrong way. And if you adjust and come at it from a different point of view, it results in a really different solution that has really different business characteristics. When you meet a founder like that, who's working on something like this, usually they're not just going to give you superficial answers to convince you to give them money. The conversations with great companies like that always felt more like – this person is really into this thing for some reason. And when I'd ask them a question, they're not just giving me an answer and trying to bounce back to the surface. They're like, here's the answer. Here's the next question you're going to ask. And let's take you all the way down the rabbit hole. So they like showing around the space. That's how it felt from the investor seat. If you think about what are the attributes of industries where this is the case, I think a huge portion of them are going to be industries that somehow just stagnated. And I think the thing that's most linked to stagnation is probably being a cost-plus industry, where there's very little incentive for progress, not much incentive to bring the cost structure down.
· Scott Nolan, Patrick O'Shaughnessy
And therefore you end up with this fixed market size that never takes off because you just get in a stalemate where all the companies maybe get to oligopoly status. The equation for max profits is just make pricing high enough to the breaking point, collect your cost-plus revenue and your margins, and then it never becomes a really compelling thing. So like space launch, for example. To some extent defense, which you see with Anduril trying to break that to some extent infrastructure, like the boring company, this is their prime thesis. So I think incumbent, stagnated oligopolistic cost-plus industries are just prime for this. [00:00:00] S0: If forced to go beyond that definition, there's only so many of those, and you've probably invested in companies effectively attacking each category or each subcategory. A lot of those are doing extraordinarily well. What else would you say? Like there's lots of great Founders Fund investments that weren't in cost-plus industries or something. What would I find if I went digging on this same thread there?
· Scott Nolan
[00:00:00] S1: I mean, Airbnb is a classic, huge example. When Founders Fund invested, it was still crossing from kind of a weird backpacking, couch surfing, air mattress in someone's living room, to what it is today. And so not that many people were that interested in sleeping on air mattresses in people's houses, but that was something that that team was really into. And how do we turn this into something much larger where people can meet each other and have a really authentic experience when going somewhere, instead of just staying in a hotel? That wasn't something many people were thinking about. And yet when you actually looked at it, you realized how big the market could be. And if they could cross over to a mainstream thing, it could be huge. That's one example. Sean Parker was on the Founders Fund team right when I joined and led the Spotify investment. And the internal memo or thread on the Spotify investment was just so well-reasoned. And it was because of this history of understanding music and doing the Napster thing, and then years and years of trying to find the right company that was taking the right formula, I think led to that and led to him seeing the potential of Spotify and why it was the perfect geography to start in and the perfect licensing strategy. And so I think it's often just like a really deep interest in something that's of personal interest to a founder and they believe it should exist. They believe there should be some way to solve this, and everyone's done it the wrong way and here's the right way. I think sometimes people are sitting with those ideas for five or ten years.
· Patrick O'Shaughnessy, Scott Nolan
[00:00:00] S0: Across all the meetings you did – first meetings – how did you improve at conducting that meeting to figure out if this was the type of person and problem that you could get interested in? [00:00:00] S1: It probably wasn't even the meeting itself. It was probably just trusting your judgment more. So I think on day one, it was just, okay, I don't know anything. I'm going to take a lot of meetings. Some of these seem good. Some seem not so good. And we need to do the work, because what do I know? I think early on, the intuition was all that you had to go on, and I think it's usually correct. And then I get probably a little bit better at the job in the next couple of years, get better at trying to analyze things, understand it. That might actually lead you astray, I think. [00:00:00] S0: The analytics might? [00:00:00] S1: Because then you start doing the analysis when you kind of already know. Like, oh, I guess we should do the work, but you kind of already know which ones you like. In fact, you should just concentrate into the fewest number of companies possible and don't dilute your average returns by indexing. And then over time, get better at asking the right questions to help harness the intuition, or like, okay, we should dig into this. [00:00:00] S0: Could you think of a single investment that your gut was not flashing yes almost immediately that you worked your way to get there and did it?
· Patrick O'Shaughnessy, Scott Nolan
[00:00:00] S0: Could you think of a single investment that your gut was not flashing yes almost immediately that you worked your way to get there and did it? [00:00:00] S1: Airbnb was one of these, we did a lot of work on it. At the time – so Founders Fund did a small angel check early on, and then did a much bigger check in the next round. And so at the angel check, it was still the very informal air mattresses. I think there had been something where some guests completely destroyed a home and there was a whole bunch of controversy around that. And then the company took a hard stance on that and said, we will reimburse the host and we are professionalizing this. And I think that was maybe the moment that you could tell it was going to go mainstream. And then Founders Fund made a huge investment. But if you just look back at the past, you might say, oh, this seems like a niche thing. But if you did the work, you could see a bunch of different trends. You could see the demographics were shifting to a slightly older crowd, not just backpackers out of college, like some people had perceived. The market share in different markets was increasing a lot. We did the work. We looked at every single market, sliced market share, marketing spend, and you could see – all these markets that they were in, they were just taking share and becoming the dominant thing. So you analyzed the data, and it was like – they're winning. It's over. They're going to win.
· Patrick O'Shaughnessy, Scott Nolan
[00:00:00] S0: There's two other components of the no competition idea. One is the valuation and price that you have to pay, and the second is capital intensity. You've invested in lots of stuff that requires lots of money to get the thing up and running and to revenue and to profitability. I'm curious how you learned about those two dimensions of earning high returns – did low competition bring lower entry prices on average? And is that something you cared about much once you found someone that was doing one of these things? And then also how you think about the amount of capital that you would have to put into the company to make it work? [00:00:00] S1: The low competition thing typically would be associated with lower valuations. But I think that trying to find value deals in venture is – [00:00:00] S0: A dumb idea.