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How to Angel Invest, Part 2.html
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<html>
<head>
<link rel="stylesheet" href="styles2.css" />
</head>
<body>
<p>![[Naval-Ep69.mp3]]</p>
<h2>Everybody Thinks They Already Have Good Judgment</h2>
<p><em>It takes years to know if you have good judgment</em></p>
<p>
<strong>Nivi:</strong> For the past few episodes, we talked about why you
should angel invest and how to get proprietary dealflow by building a
brand. Now let’s talk about judgment: how important it is and how to
develop it.
</p>
<p>
<strong
>Good entrepreneurs don’t want to be associated with bad
judgment</strong
>
</p>
<p>
<strong>Naval:</strong> In the long-term, having good judgment is
critical. Without it, you’ll end up with a bad portfolio; other investors
won’t back you; you’ll lose your money; and your brand will suffer. Good
entrepreneurs don’t want to be associated with bad judgment.
</p>
<p>
At the end of the day, judgment is the single most important thing. It’s
more important than access to deals and access to capital.
</p>
<p><strong>If you have poor judgment, you won’t know it</strong></p>
<p>
The problem with judgment: Everybody thinks they already have it. That’s
because your ability to assess your own judgment is subject to your level
of judgment.
</p>
<p>
If you have poor judgment, you won’t know it. This cognitive bias is
called the
<a
href="https://www.google.com/search?q=Dunning-Kruger+effect&rlz=1C1CHBF_enUS795US795&oq=Dunning-Kruger+effect&aqs=chrome..69i57.1403j0j7&sourceid=chrome&ie=UTF-8"
>Dunning-Kruger effect</a
>
after psychologists who popularized the idea. It’s also common sense.
People who are not that intelligent usually don’t know it. It’s partly an
ego defense mechanism.
</p>
<p>
<strong
>It takes five to 15 years to know if you have good judgment</strong
>
</p>
<p>
Furthermore, you might have good judgment in certain areas and poor
judgment in others. You might have good people judgment but lack market
judgment. The only way to know is to look over a long period of time.
Unfortunately, in early-stage investing it takes five to 15 years to
figure out if you have good judgment.
</p>
<p>
The first thing to do is be honest with yourself about your own judgment.
We’ll walk through a plan to calibrate and improve your judgment over the
long-term.
</p>
<h2>Judgment Gives You the Winning Lottery Numbers in Advance</h2>
<p><em>But you still need a portfolio effect to be successful</em></p>
<p>
<strong>Naval:</strong> At the seed stage, judgment is much more about
people judgment, product potential and market potential than your ability
to size up cashflows, customer acquisition costs or virality
metrics—because you don’t have much data.
</p>
<p><strong>Diversification is a hedge against lack of knowledge</strong></p>
<p>
When you have less data, you need a more diversified portfolio. In some
sense, diversification is a hedge against the lack of knowledge.
</p>
<p>
Warren Buffett can examine in detail a company that’s been around for 20
years. Judgment still applies, but he can pick one deal after doing
diligence on many. With seed-stage startups, you have very little data.
You might have to rely on other people’s judgment, which is why social
proof plays such a big role.
</p>
<p>
<strong
>Nobody has enough data to have high conviction at the
seed-stage</strong
>
</p>
<p>
To be successful in early-stage investing, you’re going to have to build a
portfolio, because nobody has enough data to have high conviction or
fool-proof judgment early on.
</p>
<p>
When he was posting as
<a href="https://twitter.com/startupljackson?lang=en">@StartupLJackson</a>
on Twitter,
<a
href="https://www.google.com/search?q=parker+thompson+investor&rlz=1C1CHBF_enUS795US795&oq=parker+thompson+investor&aqs=chrome..69i57.4094j0j4&sourceid=chrome&ie=UTF-8"
>Parker Thompson</a
>
wrote: “Everyone who invests after me is a spreadsheet jockey, and
everyone who invests before me is a dart-throwing monkey.” I thought that
was very appropriate.
</p>
<p>
Later-stage investors look at seed investors as making wild guesses. And
seed investors look at later-stage investors as spreadsheet jockeys.
</p>
<p>
But they’re just applying different levels and types of judgment, because
they have different data available to them. They’re going to have
different size portfolios and conviction because of the judgment they can
apply.
</p>
<p>
<strong>Judgment gives you the winning lottery numbers in advance</strong>
</p>
<p>
<strong>Nivi:</strong> Given the amount of luck involved at the seed
stage, how important is judgment?
</p>
<p>
<strong>Naval:</strong> Investing at the seed stage is like playing the
lottery—except that you can use your access and judgment to get some of
the winning numbers in advance. The better your judgment, the more numbers
you know in advance. This increases your odds, but you still need a
portfolio effect to be successful.
</p>
<p>
So it’s crucial to cultivate and hone your judgment. This is a long-term
game that will be played out over dozens—and eventually hundreds—of
investments.
</p>
<h2>Judgment Is the Work You Do Before a Deal Arrives</h2>
<p><em>Over time you’ll need less data to assess a deal</em></p>
<p>
<strong>Nivi:</strong> Given how quickly deals move, how much time do I
really have to apply judgment? Won’t I miss out if I take time to think
things through?
</p>
<p>
<strong>Naval:</strong> Judgment isn’t necessarily due diligence or even
thinking. Judgment is the preparation you do before a deal arrives so that
your subconscious can process it quickly.
</p>
<p>
<strong
>Early-stage investing is more about gut feel than due diligence</strong
>
</p>
<p>
Judgment for early-stage investing doesn’t involve extensive due
diligence. Yes, it’s smart to check references, talk to other people and
think it through. But that takes days, not weeks. Over time you will build
up a gut instinct, and you will require less and less data to assess a
deal.
</p>
<p>
You’ll know if a founder is credible by listening to them. You’ll know if
they come from a credible network, which means you can spend less
time checking references. You’ll know how customers in the space think and
you’ll develop a gut feel for what founders can sell them.
</p>
<p><strong>The best investors are immune to FOMO</strong></p>
<p>
Startups are now trained to run a tight, fast fundraising process. This is
especially true for startups coming out of accelerators. Some of them
pressure you hard to make a decision.
</p>
<p>
The best investors are immune to the
<a
href="https://www.google.com/search?q=FOMO+effect&rlz=1C1CHBF_enUS795US795&oq=FOMO+effect&aqs=chrome..69i57.424j0j7&sourceid=chrome&ie=UTF-8"
>FOMO</a
>
effect. If you push them to decide within 48 hours, they’ll say, “Well, I
don’t decide within 48 hours, so it’s not a fit for me.” They won’t look
at it, even if it’s a hot deal.
</p>
<p>
FOMO works on many investors—up to a point. I employ a 24-hour cooling off
period for deals I consider. Even after I decide to invest, I force myself
to wait 24 hours before moving forward.
</p>
<h2>Pivots Mean Your People Judgment Really Matters</h2>
<p><em>Bets on seed-stage startups are bets on founders</em></p>
<p>
<strong>Nivi:</strong> How is an investor supposed to know which companies
to invest in, given how much they can pivot?
</p>
<p>
<strong>Naval:</strong> Since companies often pivot, your people judgment
really matters. A pivot means keeping one leg in place and moving the
other one around. It’s not a jump or a leap into a completely different
industry.
</p>
<p>
Oftentimes a company pivots into an adjacent space, so it’s still
operating within the broader market. In that case, you’ll give more weight
to evaluating the team and execution and give less weight to the exact
product approach, assuming the market has enough room to pivot around.
</p>
<p>
The valuation should reflect that the company might go through pivots, and
the company’s cash burn and cash planning should, too.
</p>
<p>
<strong>Nivi:</strong> Here are some examples of soft and hard pivots:
Twitter started off as
<a
href="https://www.google.com/search?q=Odeo+twitter&rlz=1C1CHBF_enUS795US795&oq=Odeo+twitter&aqs=chrome..69i57.1887j0j7&sourceid=chrome&ie=UTF-8"
>Odeo</a
>; Instagram was
<a
href="https://www.google.com/search?q=insagram+burbn&rlz=1C1CHBF_enUS795US795&oq=insagram+burbn&aqs=chrome..69i57.2041j0j9&sourceid=chrome&ie=UTF-8"
>Burbn</a
>; Slack was
<a href="https://mashable.com/article/slack-glitch">Glitch</a>; and Lyft
was
<a
href="https://www.google.com/search?q=lyft+Zimride&rlz=1C1CHBF_enUS795US795&oq=lyft+Zimride&aqs=chrome..69i57.1783j0j7&sourceid=chrome&ie=UTF-8"
>Zimride</a
>. Uber started off with just black cars.
</p>
<p>
<strong>Naval:</strong> Uber’s move from black cars to shared rides wasn’t
a pivot; it was an extension. Zimride’s move from long-range shared rides
to short-range shared rides also was an extension—and a brilliant
innovation on their part.
</p>
<p>
Odeo to Twitter was a pivot, but it wasn’t a jump. It was a pivot from
podcasting to micro-blogging by the person who popularized blogging as we
know it,
<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&biw=849&bih=443&sxsrf=ALeKk03qGnRKPkq5VzFi-UL9NgzmK52xDA%253A1582846866334&ei=klNYXtmIFJL7-gSJxIPICw&q=Evan+Williams+twitter&oq=Evan+Williams+twitter&gs_l=psy-ab.3..0l6j0i22i30l4.3245.4318..4628...0.0..0.459.2648.0j3j5j0j2......0....1..gws-wiz.......0i67.zgfglNdlArs&ved=0ahUKEwjZmc6J9PLnAhWSvZ4KHQniALkQ4dUDCAs&uact=5"
>Evan Williams</a
>. It was a bet on a great individual who was staying within his space.
</p>
<p>
Burbn to Instagram was barely a pivot; it was more of a step. Now,
<a href="https://www.geni.com/">Geni</a> to
<a href="http://yammer.com/">Yammer</a> was a jump.
<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&sxsrf=ALeKk03woN4IpH3_oDeeBGZ6ubp28qUclw%253A1582835571084&ei=cydYXuHUBNfh-gTriIS4Dw&q=David+Sacks+&oq=David+Sacks+&gs_l=psy-ab.3..0l10.4440.4637..4950...0.0..0.149.439.2j2......0....1..gws-wiz.......33i299j33i160.iCHeOUmpJC0&ved=0ahUKEwih2s7_yfLnAhXXsJ4KHWsEAfcQ4dUDCAs&uact=5"
>David Sacks</a
>
is one of the greatest product designers we’ve ever seen. He was early at
<a href="https://www.paypal.com/">PayPal</a>, pivoted Geni into Yammer,
and ran <a href="https://www.zenefits.com/">Zenefits</a>. He was an early
investor in some of the greatest hits out there. Geni was a David bet,
similar to an Elon Musk bet. The people who bet on David would bet on him
all day long.
</p>
<p>
Glitch to Slack was another jump. Glitch was a gaming company, but
<a
href="https://www.google.com/search?q=Stewart+Butterfield&rlz=1C1CHBF_enUS795US795&oq=Stewart+Butterfield&aqs=chrome..69i57.325j0j7&sourceid=chrome&ie=UTF-8"
>Stewart Butterfield</a
>
had done something similar before. if I remember correctly. Even his first
hit, <a href="https://www.flickr.com/">Flickr</a>, had also been a jump of
sorts. People were investing in Stewart and hoping for the best—and he
delivered.
</p>
<p>But for every one of those, there’s 10 failures.</p>
<h2>Are Good Investors Piling in the Round with You?</h2>
<p>
<em
>It’s a sign of good judgment when proven investors pile into the
round</em
>
</p>
<p>
<strong>Naval:</strong> When you want to develop your judgment, the first
step is to calibrate it: Do I have good judgment or not?
</p>
<p>
It would be great if you could look at the results of your investments and
see if you were correct. But you won’t know for 10 or 15 years, and the
industry will have changed by then because it evolves and adapts quickly.
</p>
<p><strong>Look at markups in subsequent rounds</strong></p>
<p>
You can look at intermediate markups, noting when
<a href="https://www.sequoiacap.com/">Sequoia</a>,
<a href="https://a16z.com/">Andreessen</a> or
<a href="http://twitter.com/benchmark">Benchmark</a> invest in subsequent
rounds and pay higher prices. That’s an interesting metric, although it
really indicates your taste in what other tastes makers like.
</p>
<p>
It’s a
<a href="https://en.wikipedia.org/wiki/Keynesian_beauty_contest"
>Keynesian beauty contest</a
>
where each judge is rewarded based on what the judge in the next round
thinks. If your deals are marked up, it means you’re becoming a good
arbiter of future taste.
</p>
<p>
That kind of judgment is a <em>people proxy</em> mechanism; it’s not
really a way to build and calibrate your own judgment. Though it does have
value: If you can predict what VCs will fund, your companies have a better
chance of getting funded, which gives them a competitive advantage.
</p>
<p>
But being an arbiter of investor taste won’t help you with a deal like
Bitcoin, where it’s incredibly strange, nobody understands it and there’s
no subsequent round of VC funding to bet on. You have to make the decision
yourself.
</p>
<p><strong>Are good investors piling in the round with you?</strong></p>
<p>
You can also look at which investors follow you in the same round. If they
commit before you, it’s not a reflection of your judgement because you’re
probably keying off of them. But if good investors with proven judgment
pile into the same round after you, that is a reasonable indication of
good judgment.
</p>
<p><strong>Ask people about your weaknesses</strong></p>
<p>
Finally, you can ask people. Don’t ask them if you have good judgment or
not, because polite people will always tell you yes. Rather, ask them
about your weaknesses. Of course, only ask people if they have good
judgment themselves.
</p>
<h2>Judgment Requires a Willingness to Be Unpopular</h2>
<p><em>Groupthink leads to poor judgment</em></p>
<p>
<strong>Naval:</strong> People with good judgment tend to demonstrate it
in all aspects of life.
</p>
<p>
They are well read, think critically and hold a broad range of ideas and
opinions, including conflicting ones. People with good judgement are
humble and have a relatively low ego, so they don’t get too attached to
earlier decisions. They constantly question themselves.
</p>
<p>
Often, they have scientific or other technical training and work in
industries where they deal with real-world, consequential feedback and not
just what people think of them.
</p>
<p><strong>Groupthink leads to poor judgement</strong></p>
<p>
People with good judgement are willing to be unpopular. The clearest
thinkers work from the ground up and use first principles in their
reasoning. They end up relying on their own authority.
</p>
<p>
Things that lead to poor judgment: groupthink, over-socialization of
judgment and picking things because they are politically or socially
popular. Lots of people lose money in this business chasing things they
wish were true, as opposed to what actually turns out to be true.
</p>
<p>
The “<a
href="https://www.google.com/search?q=paypal+mafia&rlz=1C1CHBF_enUS795US795&oq=paypal+mafia&aqs=chrome..69i57.2126j0j7&sourceid=chrome&ie=UTF-8"
>PayPal mafia</a
>” is famous for being insular. They all have good judgment, they’re all
strange and politically incorrect—and they’re all brilliant. They’re not
afraid to hold unpopular views, and they value each other’s insights and
judgment.
</p>
<p>
Whatever people say about
<a
href="https://www.google.com/search?q=Peter+Thiel+investor&rlz=1C1CHBF_enUS795US795&oq=Peter+Thiel+investor&aqs=chrome..69i57.2502j0j7&sourceid=chrome&ie=UTF-8"
>Peter Thiel</a
>, no one wants to go head-to-head with him in a debate because he’s
brilliant and a contrary thinker. He’s a first principles thinker from the
ground up.
</p>
<p>
If you surround yourself with brilliant, contrary and first principles
thinkers, you will develop extremely good judgment; however, you may not
end up very popular.
</p>
<h2>The Best Deals Look Weird</h2>
<p><em>You want to be right when everybody else is wrong</em></p>
<p>
<strong>Naval:</strong> In investing, you want to be
<a href="https://spearhead.co/non-consensus">non-consensus right</a>. You
want to be right when everybody else is wrong. If you’re right when
everybody else is right, you won’t make enough of a return. If you’re
wrong, you won’t make any return.
</p>
<p>
<strong
>The best deals have something broken, strange or different</strong
>
</p>
<p>
The best deals are weird. They always have something broken, strange or
different about them.
</p>
<p>
They’re socially unacceptable, outside the norms of venture capital or too
niche to be interesting. The founder doesn’t fit the normal mold, or
they’re in the wrong city. Or they have a cap table problem. And so on.
</p>
<p>
That doesn’t mean you should only invest in weird deals. It’s like the old
saying, “<a
href="https://www.google.com/search?newwindow=1&safe=strict&rlz=1C1CHBF_enUS795US795&sxsrf=ALeKk02aRt6ofKE8B7EQYM-X4UNoE92soA%253A1583343567877&ei=z-dfXub8NNSxtQbVub7QDA&q=There%25E2%2580%2599s+a+fine+line+between+genius+and+madness&oq=There%25E2%2580%2599s+a+fine+line+between+genius+and+madness&gs_l=psy-ab.3...47204.50244..50589...0.2..0.169.887.3j5......0....1..gws-wiz.......0i71j33i160j0i22i30.xM5b_gkxOs4&ved=0ahUKEwimoK63roHoAhXUWM0KHdWcD8oQ4dUDCAs&uact=5"
>There’s a fine line between genius and madness.</a
>” The genius and madman both seem crazy until the genius is validated.
One out of 100 turns out to be a genius; the other 99 turn out to be
crazy.
</p>
<p>
You have to be iconoclastic enough to recognize genius founders without
being so low in judgment that you let in all the crazy ones too.
</p>
<p><strong>Patri Friedman is making weird investments</strong></p>
<p>
The way portfolios are constructed, you may be better off investing in a
lot of crazy deals than a lot of decent looking deals.
</p>
<p>
To give a recent example:
<a href="https://twitter.com/patrissimo">Patri Friedman</a> started a fund
called <a href="https://www.pronomos.vc/">Promonos Capital</a>. He’s
investing in experiments in governance: new city states, towns and
localities. These are places where people are taking local government into
their own hands and doing experiments in governance.
</p>
<p>
This seems impossibly difficult to do. The history with
<a
href="https://www.google.com/search?q=Seasteading&rlz=1C1CHBF_enUS795US795&oq=Seasteading&aqs=chrome..69i57.594j0j7&sourceid=chrome&ie=UTF-8"
>seasteading</a
>
in Honduras doesn’t look great. But all you have to do is stumble into the
next Singapore or Hong Kong—whether it’s virtual or physical—and you have
something that can create trillions of dollars in wealth and change the
way people live.
</p>
<p>
Promons benefits from two things. First, they have a unique brand because
nobody else is doing that. Everybody interested in this space knows to go
to them. Second, the vast majority of their investments are going to look
mad—but the few genius outliers should have huge returns because they’re
non-consensus investments.
</p>
<p>
Similarly, <a href="https://foundersfund.com/">Founders Fund</a>,
<a href="https://twitter.com/FutureJurvetson">Steve Jurvetson</a> and a
variety of other people built their brands by being willing to fund weird
deals long before anybody else.
</p>
<h2>You Can Give Every Deal One Fatal Flaw</h2>
<p><em>A startup that breaks all the rules won’t get anywhere</em></p>
<p>
<strong>Naval:</strong> You can give every deal one fatal flaw: the thing
that traditional venture capitalists will use as their excuse to pass on
the deal. If there’s more than one flaw, you have to worry.
</p>
<p>
<strong>A startup that breaks all the rules won’t get anywhere</strong>
</p>
<p>
Startups are rewarded for innovating on something new. If you invest in a
startup that’s trying to innovate on things that already work—such as team
structure or founder mentality—you’re just taking on additional risk.
</p>
<p>
You have to use your judgment to figure out when a startup can break the
rules and when they can’t. A startup that follows all the rules probably
won’t be interesting. A startup that breaks all the rules won’t get
anywhere, because they have to reinvent everything from scratch.
</p>
<p>
Uber was strange when it first came along, because investors considered it
a taxi business and they didn’t invest in offline industries back then.
</p>
<p>
To them it looked like the app was 5% of it and the other 95%
was people driving cars—and they were correct. The question, though,
is how much leverage accrues to the company that owns the app and how much
can they expand the market with the app by introducing new products,
attracting new customers and creating convenience.
</p>
<p>
Google was strange because everyone thought the search wars had already
been won by the time they showed up.
</p>
<p>
<strong
>Breaking the rules is easier when you understand technology</strong
>
</p>
<p>
To know which rules to break, it helps to understand technology. As an
investor, the best position is this: Others pass on a deal because they
don’t understand the technology, and you have enough technical insight to
know it’s feasible. Then, you have to make sure you can get it funded to
the point where it’s obvious to everybody.
</p>
<p>
The value comes in breaking the “rule” that you know isn’t a rule, while
everyone else thinks it is.
</p>
<h2>You’ll Get Less Money in Your Winners</h2>
<p><em>Always try to get your standard bite-size in a deal</em></p>
<p>
<strong>Naval:</strong> It’s easy to overestimate your own judgment. It’s
perfectly OK to say, “I don’t know.” That should be your answer most of
the time.
</p>
<p>
There’s only a few deals where you should say, “I have conviction.” And,
even then, be careful how much conviction you have.
</p>
<p>
At the seed stage, if you put a lot of money into one company and very
little into another, that begs the question: “Do you really have
conviction, or do you simply have better access to one deal?”
</p>
<p>Generally, the better the deal, the less access you’ll have.</p>
<p><strong>Always try to get your standard bite-size</strong></p>
<p>
If you put a lot of money into a few deals and little money into many
others, you’ll find that your winners tend to come disproportionately out
of the deals with little money invested. And that will hurt your portfolio
return.
</p>
<p>
Once you have conviction, always try to get your standard bite into that
deal. If a deal has too much space for you, that means: Either you should
invest more in other deals or less in this one, or you should get rewarded
with a lower valuation because you’re creating the signal that the company
will use to raise the bulk of the money.
</p>
<p><strong>Anyone chasing hot markets gets killed</strong></p>
<p>Anyone in this business who’s chasing hot markets gets killed.</p>
<p>
If you started seed investing when the consumer social market was hot, the
market was done by the time your investments matured.
</p>
<p>
If you invested in the masses of food delivery companies that showed up
once it became obvious Uber was winning—if you invested in companies five
through 50—you lost your money.
</p>
<p>
If you invested in crypto in 2017, you hit the tail end of the market; the
early side was 2009 to 2015.
</p>
<p>
Today, SaaS is hot. It’s a proven moneymaker. Let’s see how it plays out.
When current seed-stage SaaS investments mature in five to 10 years, you
may find the returns are a lot lower than they are today. It’s good to be
at the beginning of a market—not at the tail end. By the time you see
conferences about it and read <em>TechCrunch</em> articles about it, it’s
probably too late.
</p>
<h2>Don’t Fantasize About What You Would Do If You Were the Founder</h2>
<p><em>You’re not running the company—you’re betting on the founder</em></p>
<p>
<strong>Naval:</strong> A common trap for investors—especially if you’re
an entrepreneur—is to fantasize about the things you could do with the
company if <em>you</em> were the founder. You’ll learn the painful lesson
that it’s actually the entrepreneur who’s running the company.
</p>
<p>
It’s important to listen carefully and take the founder at their word
about what they plan to do. Don’t get caught up in the idea that somebody
else is going to run the company.
</p>
<p>
Angel investing is the opposite of value investing. Warren Buffett says,
“<a href="https://quoteinvestigator.com/2010/05/31/any-idiot-can-run/"
>Buy into a business that’s doing so well an idiot could run it, because
sooner or later, one will</a
>.” That’s not the case with startups.
</p>
<p>
With most startups, almost all the value creation happens while the
founder is intimately involved. So you’re betting on the founder.
</p>
<p>
If you bet on a founder you’re not excited about even though you’re
excited about the market or product, often the founder will fumble the
company or a competitor will come along with a much better founder. When
that happens, either you’ll be conflicted from investing in the new
company or the new founder won’t want to talk to you because you invested
in a competitor.
</p>
<h2>Invest in the Smartest Scientists in a New Field</h2>
<p>
<em
>You’re not going to become a great tech investor by reading
TechCrunch</em
>
</p>
<p>
<strong>Naval:</strong> There are many ways to build good judgment. The
timeless kind of judgment—good decision-making and the ability to size
people up—comes with experience. You can develop it by reading great works
at the intersection of science, business and philosophy. Read books that
cover how smart people think. Build so-called “<a
href="https://fs.blog/mental-models"
>mental models</a
>” and develop an understanding of microeconomics, mathematics and game
theory.
</p>
<p>
<strong
>You’re not going to become a great investor by reading
TechCrunch</strong
>
</p>
<p>
You can build <a href="https://nav.al/finding-time">timely</a> specific
knowledge in a field by diving in and learning everything you can about
it, as quickly as possible.
</p>
<p>
You won’t become a great tech investor by reading about technology on
<em>TechCrunch</em> or <em>Bloomberg News</em>. You have to go to the
source. You shouldn’t hesitate to read scientific papers and journals. You
should brush up on your mathematics. You should genuinely enjoy the act of
learning science and technology. After all, technology is applied science.
</p>
<p><strong>Invest in the smartest scientists in a new field</strong></p>
<p>
You can also develop good judgment by investing in the smartest scientists
and technologists in the space. Even if they don’t make you money, they
can perform due diligence for you on deals. They can validate and
calibrate deals for you, and they can send other great scientists your
way. Perhaps you’ll make them advisors to your fund, give them a piece of
your carry, or let them invest with you.
</p>
<p>
I did this early on, when I invested in cryptocurrency companies. I became
friends with
<a
href="https://twitter.com/zooko?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Zooko Wilcox-O’Hearn</a
>, who started <a href="https://z.cash/">Zcash</a>;
<a
href="https://twitter.com/juanbenet?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Juan Benet</a
>, who started <a href="https://filecoin.io/">Filecoin</a>;
<a
href="https://twitter.com/ryaneshea?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Ryan Shea</a
>
and
<a
href="https://twitter.com/muneeb/status/1238266251438407680?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Etweet"
>Muneeb Ali</a
>, who started <a href="https://blockstack.org/">Blockstack</a> together;
<a href="https://twitter.com/bramcohen?lang=en">Bram Cohen</a>, who
started <a href="https://www.bittorrent.com/">BitTorrent</a>;
<a href="https://twitter.com/elibensasson?lang=en">Eli Ben-Sasson</a>; and
<a
href="https://twitter.com/socrates1024?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Andrew Miller</a
>. They became my go-to people for vetting and validating deals. They told
me which technologies were real and which ones weren’t; and which
scientists were credible and which ones weren’t.
</p>
<p><strong>Scientists and technologists are a secret weapon</strong></p>
<p>
If you surround yourself with top scientists and technologists, they will
become your secret weapon. They tend to be no bullshit—they’ll tell you
exactly what they think of a new technology. And they’ll refer you to
their networks.
</p>
<p>
You’ll need to use your own judgment to decide when they’re being
unnecessarily negative or jealous, because that’s human nature. Overall,
very technical people tend to be extremely objective. They’re used to
corresponding with the real world and scientific results, rather than
people who are influenced by subjectivity.
</p>
<p>
If you can find a group of painfully honest and distinguished scientists
and technologists, that will be a secret weapon throughout your investing
career.
</p>
<h2>Invest Only in Technical Teams</h2>
<p>
<em>If there’s no technical team, you’re not investing in technology</em>
</p>
<p>
<strong>Nivi:</strong> Let’s discuss how judgment applies to evaluating
teams, product and market, traction, and social proof.
</p>
<p><strong>Every great founding team has a great technologist</strong></p>
<p>
<strong>Naval:</strong> This is the <em>technology</em> business; you want
to invest in <em>technology</em> teams. Every great tech startup is highly
likely to have a great technologist on its founding team. If they aren’t
the most important member of the team, the technologist must be
sufficiently compensated and motivated. Their name and accountability must
be critical to the project.
</p>
<p>
If there’s no strong technical person on the founding team, either it’s
not a technology business or the company has outsourced that
function—which is not just a yellow flag; it’s a red flag. For
example, I don’t consider
<a href="https://www.dollarshaveclub.com/">Dollar Shave Club</a> a
technology business.
</p>
<p>
Of course, you can make money investing in non-technology businesses like
Dollar Shave Club or Chipotle, but that’s not what we’re talking about
here.
</p>
<p><strong>If you’re not building, you’re selling</strong></p>
<p>
Anyone on the founding team who’s not highly technical should be great at
selling: to end users of the product; to investors while raising money;
and to potential employees to recruit talent.
</p>
<p>
A <em>community builder</em> is another character that can be incredibly
useful, though good ones are rare. They sell, too. Only, they’re good at
mass sales instead of one-on-one sales. Like growth hackers, they’re a
unique combination of building and selling.
</p>
<p>
Great community builders are high leverage, but they’re also extremely
difficult to find. They’re probably the rarest thing right now. Everyone
claims they’re good at community building, but you need to see the
results.
</p>
<h2>You’re Not Investing in Nice People</h2>
<p>
<em>Invest in people with high energy, intelligence and integrity</em>
</p>
<p>
<strong>Naval:</strong> I use Warren Buffett’s
<a href="https://nav.al/intelligence-energy-integrity">three-part test</a>
for qualities you want in a partner: high energy, high intelligence and
high integrity.
</p>
<p><strong>Startups are the Olympics of business</strong></p>
<p>
High energy is obvious. You have to work hard, because startups are the
Olympics of business and you’re competing against the best in the world.
To paraphrase “<a
href="https://en.wikipedia.org/wiki/Glengarry_Glen_Ross_(film)"
>Glengarry Glen Ross</a
>”: first prize gets a Cadillac Eldorado; second prize gets a set of steak
knives; and third place gets fired. If you’re going to win, you need
people who put in everything.
</p>
<p>
There’s a meme on Twitter that you should work 9 to 5 all the time, and
that’s work-life balance. That’s fine; not everybody should kill
themselves at work. But then I’d argue that you shouldn’t be an Olympic
athlete or a founder of a winner-take-all technology startup.
</p>
<p>
If you’re doing a startup, you and the rest of the core team will have to
work your tails off.
</p>
<p><strong>Be a snob about intelligence</strong></p>
<p>
High intelligence is important, because you need good decision-makers.
Intelligence isn’t just about broad judgment; it’s also about
moment-to-moment judgment.
</p>
<p>
If you invest in people who aren’t of the same intellectual caliber as
you, then you’re essentially investing down, talking down and thinking
down. You’re picking the wrong people.
</p>
<p><strong>Integrity gets tested when the stakes are high</strong></p>
<p>
High integrity is critical. If you don’t have that, you end up with a
smart and hardworking crook who can easily cheat you—and there’s so many
ways to get cheated in this business.
</p>
<p>
Integrity takes a long time to figure out. It’s hard to assess someone’s
integrity if you haven’t worked with them for a long time, which will be
the case with most founders. You can observe how they treat people around
them, including prospective investors~~,~~ co-founders and employees.
Someone who self-deals with others eventually will cross you.
</p>
<p>
Founders don’t necessarily need to be nice people. Niceness is a signal
that’s easily faked. It’s not enough of a filter. Technical people tend to
know that, so they don’t overemphasize niceness. It may be important to
you, because you’ve decided it’s more enjoyable to work with someone who’s
nice. But there are plenty of successful business people who are not nice.
</p>
<p>
Seek integrity over niceness. Integrity means living up to an internal
moral code of ethics. It’s being reliable and honest. Niceness often is
just politeness or someone sending off signals that they have integrity
when the stakes are low. Integrity gets tested when the stakes are high.
</p>
<h2>Coachability Is Overrated</h2>
<p>
<em>Great founders listen to lots of advice and follow little of it</em>
</p>
<p>
<strong>Naval:</strong> There’s a meme among venture
capitalists—especially inexperienced ones—that a good founder should be
coachable. These investors rely too much on their own abilities, thinking
they’re right and founders are wrong.
</p>
<p>
Inexperienced investors also rely too much on the idea that you can change
people in the short-term. Experienced investors know this isn’t the case.
</p>
<p>
In fact, great founders aren’t that coachable. They listen to lots of
advice, but they follow very little of it. They develop their own internal
compass. So I believe that coachability is an overrated metric.
</p>
<h2>Your Reputation Is Built by the Companies That Are Doing Poorly</h2>
<p>
<em
>Don’t invest so much that you’ll behave badly when things get rough</em
>
</p>
<p>
<strong>Naval:</strong> Angel investors tend to be on the tough side when
they get started, especially when investing a lot of their own money.
</p>
<p>
Generally, you don’t want to invest money that you’re not OK losing. If
you have too much at risk in any deal, you’ll engage in bad behavior when
things get rough. When the company performs poorly, you’ll behave poorly.
Emotionally, you won’t be able to help it, and it’ll damage your
reputation.
</p>
<p>
<strong
>Your reputation is built by the companies that are doing poorly</strong
>
</p>
<p>
Your reputation gets built in those moments. Your <em>returns</em> get
built by the companies that are doing well. Your <em>reputation</em> gets
built by the companies that are doing poorly.
</p>
<p>
In the long term, your returns also depend on your access. And your access
depends on how you behaved with founders when companies were doing poorly.
</p>
<p>
As a consequence, you never want to have too much at risk. So don’t put
down so much that you care.
</p>
<h2>Founders Almost Can’t Be Referenced</h2>
<p>
<em
>A founder who’s great for one business may be terrible for another</em
>
</p>
<p>
<strong>Naval:</strong> Some angels insist on checking references of
founders. This can work if you know what you’re doing, but reference
checking is an art that most people haven’t mastered.
</p>
<p>
Founding a startup is an act of creativity. If you think of the great
writers, philosophers and artists throughout history, honest references
would tell you they’re all crazy.
</p>
<p>
Founders are non-fungible; they’re irreplaceable. A founder who’s great
for one business may be terrible for another. The founder who can build
Craigslist—community-oriented, extremely patient and almost
anti-capitalistic—won’t work for a financial startup that’s racing to
raise and deploy lots of capital while pitching banks and regulators. So,
it’s the right founder for the right job.
</p>
<p>
References tend to be generic. They don’t work as well for assessing
founders as they do for hiring employees, where you’re looking for someone
to scale processes that already work.
</p>
<p><strong>I passed on Twilio because of a reference</strong></p>
<p>
I passed on <a href="https://www.twilio.com/">Twilio</a> in the seed round
because of a reference—big mistake. The reference came from somebody I
trusted who had good intentions. It was probably even accurate, but that
was beside the point. I should have gone with my gut feeling that
<a
href="https://twitter.com/jeffiel?ref_src=twsrc%255Egoogle%257Ctwcamp%255Eserp%257Ctwgr%255Eauthor"
>Jeff Lawson</a
>
was the right founder for the job.
</p>
<p>
I also passed on <a href="https://ethereum.org/">Ethereum</a> very early
because of a reference from a VC who was active in the space. The
reference dissuaded me in a way that it shouldn’t have—though I clued into
that one later.
</p>
<p><strong>References can devolve into checklists</strong></p>
<p>
References from VCs are among the worst type. For every deal a VC does,
other VCs passed on that very same deal.
<a href="https://www.sequoiacap.com/">Sequoia</a> does a lot of deals that
<a href="https://a16z.com/">Andreessen</a> has passed on, and vice versa.
This goes up and down the chain.
</p>
<p>
The best deals aren’t always chased by the best VCs. In this market,
everyone has their own unique point of view, and the good players have
<em>very</em> independent points of view.
</p>
<p>
References can devolve into checklists: “I better check the box that I’ve
done all these references.” Or, if you do listen, your point of view
becomes a smeared average, diluted by what other people think.
</p>
<h2>Avoid Teams That Would Sell Early</h2>
<p><em>Venture capital is a grand slam business</em></p>
<p>
<strong>Naval:</strong> Angel investing is a game of exceptional outcomes;
it’s not a game of averages. You’re better off with a portfolio in which
nine out of 10 investments go to zero and the 10th one goes 1,000x, than a
portfolio where all of them are 2x or 3x.
</p>
<p>
If a founding team hints, signals or even just <em>appears</em> likely to
sell the company early, it’s a strong negative indicator. Teams that are
overly financially motivated often will sell a company for $100M or
$200M. That’s a life-changing outcome for them; but it doesn’t
matter much to you because you own so little. It’s not going to move the
needle on your net worth.
</p>
<p>
As Bill Gurley famously said, “<a
href="https://www.google.com/search?client=safari&rls=en&q=%25E2%2580%259Cventure+capital+is+not+even+a+home-run+business;+it%25E2%2580%2599s+a+grand-slam+business.%25E2%2580%259D&ie=UTF-8&oe=UTF-8"
>Venture capital is not even a home run business. It’s a grand slam
business.</a
>” The smart VCs look for extreme outliers.
</p>
<p>
This is why smart VCs let founders sell
<a
href="https://medium.com/@rizstanford/secondary-sales-in-vc-backed-startups-a-quick-primer-for-entrepreneurs-bdc25ea7f39a"
>secondaries</a
>
early on. They take some money off the table in exchange for going for the
gold.
</p>
<p>
When you invest in a company that is going to sell early, you miss out on
compounding interest. Also, VCs downstream will read that signal and pass
on that deal, and the startup won’t be able to raise the cash they need to
become a big company.
</p>
<p>
It’s difficult to pull this signal out of founders, although sometimes
they offer it.
</p>
<h2>‘First-Time Founders’ Often Have Been Tinkering for Quite a While</h2>
<p><em>Their ‘first’ startup isn’t always their first startup</em></p>
<p>
<strong>Naval:</strong> There’s a running debate among investors about
which is best: first-time founders or repeat founders. There’s no hard and
fast answer.
</p>
<p>
I’d argue that most of the value in the industry is probably created by
first-time founders. Think of Jeff Bezos, Bill Gates, Larry Page and
Sergey Brin, and Mark Zuckerberg: Lightning strikes, things catch fire and
the company takes off.
</p>
<p><strong>‘First-time founder’ can be misleading</strong></p>
<p>
Though, the label “first-time founder” doesn’t really apply to some of
these. Zuckerberg had other projects before Facebook took off. Gates
founded
<a href="https://en.wikipedia.org/wiki/Traf-O-Data">Traf-O-Data</a> with
Paul Allen long before they did Microsoft. They measured traffic and sold
the data to cities.
</p>
<p>
Often, a so-called “first-time founder” has been tinkering for quite a
while.
</p>
<p><strong>Repeat founders tend to be better at execution</strong></p>
<p>
Repeat founders also can be extremely successful. Look at Uber, WhatsApp
and Zoom.
</p>
<p>
Repeat founders tend to be much better at execution. They’re good at
recruiting teams and generally more careful about what markets they enter.
Repeat founders also have better connections, which makes fundraising
easier.