Invest Like the Best with Patrick O'Shaughnessy
· 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.
· Patrick O'Shaughnessy, Scott Nolan
[00:00:00] S0: A dumb idea. [00:00:00] S1: It's not the right plan. Maybe if you have a very small fund and you can pick up some interesting IP, or this company maybe will never be that huge, but this is a really good deal. And you look at multiples and stuff, and it starts to look a little bit more like PE or something. I think that can probably be okay. But for true venture, I think it's dangerous. Because either it says something about the company's ability to raise capital – that they're unable to at market prices. And unless this is the last round that they need to raise, or they really are going to be a capital efficient business, that's probably a risky thing. Maybe the team is incredible at debt financing, but terrible at venture financing, and so they're going to switch to debt and that's going to be amazing. You could imagine a situation like that, but typically if you're meeting a company and it's a crazy value deal, it's probably just not going to end up being that good is what I've observed empirically [00:00:00] S0: Do you think if we did an analysis of the actual dollars deployed by Founders Fund, that more of the dollars would have been deployed once the company was already popular?
· Patrick O'Shaughnessy, Scott Nolan
[00:00:00] S0: Do you think if we did an analysis of the actual dollars deployed by Founders Fund, that more of the dollars would have been deployed once the company was already popular? [00:00:00] S1: Yeah, that may be the case. Yeah, if you look at actual dollars deployed, it's probably more the whole concentrate into the winners strategy. I think the way that that can still be a good strategy, even if the company's popular is – A, it's popular, but not as popular as it will be. Or B, this idea that up rounds, it's almost like anchoring in the past versus looking to the future. Peter has said this a bunch of times and has guided the Founders Fund team to think this way. It was more talked about in the early 2010s, but if you've got a company that was growing steadily, but then there's a big up round – it's probably the case that that up round is not even enough up. That if it's like a 2x up round, maybe it should be a 4x up. [00:00:00] S0: Yeah. What's going on there? There's that famous quote of his, which is the steeper the up round, the greater the undervaluation. What is actually happening that makes that true?