Invest Like the Best with Patrick O'Shaughnessy
· Patrick O'Shaughnessy
[00:00:00] S0: Can you say a little bit more about this notion of Act 2 teams and management teams, and why that is an interesting concept to you when you're thinking about the relationship between an Act 2 team and a potentially very durable compounding company?
· Henry Ellenbogen
[00:00:00] S1: This is something that is so dear to me because one, it's something we invest in, but two, it's actually at the heart of Durable itself and it's one of the reasons that I think Durable is just different than other investment firms because we ourselves were an Act 2 team. The best way to explain it is by example. At my part firm I invested in Workday when they were at about $100 million of revenue scale. What was so interesting was that the two co-founders of Workday, Aneel Bhusri and Dave Duffield, had basically been the people who had pioneered HR systems of record in the previous client server world. They were literally the people who built PeopleSoft, scaled PeopleSoft. And then… a lot of history there, but there was basically a very aggressive takeover by Oracle. And so in many ways they had felt they hadn't frankly completed their vision, so they came together. But what really also lit up the vision was cloud. Now this sounds so obvious today, but 2012 when we invested in Workday, I think a lot of the understanding of the cloud was not as obvious by investors. And frankly, I'm not sure I fully understood it either, but what I did understand was this was an Act 2 team. By that I mean if you understand HR systems of record, there's a bunch of the stuff you have to build into the product that for lack of a better word, is exception management. And if you don't understand that exception management because you’ve done it before, you're gonna not properly be able to do it. And because this was an Act 2 team, they actually knew how to leverage the modern technology but also build the system of record in the way it dealt with the edge cases at super scale. And then obviously they also understood what segment of the market to go after, and then how to serve it. That to me is the image we have at Durable when we look at an entrepreneur who has solved and successfully won a product area or an area of business but now wants to go do it again. And there's huge advantage when you go do it again, you are essentially solving the same problem but with total clarity at the beginning. The other thing is if you've been successful, it allows you to align all parts of the organization, the people, the organizational structure, the investors, exactly how you wanna go do it.
· Henry Ellenbogen
One of the examples of that that comes to mind is Max Levchin, a lot of people know Max obviously is one of the co-founders of PayPal. We first invested in Max, actually it was one of my first private investments in my whole career. We invested in Slide, right? And for many years until recently, we're now investors in Affirm. I used to joke, I'm the only investor in Max who hasn't made a lot of money. But with all jokes aside, Max to me represents the best of an Act 2 entrepreneur. For those of you who don't have the benefit of knowing Max, first of all, he truly understands technology and he really understands how it can be used in very complex systems to solve problems. He can recruit exceptional people because he speaks their language. He's also a very good leader and people believe in him. He's also exceptionally resilient. We could talk a lot more about Affirm, and we could talk a lot more about the relationship with Max, and some of the things about how he transitioned to public markets later. But I would say to us, Max is a perfect example of an Act 2 entrepreneur that we had already been in business with. If Durable does anywhere from five to 10 new investments a year, a lot of times it actually is with Act 2 entrepreneurs. And then if we're lucky, and this happens because of compounding relationships for having done this for 20 years, a lot of times it's with people that actually we were investors in their previous act. And I think that's also great, because they know us and we know them, we know each other's strengths and we know exactly how we can help each other. The Maxes of the world get to do business with who they want. But I think what it allows them to do is with a clean sheet of paper, decide who they want to be in business with. But obviously from our standpoint we don't do a lot of new things and it allows us to basically really align our resources to support them.
· Patrick O'Shaughnessy, Henry Ellenbogen
[00:00:00] S0: What changed the most in your own Act 2? So as you structured Durable itself, you have the same features of the companies that you're looking at investing in: last a long time, do really well, be tightly aligned, all these things that you're referencing. What were the biggest learnings that you took with you and that you jettisoned coming from your first act to your second act? [00:00:00] S1: I almost named Durable Act 2 Capital, by the way. [00:00:00] S0: Oh wow.
· Henry Ellenbogen
[00:00:00] S1: It was such a prominent view in what I was trying to do. We talked a little about the investment philosophy. I mean, the investment philosophy is really simple. Let's invest in small companies that can compound over time and become large companies. And what's our advantage that we bring over other investors? We think we're great at people and understanding change. So, basically everything we do at Durable, because we're an investment-driven firm, is in support of that investment mission. First of all, we essentially with a clean sheet of paper said, if we were gonna go purpose-build an investment vehicle to allow us to do this, how would it actually be structured? Essentially, the percent of capital that we put in the public markets and the private markets is aligned against that. And then the second thing we talked about is organizationally, how are we gonna go align against this? The way we think about people is very purposeful. We really believe that very few people actually operate the way we do. We think Durable is just different. It's different because my partner Kathryn, who worked with me when we first underwrote Figma in 2020 and also when we led the investment round in '21, was the same person who was at the all hands meeting with Figma when Dylan announced to the company that they were going public, and is still the person that basically looks at the company when they announce their public earnings. I mean that's just different. So you have to have people who can work with companies that are valued at 2 billion and they're private and have 30 million of run rate revenue. And now Figma is a $1 billion revenue company, a public company and can continue to work on that. And investment firms aren't structured that way. So if you want to have people who can do that, you gotta develop them internally. Second of all, it's time allocation. In general, at any point in time we probably have 10-15% of our capital in the private markets and the rest in the public markets, but we have to be willing to spend the appropriate time on new ideas. So when we look at Duolingo and the right decision for Duolingo and maybe the right decision for us is only to invest $20 million. We don't look at it as a $20 million investment on a $15 billion vehicle. We don't look at it as 10 basis points or 12 basis points.
· Henry Ellenbogen
We actually look at it as our future compounder. Our investment memos are just fundamentally written different than other investment firms. When we look at an early stage growth company that is not already competitively advantaged, we write the memo that says if Duolingo does what we think it can do over the next three years, not only do we make a fair return for the risk of the company, but at that point in time we would want to buy more at these higher prices. And if we can't write the memo that we want to buy more at higher prices, we can't buy the shares and our thesis can't be, it gets bought. Or our thesis can't be it'd be a great talent acquisition by someone. So that has to be aligned. And then the investors we're in business of, we have incredible investors. We have to be transparent with them that in order to pursue this philosophy, we're gonna have what people would say is monthly or quarterly volatility in our performance when they look at our performance. And that sounds so obvious, but increasingly the market has changed where capital is short cycle, so many people are on one month basically incentive models, not even yearly, one month. And so we have to have been very transparent with our investors and told them what we're trying to do, deliver on those promises, but deliver on those promises over the right period of time.