How I Invest with David Weisburd
00:02:15 · Matthew Harris
[00:02:15] S0: I think certainly going back in time, there were elements of risk management that were quite unconscious. I mean, everybody gets into venture capital. Anyone who ends up being successful in venture capital with a risk seeking frame really is about actually looking for audacity, seeking out improbable founders and improbable outcomes and non consensus companies and markets and even the shape of the humans you're funding. And that certainly characterizes our partnership. But we were born out of Bain Capital, which of course in its other asset classes does have aspects of risk management which are good and proper. If you're running a private equity strategy, avoiding losses is prudent. If you're running a credit strategy, avoiding losses is critical because you can't really make up for a cluster of losses with vast returns elsewhere when you're in a fixed income world. So our question, I think, and I and I have to assume that there was some element in the early days and even the middle days of Bank Capital Ventures that sort of through osmosis carried some of that flavor of risk management unconsciously into which deals we brought forward and which deals passed investment committee. To be specific, though, I think it was really about valuation sensitivity. So it was actually kind of less about, you know, avoiding outlandish projects that ended up working because we did Crusoe and, you know, almost ten years ago, and that was when it started as an example of a company, you know, they were mining Bitcoin at the oil heads in, you know, Arctic Canada. So it was an outlandish proposition, to be sure. And those are actually the sort of thing we like. But where we struggled historically is sort of paying market price when market price got really high. And I think that that's a fundamental problem actually in a power law industry because price is a signal of a sort. It can obviously be wrong. But the fact is like Databricks and Stripe and Ramp, I mean, the companies that end up being massively valuable are overvalued, quote unquote, at every round. And so if you take a view that you're going to turn down things that are overvalued at the very moment in time they're being valued, you will systematically miss the power law companies on average.
00:04:46 · David Weisburd, Matthew Harris
[00:04:46] S1: How would you describe that so many of the winners are quote unquote overvalued? [00:04:53] S0: We're talking about semantics here. I mean, in retrospect, they were undervalued. Right? [00:04:57] S1: But But on on a multiple basis.
00:04:59 · Matthew Harris
[00:04:59] S0: Because they have extraordinary founders. They have extraordinary ambition. Those elements that led to them being these hyperscaled winners were present at the time. And thoughtful investors saw those. And multiple thoughtful investors saw those characteristics, the extraordinary nature of the Collison Brother leadership or Eric at Ramp and said, You know what? I will definitely pay 50% more on a multiple basis to back these individuals because of the scope of their ambition and the quality of their leadership. So it has to do with some subset of the market actually being perceptive. It leads to another problem in our asset class, though, which is that if you say to a venture capitalist and I'd curious your perspective on this, if you say to venture capitalists, all the best deals are 50% too high on a multiple basis. Well, that's going to lead to some perverse behavior. Right? Because you brought a deal to committee, so your partner brought a deal to you and said this you know we we've looked at application layer AI companies and averagely 20 times revenue is sort of where the average app you know application layer AI company is going. We've got a really interesting one. It's 20 times revenue so you know perfectly appropriately priced. Like by rights, you should say, look, unless it's 30 times, we shouldn't do it. Because my all my pattern recognition tells me that unless it's 50 above market, it's not a power law company. So we should pass on anything that's not 50% too expensive. That wouldn't ever be like written down in an investment committee charter, of course. But the fact is like that mindset is what leads to bubbles in our asset class because people have a price quality relationship in their mind and therefore, almost the higher the
00:06:51 · David Weisburd, Matthew Harris
[00:06:51] S1: bet. This episode is presented by Juniper Square, the operations partner for private markets. Early Bird, a firm firm in Europe, did did a study on this. They figured out that that this price persistence continues to persist. In other words, like, every round is overvalued versus the comps. Said another way is that the overvaluation is in relative to the competition set. But because in venture capital, the outcomes are so big and the markets are so big, even if another competitor could have gotten a 100 x on that return, but this competitor would get the 75 x if they win, It's smarter to go with a team that's likely to win than the team that would have theoretically given you the 100 x. [00:07:37] S0: Very clearly. This is... The physics of power law mean that you should be extremely price insensitive if you have a greater degree of confidence that you're backing the power law winner. Now that's true, but obviously everyone can't be right about that. So if everybody's playing that same game, but most people are wrong, then everyone thinks they're backing a power law winner, then every price goes up by 50%. And then the next time you play that game, the starting point is 50% higher and everyone goes up 50% from there because they've convinced themselves they have the power law winner. That's what inflates a bubble. When you look at what appears to you to be a bargain and your reaction, instead of feeling greedy and excited, is to feel suspicious and aversive, then you have a kind of a market where prices are going to trend up no matter what.
00:07:37 · Matthew Harris, David Weisburd
[00:07:37] S0: Very clearly. This is... The physics of power law mean that you should be extremely price insensitive if you have a greater degree of confidence that you're backing the power law winner. Now that's true, but obviously everyone can't be right about that. So if everybody's playing that same game, but most people are wrong, then everyone thinks they're backing a power law winner, then every price goes up by 50%. And then the next time you play that game, the starting point is 50% higher and everyone goes up 50% from there because they've convinced themselves they have the power law winner. That's what inflates a bubble. When you look at what appears to you to be a bargain and your reaction, instead of feeling greedy and excited, is to feel suspicious and aversive, then you have a kind of a market where prices are going to trend up no matter what. [00:08:30] S1: I wanna get back to this question on whether we're in a bubble because I think it's an important question. But first, it seems undeniable that we are in a consensus market. Mark Andreessen says there are no more diamonds in the rough. There are only diamonds. Do you agree with that? [00:08:47] S0: I agree that we're in a consensus market. I disagree that there's no more diamonds in the rough. [00:08:52] S1: How do you differentiate those things?
00:08:52 · David Weisburd, Matthew Harris
[00:08:52] S1: How do you differentiate those things? [00:08:53] S0: I observe that we're in a consensus market, which is to say a company is anointed. This phenomena has a name. It is king made. And maybe there's two, maybe there's one, but there's a leader anointed, often two, and then money piles in. And there are firms whose strategy is to be in the leader or number two with a chance in a sector, and they'll pay almost anything to get into one or two. And not for love or money would they invest in anyone who's not already anointed in the winner's circle. So I describe that as a consensus market, and that's where we are and actually would differentiate that from 2021, where it was much more of a thousand flowers blooming. I mean, there were there were firms doing, you know, two two unicorn deals a week. So there were just a lot more. It was a breadth of the market that was getting sort of pumped up and valued at high levels. It wasn't that people were really radically disagreeing with each other, but it wasn't narrowing in each sector the way it is today, where you have a sort of one, two, rarely a three. So I observe that it's consensus market. But Mark's statement goes further, which is to say that this is as it should be, that there's no point in doing anything other than backing the, at the moment, obvious winner. And we have seen things as more dynamic. We backed Ligora. [00:10:24] S1: One of our companies as well.