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Capital Allocators – Inside the Institutional Investment Industry
[REPLAY] Josh Wolfe – Seeing the Lux (Capital Allocators, EP.65)
01:09:30
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Capital Allocators is brought to you by my friends at WCM Investment Management. WCM has the courage to back future histories not evident today. Informed by their unrelenting focus on moat trajectory and elevated by insights on corporate culture, WCM's deep roots in public markets set the foundation for its approach to private investing. They didn't just want to enter the private markets, they wanted to improve the investing model itself, build something better, aligned, more thoughtful and truly long term. As a firm owned by its people and grounded in Laguna Beach, WCM is built for alignment and independent thought rather than chasing a scoreboard. WCM invests with a partnership mentality to build meaningful relationships. With founders reimagining their industries. They show up earlier, stick around later and let value compensate compound over years. WCM's style is their edge. Authenticity over formality, two way learnings over checklists and stories over slide decks. To learn more, visit wcminvest.com this testimonial.
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Is being provided by TED sites and Capital Allocators who have been compensated a.
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Flat fee by wcm.
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The statement was made in connection with Capital Allocators testimonial and production of podcasts and does not depend on the success.
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Or level of business generated.
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The opinions expressed are solely those of Capital Allocators and may not reflect the opinions of others. Investing involves risk, including the possible loss of principle. Past performance is not indicative of future results.
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Please visit wcminvest.com for WCM's ADV and further information.
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Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can keep up to date by visiting capitalallocatorspodcast.com.
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My guest on today's show is Josh Wolf, the co founder of Lux Capital, a billion and a half dollar venture capital firm that targets cutting edge solutions to the most vexing puzzles of our time. Josh is an innovative thinker whose ideas have found their way to columns and Forbes lectures at mit, Harvard, Yale, Cornell, Columbia and nyu and Twitter. Our conversation covers Josh's early passion for science and finance, building a competitive advantage in venture capital from scratch, the full blown investment process at Lux, including sourcing ideas, conducting due diligence, making investment decisions, constructing portfolios and exiting companies, navigating a challenging private equity environment, posting on Twitter, active versus Passive management, dinner table conversation and life lessons. I hope you enjoy the show and if you do this week, why not reach out to your parents? If they're anything like my folks, they probably aren't that technologically inclined and might need to learn how to use the podcast app on their phone. Reach out to them, send your love and show them how to use the app. And then tell them you might want to listen to Capital Allocators. Thanks so much for spreading the word. Please enjoy this wide ranging conversation with Josh Wolff.
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Josh, great to see you.
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Great to see you, Ted.
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Look, I always love starting with so much background, and I know yours is as interesting as anyone, so why don't you dive right in?
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You know, grew up Coney Island, Brooklyn, and.
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So were you competing with Joey Chestnut back then?
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No, man. I mean, that's just like 74, I think, is the. Is the number.
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It was in the 70s and it's. And on a humid day. So apparently think about a humid marathon day.
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I will concede I am a Kobayashi fan and the commercial interests have skewed him out of things. And Joey Chestnut's in there, but. Yeah, no, I mean, Coney Island's famous for way more than hot dogs. I grew up within spitting distance of the Cyclone, which to me is this great metaphor of the highs and lows, both emotionally in life, but of the investing business. You've got all kinds of carny charlatans that basically sculpt you into a somewhat cynical, squinty eyed, distrustful person of somebody trying to scheme over you. Which I think in my business, where you never really know if somebody is going to be literally changing the world and inventing the most important thing or trying to run a fraud is an important skill to have.
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Give me a story of someone trying to defraud you.
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Well, you just, I mean, look, you go through Coney island, you have the carnival barkers, right? And everybody's just trying to hustle. And you go on the boardwalk. And it is arguably the most diverse part of New York City because you have Hasidic Jews and you've got Puerto Ricans and you've got African Americans and Latino and white old Jewish people. And like, everybody's running some scheme, right? And so you just, you see it, you see the hucksters. Why? In part because you have an immigrant life that is coming, and you have people that are hardworking and motivated and they're driven by merit, and they're trying to make a life better for their family. And you have other people that are in the same situation, but they're taking the easy way out. And so you have this amalgam of ethics and morality and ambition, and it just makes for this awesome hodgepodge. But if you get mugged at an early age, or you get conned at an early age, or you get beaten up at an early age, you quickly develop this skeptical, you know, cynical, thick skin.
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And did you have all those things happen?
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I did, yeah. And my mother taught me at a young age. I got mugged for, you know, back then it was like your JanSport backpack and your starter jacket. Those were like the cool things in like late 80s, early 90s. But none of that stuff is worth your life, right? So you just give it up.
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And what was the con that got you?
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I think at a young age I was always very naive and gullible. And so I think even if it was like friends playing prank, there was always somebody that was just trying to snooker you. And so I'm very guarded and generally distrusting, which itself is a natural evolution, I think, to sort of almost expect the worst from people. And even, even in life and business, like I expect, you know, technology's change and businesses change and products change and markets change, but I think human nature is this sort of Shakespearean and in my view, a bit Hobbesian, you know, constant.
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Yeah, so that's where it all started.
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It all started at Coney Island.
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And what was your, like, early formative education like?
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Mom a school teacher, she pushed me to be a nerd. You know, I love playing basketball, I love hip hop, I love heavy metal. Like, I love. I love the outsiders.
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Right.
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I love people that are sort of always outside the mainstream, which I think to this day serves me well in looking for people that are, you know, generally, whether technologically or in markets, just not trying to fit in with the consensus. But always, you know, was driven by an interest in science and in finance. I got really lucky. When I was in high school. I happened to watch this movie and the band played on on hbo, which was all about the AIDS crisis. And I was like, you know, gee, I want to do something big and I want to cure aids. And at the time I got selected to do this Westinghouse science talent search, which then became Siemens and Intel and others have sort of taken on the sponsorship. And I worked my way into this lab, SUNY Downstate in Brooklyn. And you know, I was probably 13 years old. There's no way that they're going to let some 13 year old work in a lab. And I just wouldn't take no for an answer. This guy, Dominic Oss, he was a PhD scientist. He took a liking to me, took me under his wing and. And the plan was to do this pretty sophisticated immunopathology research about the progression of a protein in AIDS blood that went from HIV into full blown aids. And while we're spinning down centrifuge and waiting for blood to come, he was trading futures and options. And I became way more enamored with capital markets. And I was like, okay, here's a guy who's making money, which is something I wanted to do. And he was doing real science. And so I literally learned everything that I learned about markets from that free giveaway guide that they give you, the Wall Street Journal Guide to Money and Investing, when you first get a subscription. And. And I learned what a stock was and what a bond was. And then from there just would network everywhere and anywhere I could to somebody that was from Brooklyn or maybe went to my high school or ultimately when I went to Cornell, was a Cornellian that would give me a shot.
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And was that initial interest. So you had science, but that was public markets.
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Yeah, public markets. And the interest in venture. I mean, I didn't know what venture capital was until late 90s. Now you have this boom in Internet and you see all these people particularly there were a few people at Cornell that started, I think was called theglobe.com and all of a sudden there were these young millionaires on campus. You know, it would go bust years later, but it was sort of inspiring. Wait a second. There's this pool of capital that could be formed and you can invest in stuff that doesn't yet exist. It isn't even publicly listed. And in some cases it's off the beaten path and it's almost secret. And that totally appealed to me. I mean, that in different walks of life, right. I always loved the bands that nobody had discovered yet. I liked the New York hardcore bands and the heavy metal bands that nobody was talking about. I loved the art that was off the beaten path. And so, you know, I'd always root for the underdog in sports. And so it was the same thing here. You're rooting for these scientists and these technologists that are inventing something nobody really knows about yet. And there's this thing called venture capital. And there was a sexiness of that even, right. Ventures like an adventure. And then I just read everything I could and talked to everybody I could and became obsessed. And it was the perfect hybrid between science and finance.
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Yeah. So when you put those together and you started learning more and more about investing, what are the key tenets of whether it's a philosophy or sort of how you think about how investing works or should work.
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It starts with, I think, looking where other people are not looking. So if you are looking where everybody is looking, as Buffett has said very famously, you pay a high price for cheering consensus. So that means reading voraciously and trying to understand what is the consensus in markets and then finding the variant perception what's the thing that nobody else is thinking or talking about. And often if you can identify the reason they're not talking about it, you're further advantaged. So that to me is just a very competitive intellectual curiosity. I want to know what everybody else is reading and talking about and then I want to go find the thing that I think they're not talking about and try to become an expert in it. And that sometimes leads me on wild goose chases and down rabbit holes, but often leads me into interesting things that then end up having positive outcomes.
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That sounds like a typical variant perception public market mindset. Does that apply equally to what you're doing today in the private markets?
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I personally think so. I'm inspired by people in global macro. I'm inspired by long, short hedge fund guys. I'm inspired by deep value, Buffett, Munger, Markel type, Klarman. And then I'm inspired by the, you know, the early John Doerr and Pierre Le Monde, Kleiner and Sequoia partnership type who were literally investing in people that were inventing the future. And I think that that guard has given way to people that are funding, you know, what I consider fufu apps and you know, mobile stuff that I think has very little relevance but like real hard technology, it's provable, it's real, it's verifiable. It's not, you know, the things that are sort of prone to fraud so you often see in other fields. And then it's like, okay, simple questions like how much money will it cost to accomplish X and who will care when you accomplish X? And then you get into certain philosophies about risk and value and how they're created or destroyed, which I think guide how we allocate and how we size things and who we invest behind.
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So what was your path to starting to read about investing, being passionate about it, finding this great 13 year old marriage between science and options trading, to, you know, having your own private equity fund?
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The honest answer is luck. I mean, I always say that the governing force of my life is randomness and optionality and ex post facto. You explain everything very clearly as this linear chain of events. But it's, of course, this messy amalgam, you know, entropic craziness. I graduated Cornell, went into investment banking. I joke. I wasn't smart enough to collect my first year bonus, which proved to be the best thing ever. Partnered with Peter Hebert, who I was at Solly. He was at Lehman Brothers in equity research. He is the perennial optimist. I'm the perennial cynic. It's this perfect yin and yang. We joke. He invented the airplane. I invented the parachute. He looks. He looks for the best in people. He looks for the best in outcomes of our companies. I, on the downstroke, I'm thinking, okay, what could go wrong? Let's kill all the things that can go wrong, because every one of those things is a risk. Financing risk, technology risk, market risk, product risk, et cetera. You kill those risks and value gets created, because a later investor should be basically investing and paying a higher price than you and demanding a lower quantum of return for a lower quantum of risk. And so we just started to kick around, okay, what areas were totally neglected that people were not looking at? And it really was the physical chemistry, material sciences. And those were happening at universities and government labs that were not being fawned over by venture capitalists during the late 90s, early 2000s, when everybody was looking at computer science and electrical engineering and optical networking with the telecom boom and the dot com boom. And so we carve that out and you start celebrating these scientists, some of whom were Nobel Prize winners. And you have time with a guy like Rick Smalley, who is at Rice, who invented or discovered the fullerene, the C60 carbon nanotube and buggy ball.
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And.
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And you know, it's like, oh, my God, we're sitting with Nobel laureates and they're like, inventing the future. And there's this crazy stuff and nobody's paying attention to them. So then we went out and said, okay, let's raise money around this. And I always joke that when you raise friends and family money, you know, it's good that one of them have both and your friends have or family have money. We had a lot of friends. We had a lot of family. None of them had any money. And we got very lucky. And through a guy that I knew in my investment banking group, he had a father who had worked at trw, and TRW was one of the early Carlyle Group acquisitions. And we got an audience by pure luck with this guy, Bill Conway, who was one of the founders of Carlyle. He's not really bullish on venture. Carlyle is one of the greatest private equity and bio funds, but he doesn't love venture capital. But there was something, whether it was the right day or he liked us, or he liked our strategy or the way that we were talking or thinking and he said, I hope you make a billion. And he became an investor in locks. He became an investor in our management company and asked us the most important questions as we started to think about how we built the firm. And I really credit him enormously with the path and the trajectory. It was this fluke introduction that I think changed our lives.
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What were those questions?
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Why should you exist? Why the heck does the world need another venture fund when there's 1000 of them out there? What are you incrementally going to be producing? How can you compete? Number two, what will be your competitive edge? What's going to be your really durable advantage competitively? When you're looking at these amazing people at Sequoia and Benchmark and Accel and Kleiner, why would an LP possibly give you money, number one? But why would an entrepreneur possibly take it, number two? And that was what we spent really the next three, four years focused on, which is how do we persuade an entrepreneur that they should take Lux's money when they had no idea who Lux was, they had no idea who Josh Wolf or Peter Hebert were. And that sort of competitive thrust that we didn't want to wait in line, that we wanted to sort of start asserting the value that we could bring in a non cliched way to entrepreneurs was what ultimately defined the early platform for Lux.
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And how did you answer those questions over time?
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Some of it was studying history and looking at, okay, what's valuable? And when you look at a company, what do they need? They need to be able to raise future capital. Well, we had no relationships. And so the financing risk for a company that we might invest in was going to be very high. Right? Because we had no signaling value. Like if Sequoia or Benchmark is investing in a Series A company 10 years ago, the next three rounds were taken care of because you had Sequoia and Benchmark in there and there was social proof and positive signal value. We had none of that network of entrepreneurs, you know, to be able to recruit people. And we had none of that intellectual capital. We had a little bit of that because we were early to some spaces and we were providing some thought leadership. So we ended up building these three entities and we did them out of necessity so that we could Point to them and say these are ways that we can tangibly help you as opposed to being some cliched BS VCs that say we're value add investors. And so we created a public policy group and we were able to go down to Capitol Hill and influence where legislature and non dilutive money was flowing so that we could get large sums of cash for the spaces we were investing in and ultimately for the companies we were investing in.
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How did you do that, knowing probably at the time very little about how Washington worked?
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Not only did I not know how Washington worked, I wasn't even a registered voter, okay? I was young, I was naive and again, luck. There was a guy who happened to work in the Clinton administration. He had seen me give a talk about nanotech and advanced materials. He saw in his own self interest there's an opportunity here to form some public policy groups and start advising. And why don't I get thought leaders like Josh and get 20 of them and go down and meet with the senators and congressmen and influence what's going on and then get the companies, the big ones and the small ones and all the service providers that want to, you know, get their business. And so it was really his construct to go do this. And then we benefited from being on that platform and it gave us access and entree into a lot of the key decision makers and frankly heightened my cynicism about politics and the way that everything works. Then we saw in the media business, one of the great things that an unknown company or an unknown entrepreneur wants is to be known. And so if you can raise their visibility in their profile, that is a very valuable currency. And so we ended up partnering, inspired by the late 90s where George Gilder, if you remember, and he had the Gilder Technology report. Exactly. But George Gilder was doing telecom and he was writing about these companies. And he would put a company's name in big bold letters and the stock during the bubble would be up 30, 40% in a day just because it was the sort of Keynesian, like social proof of people knew that other people were reading, that other people were reading ad infinitum. And George ended up going bankrupt personally. And we learned a lot from him about what to do and what not to do. But he was really a great thought leader about the directional arrows of progress in technology. And he was right about many things, he was right about many companies and he was also wrong about a lot. Key was partnered with Forbes, who did the distribution and the marketing and the management for this. And we Ended up doing the same thing. Through that, we got a partnership with Forbes, which was a great brand. We were able to have a megaphone. We had a soapbox and always fully disclosed, which was one of Bill Conway's great admonitions is 10 years to build a rep and 10 seconds to lose it. And so now we had access, access and entree to Nobel laureates and CEOs and billionaires who otherwise would not have given us the time of day. And suddenly, in part appealing to their vanity and ego, invoking the old Ben Franklin quote, would you persuade, appeal to interest, not reason. We were able to get access and appeal to their interest to be profiled in something like Forbes with full disclosure. And so now you have the public policy piece, you have the Forbes and media piece. And then Peter, my co founder, had this great idea. Look, anytime there's a high degree of informational uncertainty, people will pay a lot of money for information to reduce that uncertainty. And the evidence was the foresters of the world and the Gartners and the corporate executive boards and even Gersten Lerman that were mostly selling to hedge funds. So we spun out a lot of our intellectual property into this business called Lux Research. And at peak employment there, we had, I think 140, 150 people. We ultimately sold this to a private equity firm. These are, you know, two thirds of them are PhDs in chemistry and physics and material science. We had eight offices worldwide. It was this great intellectual catchment of what the big companies were doing, what the small companies were doing, who was full of it, who was for real. And when you put all those things together, if you were an entrepreneur now we were able to answer that original bill common question of like, what is our edge? We were able to come to you and say, we can get you tens of millions of dollars of non dilutive money. We can raise your profile in the media when the time is right, with appropriate disclosure. And most importantly, we can get you access to all the key decision makers who are going to be customers, partners, investors, acquirers, licensors. And that became real. And that was really the foundational thing. But all that was done out of necessity because otherwise why would an entrepreneur have taken our money? Right?
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How did you sequence all of that?
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Again, a lot of it was like randomness, right? Somebody heard me speak and said, do you know anything about Capitol Hill and the way that all this works and the way that money is flowing? And I said no. And that happened to coincide with the fact that we were writing research and putting out ideas, trying to get thought leadership. And that led to this nanotech report and the Forbes joint venture and then the spin off to Lux Research. And so it's so easy in hindsight to make it seem like this was so well thought out and orchestrated in a linear way. And I don't believe at any of our companies that is true. I don't believe in our own existence proof that is true. I just think that there's so much randomness, but when you see the thing and you seize upon it, it starts to make sense and then you sort of fit it to your narrative and then it develops from there.
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So somewhere along the way, the linear aspect is you needed to raise money and then find the companies to invest in.
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Exactly.
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We're in the sequence. You say, okay, we now have some proposition that allow us to go raise money. Or did you just try to raise money and then build this? As you went along, putting out the.
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Thought leadership, giving speeches, writing article, became a magnet. It became the beacon light where people were suddenly attracted to you. Why? In part, they wanted to be profiled or they want to be mentioned if you're giving a speech. In part because they knew that you were connected to somebody else and so they wanted access to it. And so that was some of the early deal flow. Over time, we became much more sophisticated in the approach for how we were hunting for deals. But in the very early days, that's what it started. So you have this opportunity set and then you went and said, okay, well, we want to invest in this now. And so you have this chicken and the egg problem. Always either you have a good idea and you're able to raise the money and then you're looking for the deal flow. Or in our case, we were able to generate the deal flow and the access and relationships with entrepreneurs who liked and trusted us. By the way, we're out there promoting them and singing their songs. And so all of that sort of just came together. And we were able to successfully raise what was our first fund, really, as a pledge fund from Bill Conway. And we went and said, we want to put our money where our mouth is. And really, very bluntly, we want to put your money, Bill, where our mouth is. And he laughed. And it's one of the great things, I think, very successful and very wealthy people. There's a wide spectrum. There are people who will sit and spin your wheels and waste your time for six months or a year. There are other people who can decide on a spot, the 90, 10 of it. He was one of those Pete Peterson who passed away was another who was an early investor at Blackstone. And they can make decisions very quickly with reasonable sums of money and get to the 90, 10 of it. The deal flow, we get the opportunity. The opportunity we then marketed, we were able to raise money and that became sort of fund one.
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When was that? When did fun one hit?
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That was 2003 four time frame or 2004, 2005. And then fund two, which was really our first institutional fund was about 11 years ago, and that was $100 million fund. And then two, three years later, we went from 100 to 250 and then to 350 and then 400 and then some opportunity funds and now just under a billion and a half. We have periodicity where now we're about every two years raising about $400 million.
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A
So let's dive through the investment process. You mentioned after a little while these initial deals were coming to you, but then you sort of formalized how you were going to go out sourcing ideas. What did that process become?
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The truth is some of it is pattern recognition. And you're saying, okay, well what are we doing? Well, some of it is inbound and you're sourcing it. And some of it is we're having ideas based on the stuff that we're reading or seeing. And some of it is people driven, where there's certain personalities that you're attracted to. And so over time, as you look at that and you observe it, you step back and you say, okay, wait a second. We have sort of three different styles that we're developing here. One was very much a manifestation of my own personality, which is thesis driven. I read voraciously. I find that varying perception. I'm thinking about the thing that other people aren't. And I'm coming up with a thesis. If I've heard the thesis, if I've read about the thesis, to me the value is very low. If nobody else is talking about it, to me the value or potential is very high.
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What's an example of one of those?
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Well, nuclear in Fund II was something where nobody was talking about nuclear. Everybody was talking about clean tech and green tech and alternative energy. We decided that we thought nuclear was interesting in part because nobody was talking about it. And then when you scratch the surface, double click in and say, okay, what is the biggest problem? The answer is, and I always like to ask this sophisticated two word question, I joke, which is, what sucks? The thing that sucked about nuclear is what do you do with the waste? And there was this global market for it there were 440 global reactors. There was this whole defense industry of pre and post Cold war bomb making where billions of dollars were being spent and it was mostly going to the Bechtels and Floors, the big engineering contractor firms. And we were able to start a company, go after that market and frankly got lucky. Albeit the strategy was sound in that win, lose or draw, if there was new nuclear, we won. If there was status quo because plants get older, they produce more waste, we would win. And if there was a catastrophe which was unpredicted and improbable, you would win because it's all waste cleanup. Sure enough, a year or two after finding that company, there's a global catastrophe with the Fukushima disaster in Japan. And we became the only US company picked for the cleanup. And we went from a million to 20, 40, 80, 100, 140. We sold that at 40 million of EBITDA 10 times to a big French company, Veolia. And it was very gratifying, not only because of the work that they did that was meaningful, but because it started as a thesis. Another thesis was around tattoo technology. There are millions, tens of millions of Americans that have tattoos. And I joke that you are generally long regret when you get one and you want to reverse that trait at some point. And if you have dark skin, of which there's been this great prevalence over the past 10 or 15 years, particularly for African American and Latino athletes, where you have mimetic copying of athletes, you can't get laser treatment because you're going to bleach your skin very light or white. And so there was a big opportunity there and we probably saw about a dozen different companies and finally funded an entrepreneur just about a year and a half ago in that space, but entirely thesis driven. So sometimes the theses.
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A
Is that happening?
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It is. So this particular technology came out of Princeton. It is a femtosecond laser. It removes all colors and painlessly, which is the important thing. And in one treatment, which is the big thing, because the asymmetry economically to get a $60 Celtic tattoo is very quick to get it removed is ten $600 laser treatments, which is 6,000 bucks. And so that asymmetry of regret we felt was arbitrageable with better technology. So that's under development. They start, they work on pigs, because pigs are the biggest proxy for our own skin. It'll probably launch internationally first and then come to the US but sometimes you find these theses or you develop these theses and then you're out hunting for the Confirming or disconfirming evidence. There's one that I fell in love with, which is always a dangerous thing. And the thesis that we developed internally, we call the half life of technology intimacy. And the idea behind this, and I'm going to give you different years and you'll see the half life and how it progresses is the quest to identify certain directional arrows of progress. If you can identify directional arrow of progress, and this is true in private markets or in public markets, you may not know this specific company, you may not know the specific technology, but it's very hard to believe that it's going to go any other way than the way it's trending. It's very hard to see how you would go from carbohydrates to hydrocarbons to uranium in energy.
- [25:47]
To go against that. In other words, the directional arrow of progress is towards more and more energy density per unit of raw material. So that to me felt like there was an inevitability of that directional arrow. Solid state lighting, to go from a flame to a filament bulb to an LED is a directional arrow of progress. We're not going back the other way. People are not going to be walking in the streets holding torches. Semiconductors and electronics to go from mechanical spinning drives to solid state drives to flash memory is an inevitability. So when you can identify that directional arrow, I think it holds secrets for you to unlock. In this particular case, the thesis around half life of technology intimacy was 50 years ago. This is all about the way that we interact with our machines and vice versa. Fifty years ago, you had a giant ENIAC computer that was like multiple refrigerators. And the way you interacted with it was go up, flip some switches, pull some plugs, and stand up and touch it. 25 years ago, the first half life you basically have. The dominant form of computing is a personal computer. It is on your desk. You are tickling the keys with your fingers. You have a mouse under your palm, and that's the way you're physically interacting with it. Twelve and a half years ago, the dominant form is that same thing, but now it's a laptop and it's physically on your thighs. Six and a half years ago, you have an ipod, which is now separated from your body only by a thin film of fabric. And you're swiping it and you're touching it and caressing it. It's the first thing you see in the morning, last thing you see at night. Three and a half years ago, it's the thing on my wrist now which is the iWatch and it's in direct contact with my skin 24 hours a day. A year and a half ago, it's AirPods that are in my ear. And when you step back and you see that directional arrow of progress, it is that we are going to be less hunched over a QWERTY keyboard and a mouse and much more natural human interaction with our computers. Which means the technology has to get more and more sophisticated while it gets more and more invisible. So I got very interested in voice and gesture and the way that you and I are interacting now. I'm motioning with my hands, I'm using my voice. We already have Siri, we already have Alexa, etc. And Google. Now as voice assistants, you already have gesture in the form of cameras like Kinect from Microsoft Xbox or Leap Motion. And we felt that the next logical thing would be not visually detecting what you were doing, but actually picking up the signal off of your own body. Sure enough, I get introduced and I always say I have this phenomenon I call 100 0100. I have 100% certainty we will be funding the most crazy cutting edge shit that you can imagine. I have zero percent certainty what those things will be because just intellectual humility says you just never know. But I know with near 100% certainty where I will find them and is generally at the cutting edge of our already cutting edge companies. And so in this particular case we funded a company here out of Columbia called Calliope and we helped to start it up and it was about sequencing the gut brain axis. And that's relevant for everything from pharmaceuticals, for obesity and metabolism, to even psychosocial disorders and anxiety and depression. The founding scientist of that is a guy, Charles Zucker. Charles Zucker is a thesis advisor to this young guy named Thomas Reardon. And like any great sci fi character, he goes by Reardon. Reardon GROWS up. It's an amazing story and I'll show you how the paths interconnect. And just the humility of this randomness and optionality. He's got 18 brothers and sisters, 10 of them biological, eight adopted. He is a math and science prodigy at 17 up in Cambridge and he's taking classes at MIT, auditing them, not actually in college, never goes to college, Gets tapped by Bill Gates and he becomes Bill's right hand guy for the next 10, 11 years. And while he's at Microsoft, he single handedly codes Internet Explorer, which we've all used. And he's also Bill's right hand guy during the entire doj Monopoly trial, makes a lot of money, retires, then goes and founds another company, joins Open Wave, gets sold to phone.com, they basically invented the mobile browser, and then really retires. And now he's wealthy and he's retired and he's in his early 30s and he does what anybody in that position would do. He goes back to college and he actually gets his degree from Columbia in Latin and Classics. And then crazily, he spends the next eight years getting a PhD in neuroscience, which is where our paths intersect. So now Charles Zucker, who he backed in his company Calliope, is his thesis advisor, one of the people where he has to defend his committee. And Charles is like, you gotta meet this guy. And here we have this thesis around the half life of technology intimacy. And here's Reardon, who is developing technology that can detect from your neurons what you intend to do and perfectly model all the movements in your hand.
- [30:04]
A
And when I practical application of that.
- [30:07]
B
You are putting on a wristband that sort of is like an Apple watch that is able to detect the nerve signals that are firing. So when Ted is sitting across from me and decides to type something on a computer, you are thinking what you want to type, you are translating that through your nerves to the muscles that are innervated by those nerves in your hand. And then you are physically typing on a keyboard. What if instead you could just go from thought to the intention of wanting to type where those words actually pop up on the screen? And that, to me, as they say of any sufficiently advanced technology, is indistinguishable from magic. When I experienced the demo that did exactly that, what I just described, it felt like magic. You're sitting there with these two things on your wrists that are sort of like sweatbands or wristbands that are detecting the nerve signals from your hand. And as I think about typing and I'm not actually touching a keyboard and I move my fingers, the words are popping up on the screen. It felt to me like Sorcerer's Apprentice. And we ended up funding them shortly after. It was a $30 million financing Amazon and Google and a whole slew of other venture funds that participated. And I joined the board. It is the one company in the past several years that I lost two nights of sleepover in pursuit and became totally obsessed with the founder and the vision and what they're ushering in, which is basically the future of how we will interact with our computers wearing these small devices and effectively being able to, in three dimensional space, change songs and lighting and control robots and machines and anything that today has buttons and levers and touch screens, etc.
- [31:36]
A
How do you think about the due diligence process? These are incredible ideas, great themes that make sense, inevitabilities. You find the entrepreneur who's on the idea and he's got this thing that's magic, that works.
- [31:49]
B
Yes. Well, the two words that you just used are the most important thing. It works. I remember I had a friend at Morgan Stanley who was making some big, large private investments and he went to visit a genetics company and he said, you know, you guys have invested in a bunch of this stuff. And one of my partners was the founder of Illumina. And he said, what should I ask? And the number one question was, does it work? And it's so crazy how many VCs do not. I mean, you. The book Bad Blood that details the Theranos saga is just insane that so few people actually verified. Does it work? The hard technology you can see, does it work now, if it doesn't work, fine, how much money and how much time until it can do what you say it can do and you can actually fund to those milestones. But I think where people get in real danger technologically, which is one of the things you have to diligence, is just never asking, does it really work? So that's one. But if you invert and you say, well, what are all the things that can go wrong? So you take that sort of cynics mentality to begin with. Is this a team that can recruit? How do you diligence that? Well, you see these people and you say, is this a guy that I would want to work for? Or is she somebody that I think is going to lead a company? Can they raise money? Are they good storytellers? Are they going to get people to part with their jobs where they are, and move cross country and convince their spouse that they're going to take a lower salary and a higher equity stake and a risk, you know, that's really important. The people in the industry that you talk to and you say, well, if they could invent this thing, would it matter? And some people be like, oh, you know, people have tried that and they'll poo poo it. And other people be like, oh my God, if they could do that and they could do it at this price point, that's a really big deal. And so you look at each of the risks of how something could fail. Technology risk, market risk, product risk, people risk, financing risk, and you give your best subjective assessment because none of this, I mean, I joke. I haven't looked at a spreadsheet in over a decade. There's nothing for us to model. It's about human nature, it's about their ability to recruit, it's about psychology. It's ultimately about whether the technology works, which is scientifically verifiable. But all the other risk you're taking is sort of a function of the price that you're paying and the expected return that you hope to get.
- [33:51]
A
So let's say you have the technology and some of these things are going to be, let's call it unique. There may be other teams chasing it. You've got a thesis, you've got technology you think works. And then there's the people side of the equation. What do you do in the situations where you don't have all the ducks in the row? Maybe it's not quite the right people, but the technology works and you're enamored with the opportunity set.
- [34:12]
B
It's always better. And this is a classic cliche in venture capital. Would you rather have an A technology with a B team or an A team with a B technology? And it's always the latter. You want amazing people. You want, as one of my lead partners says, amazing two legged mammals. That's what we're betting on. Those are the people that in the face of a technology failure can figure out, do we license something, do we jettison this? Do we acquire another company? They figure out how to survive great technology without a good operator or even a good promoter. Somebody that can raise money and recruit people just wallows in obscurity. So it's really about great people. Now sometimes you have a great inventor, but you don't have the great operator or you don't have the great promoter that can raise money, or you don't have the great recruiter that is convincing people to move. And that's really hard. But that I think is the most important role that we play between we've got 120 plus companies, we've got 10 people on the investment team. These are people that all day are spending time meeting with VPs and junior people at other firms, they're meeting with senior people at other firm. And our number one job, aside from sourcing deals, is sourcing people and then figuring out if you've got the right people. No matter how many heuristics, no matter how much pattern recognition you have, we still get it wrong. And being able to read somebody's ethics, somebody's integrity, somebody's ability to persuade other people Somebody's ability in tough situations to do the right thing. You sometimes have pattern recognition from past examples, but a lot of times they're presented with an entirely new situation and you don't know if they're going to do the right thing.
- [35:42]
A
Yeah. As you get through it, how do you make decisions as a team when you're making your investment decisions?
- [35:49]
B
So there's a wide range. There's things where everybody agrees at the firm. Structurally, Pete and I are the final decision makers, but everybody's got a voice and a vote. It is very rare if everybody on the team was totally against something, that we would do it. Similarly, if everybody was bullish on it. But Pete and I felt very strongly, maybe on ethical grounds, that it's a space we shouldn't be investing in, similarly, that we would do it. So that's the starting point, which is structurally sort of the buck stops with the two of us. We have implemented, starting about five years ago, a process where if there's a super strong table pounder, where the vast majority of the team does not agree, but somebody is psychotically passionate about a particular entrepreneur and opportunity, they get one of those in a fund. And the reason that we do that is, number one, we want to avoid a situation where we made an error of omission that this person accurately saw something that the rest of the team didn't. And we, of course, pride ourselves generally as a team of being contrarian, thinking differently from other firms. But at a meta level, if we ourselves are thinking exactly all alike, then something's off. So the reason we only give them one bullet to do that in a fund is mostly because of me, because I can be generally persuasive and a passionate table pounder. And if I was able to do that every Monday during our partners meeting, I'd end up with a full portfolio. So you got to really think about, is this the silver bullet that I want to shoot?
- [37:02]
A
So that includes 100%.
- [37:04]
B
Right? Because otherwise it's total hypocrisy. So you get one of those. Now, how many is that up to add up to? It could be right if everybody exploited it. Amongst 10 investors on the team, 10 of our companies. Now, a fully funded structured portfolio for us is somewhere between 25 and 30 core positions, which means that each investing partner is doing between one and two core deals a year, and a core deal for us is investing somewhere between 15 and 25 million per company as a starting point, and maybe reserves of another 20 million or so. We have an active seed program where you could do A lot of those. But what we limit it is that the total aggregate dollars that we invest in seeds, which are typically sub $2 million, it could be a quarter million dollars here, half a million there, a million and a half here. But the aggregate dollar value of that equals one core position. It'll be less than, say, $20 million, which could be 40 companies at half a million, it could be 20 companies at a million. The problem with seeds is they require a lot of time and you don't necessarily know if they're going to turn into something that's going to bloom and be wildly successful. And so we try to be very mindful, Pete and I in particular, as sort of portfolio managers. We're allocating cash, we're allocating the most important thing, which we never get more of, which is time. And you don't always know until after the fact. Did we waste time and was this an era of omission? Did we miss it? Should we have spent more time? Was it an error of commission? So the portfolio construction is a combination of our seeds, our cores, a methodology where people don't harbor bitterness if the rest of the team doesn't want to do it because they get one of those. But mechanisms to prevent cheaters from basically being overly passionate, like I might be. And that's the core construction hypothesis.
- [38:37]
A
Are there lessons you've taken from your knowledge of public market investing? When you think about the other layers of portfolio construction, other than sort of.
- [38:44]
B
Time and size, aside from timing and sizing different sectors at various times, can have countercyclicality. You even see this at a existential risk at firms, by which I mean there are people that co mingle life science investing and it investing. And sometimes the IT investing is doing very well and it just happens to be that there is a tailwind, let's say right now, between high tech and fang stocks, and therefore there's more money going in. You might have companies that stock value has appreciated, they might be more likely acquirers. You might, on the other hand, have more difficulty getting talent because they're very highly prized and they're being very paid very highly. At the opposite end of the spectrum, you might have biotech that's in a doldrum or in a winter, and capital is scarce and there's been consolidation and big pharma has more leverage because they're able to acquire companies. So you cannot be ignorant to the market dynamics of where there's consolidation, where capital is scarce, where capital is abundant, where talent is scarce, where talent is abundant and you sort of have to predict. And I hate the cliche about the, you know, skating where the puck is, but you have to anticipate the thing that everybody believes today is scarce might become abundant and vice versa. And so in the biotech arena, we would look and say, okay, everybody in the public market some years ago was talking about vaccines being totally taboo and uninteresting. And that actually turned us on and said, okay, let's go find the best vaccine assets. And we ended up starting a company out of Harvard and Berkeley that was focused on just that, ended up taking that company public. We did another one out of Hopkins in a similar space, took that public. Actually, just today we have a company that was nearly an eight, nine year old company called Vistera that we spun out of MIT that was just acquired by a Japanese firm, $430 million. All born in these sort of contrarian views at the time where the capital markets were not rewarding the assets. And we made the bet that the pendulum would swing and there would be a reversion and that these things that today were not valued would one day be valued.
- [40:28]
A
A lot of times when you think about a contrarian stance in the public markets, there's a vector of time and sometimes they're trades or they're longer term strategic plays. How do you think about that kind of contrarian notion in a private equity structure?
- [40:43]
B
I think about it as what I think you would call as well, time arbitrage, which is if you can take a longer time horizon view than other people, I think you are advantaged. Now why is that? Well, if everybody's focused on the month or the quarter or the year, then they're not focused on the two or five or ten years. You see this even by the way, the pressure that public shareholders have put on many public companies to cut R and D spending and to reduce investment in very long term things so that they can get near term earning boosts have meant that you've increased the probability, particularly in pharma that they are going to acquire a biotech company because they've outsourced R and D. Same thing for semiconductors. You can look at those trends and see where are the short term pressures on companies that may create a time arbitrage where the fact that you were thinking two or three or five years out, when the market is generally discounting one to 18 months and the turnover in many of these companies is sometimes two to six months, I think that's an advantage.
- [41:34]
A
How do you think through exits?
- [41:36]
B
Well, we think about them a Lot. The honest answer is many of our companies get bought, not sold. Usually the companies that we are trying to sell are companies that may be struggling, maybe they struggle to raise money. And we're looking and saying, okay, how do we off ramp this company? And sometimes you get lucky and you know, it's just the right place, right time. I'll tell you. In the case of Kurion, we benefited not only from the fact that it was a good business, but the acquirer had come out publicly the prior year and said that the particular segment of waste cleanup in the nuclear markets was something that they expected to grow to x hundred millions of dollars from a base of like single digit millions. So there was almost a public commitment bias where they had gone out and said that they were going to do this thing. They had created the expectation of their shareholder base and they, they didn't have anything, they weren't doing it. So here was an opportunity where if you read between the lines there, sometimes you skew the odds because there's a public company that needs to acquire something and if you've got the product and the inventory, you can sell it to them.
- [42:35]
A
What have been your biggest mistakes?
- [42:37]
B
Oh, there's long lists. So you know, there are of course errors of omission. The story which I tell publicly is about Cruise Automation. We offered them a $20 million financing at a 40 million pre and they wanted 80 million pre money. And we thought that was absurd and too high. In the course of diligence we introduced them to GM. Another firm ended up pricing it at 80 million and put 20 million in. So now you got 100 million posts, which is about 50, 60% higher than what we were willing to do. They were willing to pay double the price within nine months or 10 months. GM bought them for a billion dollars. Nominally that was an 11x miss for us. Very quickly we look at that and say process versus outcome. I still believe that the process was right and that being price disciplined was right. But the outcome sure stings because that was a missed opportunity. Conversely, there are companies where we funded a company called Crystal Is. This was a spin out of Rensselaer. They were making UV LEDs and the basic thesis was get rid of mercury, that would be used to produce ultraviolet light for water purification and you would sell into municipal markets. These were the likes dominated by Danaher, that owned a business called Trojan uv. And here we ended up making three, three and a half times our money. But we considered it a process failure because all the expectations, all the modeling that we had and what the outcome could be the reasons that a business would be bought all proved false. And the reason we ended up making money was ultimately because of the way we structured the deal and the preferences that we had and the liquidation terms. And so that was one where even though we made money for our investors, we considered a process failure. Other mistakes, not removing a CEO soon enough, we have always felt, and it's so hard because you develop relationships with people and they're human and they're not just an algorithm. And you don't just hit a key and dump a trade and cancel an order. There's people and you like them and you like their families. But oftentimes you start to see the sign where the team doesn't have faith in their leader, or the leader can't raise money, or they can't speak publicly, or they can't get press, or they're losing the competition. Not firing somebody quick enough has always been a mistake and we've always come to regret it that we didn't do it sooner. And we still don't learn the lesson to do it quick enough.
- [44:45]
A
So take a step back and think about the private equity environment. You know, there's a lot of capital. How does that affect how you're going about your business?
- [44:56]
B
So the way that I'm thinking about it now, and it's always better to make observations than predictions. You can make some observations that I think are important and I don't actually see a lot of people doing this. But here, here's what we see. First of all, enormous amount of general private equity money to the point where I think you're going to see a narrative of LPs just pulling back generally from the asset class, because they see a huge amount of overhang. They see a huge, if not fairly valued, richly valued or frothy public market. You see the prospect of rising rates, you see peak profitability, you see margins that are starting to get squeezed. We had a tax boost that has risen markets even further, but that felt like a sugar hit. So private equity, generally, of which venture capital is like the tiny bit that's generally clustered into that ass glass, I think is going to see a huge pullback in at least new allocations, if not the pace of allocations. So that's number one. Number two, in the venture world specifically, there's a bifurcation that I call the minnows and the megas. The minnows are the very large number of new funds that are being formed, typically by a one or two person gp, meaning there's Somebody that might have been at a famous firm or did a famous deal, but they didn't get the economics, they didn't get paid for it, there wasn't succession planning at that particular firm. And they say, you know what, I'm the one that just did this deal and the LPs know it by the way. And they say I'm going to leave and spin off and I can raise money from this endowment or this foundation or this family because they like me and they think that I'm going to amount to something. And so they're able to raise 25, 50, 75, $100 million. And as a single GP, that's a pretty good deal. There's hundreds of those people. And so we look at that and we say those are people we want to be friends with, in part because some of those firms, those people are going to end up consolidating, they're going to be real firms and it's better to be peers and reciprocal peers than competitors. But they're also a source of deal flow for us and they can really withstand to fund companies through series A and B and C rounds. So they are a source of competition on the one hand to be early check writers that are competing with us, but also a source of deal flow at the other end of the spectrum. You have Godzilla, which is SoftBank, that came in with nominally $100 billion, that is really writing market clearing prices 150, $200 million plus prices to own 15 to 30% of businesses. I think that there is a real risk there which people under appreciate, which is many of these businesses either have commercial deals that are tied to them or economic terms that are tied to them. Where the VCs or the entrepreneurs that might be celebrating they just became a unicorn and are valued over a billion dollars. And SoftBank just validated them. Their money is dead and zombied and trapped because SoftBank is effectively going to control the company from there on out. And so if it's a pure exit and you're able to do a secondary into that, I think as some people are, I think it will work. Otherwise I think that there's a lot of danger in that. I think there's some ulterior motives of why SoftBank may be doing what they're doing. That in turn though has prompted a lot of firms, Sequoia NEA and others, to raise multibillion dollar funds. You have the minnows on the one side that are raising a lot of people, raising small amounts of money and you have a Handful of people that are raising multibillion dollar firms. We want to be situated in this $400 million, $500 million range as a fund where you're able to benefit from the guys that are supplying new deals to you and have product that you yourself are originating. We love doing New coast, but also funding in the series ABC Rounds to give to these later stage guys. You also have kkr, Apollo, Carlyle, TPG that are actively doing investments in much earlier stage things. In part, they're doing it because it's opportunistic to bolt on. And so we see an exit path where we might be able to sell a business to Apollo and we're friends with them, we like them, they can add it as a technological advantage and part of their narrative and get maybe a higher multiple on an otherwise cash flow generating PE business. They also want to make these investments in part for the competitive threat. They see the pace in which, whether it's Amazon buying up businesses and competing. If you're Cerberus and you own Albertsons and you see what's happening in the grocery and retail market, you're worried about what the technological threat is and how sustainable your cash flow and your competitive advantage is. So private equity is coming downstream. You got growth and crossover investors on the hedge fund side that are also providing capital, which is for us, an opportunity to bring them in and capitalize businesses at ever higher valuations. But there's just, at the moment, I would say too much damn money in the space. I think that secondaries are going to be a great spot for LPs where there's going to be a lot of people that get out over their skis and are going to need liquidity. And people that have ready pools of capital, I think are probably going to be well positioned in that next part of the cycle.
- [49:17]
A
What happens to that dead capital, let's say, the softbank money? Will somebody create a marketplace to allow those people to exit some of their ownership?
- [49:25]
B
I honestly believe it's going to ultimately be up to softbank. The most skeptical, cynical, borderline conspiratorial view would be that if you're investing it and we work at a $20 billion valuation, putting one or $2 billion in, and then you're pricing up your own deal six months or a year later and doubling the valuation. What you've done is created paper asset value and that paper asset could be seen as collateral against say, an indebted corporation. And so I think people have to really double click into what's going on there. There's no doubt Softbank is extremely influential. There is enormous reach, there's enormous karatsu in the Japanese sense of a lot of interconnected things between companies. But there's other things and other motives that are going on there that I think people are naive to.
- [50:04]
A
Yeah, you do a lot of interesting tweeting.
- [50:09]
B
Yes.
- [50:09]
A
Do you have a strategy or a thought process that leads to what you put on Twitter?
- [50:14]
B
First of all, you're kind to euphemistically call it interesting. Look, there's like four things that I rail against, right. That, to me, are sort of thorns on my side. One of them is Trump, and that's just my personal politics. I think it's corrosive and I'm disappointed. The other are when I see people who I think are knowingly exploiting the credulity of their own followers. I've never loved preachers and people that I think are sort of charlatan hucksters. And you see me rail against Trump, you see me rail against Ray Dalio and Bridgewater, of which I've got a lot of skepticism. You see me, which is heresy in the venture world. Rail against Elon Musk, specifically as it relates to Tesla as a publicly traded company. You don't really see me doing that about SpaceX. And then the last thing that I rail against also, which I think is utter bs, is IBM, Watson, and I think it's actually dangerous what they're promoting. So, yeah, those are the things that get me hired. Otherwise, I love finding people that are on the edge and those, again, it could be artists, it could be musicians, it could be inventors, but people that are off the beaten path. And then I love finding disciplines that intersect that people wouldn't have thought of a lot of that. We're involved in the Santa Fe Institute, and I'm a trustee there, and it's a majorly inspiring place. But what you can learn from an ant colony and how they forage and how they mathematically, without the knowledge, precisely position their dead from their food source, or how we as venture capitalists will look for where our next deal is coming from and what you can learn from the signal theory of how ants lay down pheromones and find randomly a food source and then redouble back to the hive. You know, there's. There's interesting analogies, I think, if you can find interesting analogies. I love tweeting about that kind of stuff, too.
- [51:54]
A
I know you recently did one about parallels in biology and markets and industries. Can you walk through that storm Totally.
- [52:02]
B
So there's two basic things I talked about in biology. One, it's interesting, actually, here in New York City, we have Cornell Tech. Cornell Tech is really run by this guy, Dan Huttenlocher, who's also on the Amazon board. Very smart computer scientist. And it's great that Cornell is here in New York City, and I think there's going to be a lot of big competitive thrust that come from that. It turns out Dan's father is this guy, Dave Huttenlocher, and I've been using his chart for years in public speeches that I would give. He was a neuroscientist who discovered this curve that showed from the time that you were born until about age 3 or 4, you had this exponential increase in the number of synaptic connections between your neurons. Basically, it's like exploration between the nerves, almost like the ant foraging. And then around age 4 or 5, you start to get this precipitous pruning, which means that the number of synaptic connections really just starts being pruned. And the question is, well, why pruning?
- [52:48]
A
As in declining or disappearing off?
- [52:50]
B
Yeah, no decline. Both. So the rate of the synaptic growth is slowing, and then the number of connections between them are dying, in part because they're not being used, in part because the things that are being used, just like the ants doubling back on that pheromone signal, are redoubling. And some of that is genetic, and some of it is fixed action patterns where you're doing the same things over and over, or hearing the same words over and over, or repeating the same words over and over and over time, that sort of becomes you. Okay, well, what's the parallel? If you look at that chart, if you substitute the number of neurons or the synaptic connections between them over time, and you look at any industry, you find the exact same pattern. The number of entrants into the US Automobile industry, it started off slow, exponential increase and then precipitous pruning. Same thing. Color tv, airplanes, airlines, the Internet, number of biotech firms, industry after industry. What this tells you is that this is a universal phenomenon. And when you can find, in that same way that you can find directional arrows of progress that tell you where technology is going. When you see these universal phenomenon that are taken from discipline X and you apply them to something in markets like discipline Y, to me, that's. It's like discovering a secret. It's like, wait a second. This same phenomenon, even if we don't understand the mechanism of it, it Is there, it's observable and it's predictable. So the neural growth and synaptic pruning is an identical pattern that you see in different industries. And it tells you like in the scooter business right now in vc, it's just like you're going to have a dozen of these scooter companies and the vast majority of them are going to fail. And you want to look at where you are in that cycle and figure out, okay, what's the clever thing that you might be able to do in that space. Second analogy which I talked about was the slime mold. And the slime mold is the single cellular organism which in the presence of abundant resources in the environment just sort of furls out like a blob, you know, like out of a sci fi movie. And then when resources get scarce, it starts to recongeal and spore off, waiting to basically spread again and find, you know, new source of food and resources. Okay, what's the analogy? I believe that the economy and people are sort of like this slime old. When resources are abundant, people feel the freedom to spread out and try lots of experiments. So you would see people that are otherwise in conventional conservative roles, consultants and bankers and lawyers suddenly start to say, huh, you know, I have a friend who just raised venture money and, and my God, he's got a valuation of this. Or she just raised a ton of money. And you know what, I'm smarter than them, I could do that. So you get the social proof of people doing that. You have an abundance of capital where a lot of money, including people who did a startup, made it rich, are now becoming an angel investor themselves and it becomes a positive feedback effect. A lot of experiments get tried. The first beneficiary of that are the real estate companies and the WeWorks and the people that are reinventing themselves and taking crappy class B and C office space and basically filling it with people that are sort of these day jobs like startups. The operating leverage that those businesses, by the way get on the upside is huge. But once you have this precipitous pruning and these people start disappearing, I think the operating leverage that you get on the downside is going to be really painful. And you saw that by the way, in the late 90s or early 2000s with the Regis and the workspace guys. These guys got crushed. And so I think the same thing will happen there. Then you have this recongealing and I think people go Back to the McKinsey's and the Goldmans, and the, and the Accentures and the JP Morgans that they might have left because they're going back to the safety of the mothership. Now. The interesting thing about that is who cares? And I think you have to look and say, well, why does this matter? It matters because it portends when the good times might end. And the simple heuristic that I've used, which is totally imprecise and non empirical and really off my thumb is asking a set of people on any given week, how long do you think that this can go on? This really started with a conversation I had with Jerry Yang a few years ago. He's like, after WeWork and Snap and a bunch of these other things, I thought it was over. But I think we've got two more years. I took that line, two more years and I started counting what percentage of people were saying, I think we got two more years. The logic behind this was if you just took five people that you speak to in a week, if one of them said, I think we got two more years, but everybody else is uncertain, you've got four more people that could potentially become incremental buyers. But if four out of the five people that you're talking to all say, yeah, I think we've got two more years, then you've only got one more incremental buyer that could be converted into a believer. And so I think when I started this, it was like 10% of the people I spoke to said, two more years. And then it got up to about 30% and then 50 and then 70. And so I think we're at about 70, 75% now and we're close to, but not quite at 80% of my imperfect sample size on a weekly basis, when we are, I think that's when.
- [57:14]
A
Things turn, because it's going to, then there's nothing left. And people, there's just.
- [57:18]
B
You have a diversity breakdown. To use a principle from, from Santa Fe Institute, where it's like being on a ship. If you have equal people on the left side and the right side, the ship is well balanced. Just like in markets, if you have momentum and you have growth, you have people that are providing liquidity from one side to the other, you have stability amongst that diversity. When there is a diversity breakdown and you get homogenous belief and everybody basically believes that this can go on for two years, it will happen. And then who's the incremental buyer?
- [57:42]
A
So if you put these two lenses together, so the one lens is the inevitability, the directional, and the other is where the trend is and is everyone on the same side of the boat and apply them to public markets, active investing and indexing?
- [57:56]
B
Yes.
- [57:57]
A
Where do you think this goes?
- [57:59]
B
There are people that say, oh, the decline in the number of publicly listed companies and the shift to institutional investors from large scale retail, I'm talking over a century to institutional investors, the T rose, fidelities, et cetera. And now the rise of the passive indexation. And this is all overblown. They will say, I actually believe that when Buffett was talking about weapons of mass destruction and derivatives that at the time you're thinking about options and all these crazy structured high fee products that the banks would come up with. But I think that the ETFs and people like MSCI that are constructing these things and the blackrocks at all, they basically have one algorithm which is if money comes in, buy. And you have all kinds of different thematic ETFs. And so companies that shouldn't even be in one ETF but thematically fit the mold get thrown in there and then just there's indiscriminate buying. And so I think that when there starts to be selling, you're going to have the same thing where people are. It's almost like a drag along, right? You know, in venture capital, in the public markets, companies are going to be sold indiscriminately in the same way that they're being bought indiscriminately. So I think that there is a big structural issue. I think that similar as we looked at vaccines when they were out of favor today, universally you say activists and active managers, like they're totally passe, they're out of favor, which is true until it isn't. I think that there will be some smart people, particularly on the short side that are able to identify bad companies that are being sold. And then when capital dries up and their cost of capital comes up and the margins and the profits and the cash aren't there, these companies are going to get crushed and people are going to be running trying to find the short sellers and the active managers that have figured this out.
- [59:27]
A
Let's turn a little bit on that. What is dinner table conversation like at your house?
- [59:33]
B
Well, it's a mix of, as you can see, I love sort of kinetic, frenetic random thoughts. And so we jump from topic to topic. I've got three kids. My wife happens to be in the hedge fund business and she's way smarter than I and I like to say I do the private market, she does the Public markets. She's on public boards and brilliant. But we'll talk about everything. We'll talk about life principles. Conversation that we had earlier in the week was about one of the principles I like, indoctrinate them with little quotes. So one is the difference between fitting in and standing out. And this is true of markets, it's true of peer pressure, it's true of life choices that you make in a career sense. But you know, how do you find the balance between wanting to fit in and do what people want you to do and feeling the confidence and self esteem to stand out? And so we talked about this in the context of, for the young kids, like doing drugs and peer pressure and making good decisions. We'll talk about in a related area, studying people who make big mistakes. And there are some people, and I disagree with Peter Thiel about this personally, where he says you really study the successful people, you don't study the failures. And I disagree totally. I think by studying the people who made willful mistakes, you learn an enormous amount because you're invert. You decide what not to do. And of course some people had good process and got unlucky and they failed. But there's a lot of people that make horrible mistakes with the kids. We sat around, we looked through the Post, the Post, by the way, the New York Post. It used to be the greatest 25 cents that anybody could spend. Now I think it's 50 cents or a buck. But you look through and it's this catalog of inane human misjudgment. So kid was sadly, tragically taking these Instagram pictures where he's sitting on the roof and showing his feet dangling or whatever. And of course he plummets to his death. I want my kids to know that. I don't want to shield them from that. I want them to see that so that they know this was a stupid decision. So cataloging the stupid decisions, thinking about fitting in versus standing out. We talk about another principle is it's always better to have it and not need it than to need it and not have it. And they've been indoctrinated that since they were like two. And they didn't understand it when they were repeating it, but now they see it. And that's everything from bringing an umbrella outside to thinking about how you hedge in life. And so they actually understand that concept at a young age of how do you hedge? But we talk about everything. We talk about geopolitics, we talk about mom and Dad's day at work, we talk about conflicts that we're having with people. We talk about Trump, we talk about politics, we talk about civility, we talk about being intellectually curious. We talk about the history of a riff in a rock song that came from something 30 years ago and a sample from a hip hop song that came from something 15 years ago. And so it's really a smorgasbord of stuff and it's just sort of the way our brains work.
- [62:05]
A
I imagine everyone listening would probably join me in wanting to be a fly on the wall in your house for most of those. So I want to ask you one more question before we turn the closing questions, which is when we've met, and I've seen this also inside your office. When you leave a meeting, there's almost always a task list you're creating to help other people. Where did that come from?
- [62:25]
B
Part of it is entirely self intellectual honesty, Machiavellian. It is reciprocity. I'm going to help you. I'm going to do something because maybe you're going to help me. There's a calculated part of that, but part of it is people. To me, these two legged mammals, these humans that we bet on, it's just you never know. You're going to leave here and you're going to have a conversation with somebody else. And if I've planted in your mind an idea or a new thesis that I'm working on, or I tell you I'm really trying to find somebody that can do X, Y and Z, you're now primed to think about that. And if I can do that same thing for other people, it's just, as Charlie Munger would call it, this beautiful web of deserved trust that to me is just very gratifying. I think people always feel happy when they're around friends, when they make new friends, when they feel that people have their back. So even if there's that root and people deny it, that there's signaling going on about who we are and what we want to do, and there's some transactional nature at root, people love the camaraderie and companionship and friendship. So the more that you can do to help people, the more you get of that. Even if in my cynical Hobbesian way, I view that that is a fundamentally selfish thing.
- [63:30]
A
Okay. I think most people you interact with probably disagree with you on that. All right, let's turn to some closing questions. What was your favorite extracurricular achievement growing up?
- [63:41]
B
You know, I would say growing up it was the Westinghouse, you know, science stuff. But later and outside of work, it was Coney Island Prep. I mean, this was, to me, sort of taking the best things I learned from professional life and identifying talent in helping to build an organization. But it's entirely non profit and philanthropic. When I grew up in Coney Island, I always felt that kids needed two things. The right heroes and a deep desire to learn. And anytime that, like Puffy or Jay Z or some rapper came to town and said, keep it real, that to me was a euphemism that was basically like, maintain the status quo and buy my stuff. And instead, if you could flood the zone, particularly for inner city kids, not to become consumers, but to become producers. And I don't mean of music, but of content, of science, of intellect, of writing, to be producers in the world, I think you could skew the odds because there are enormous number of people in Coney island, let alone the thousands of other poor communities that lost the ovarian lottery. There are brilliant people there that did not have the nepotism. They don't have the access. They don't even have the role models. And so I think anybody in the inner city that just is, you know, has basketball players and hip hop as their role models, both of which I love and grew up obsessed with. It's a total disadvantage. So Coney Island Prep, to me, I got to meet this young guy, Jacob Mnookin. He was the executive director. I joined the board. Everybody else took a step back. I basically became chairman, and I've been chairman for 10 years. We started with 90 kids in the projects in fifth grade, and we stopped calling them kids that first year, and we started calling them scholars and we set expectations for them. It's so critical of, like, you are going to college. And for the vast majority of people, they're the first people to graduate college. You got a family of four making less than $25,000. It's a disaster. And so we went from 90 fifth graders to now over a thousand scholars. We're K through 12, and for the past two years, we graduated 100% of our kids into college. And that feels amazing, and it feels scary because I don't know if we can keep them there. And that's our next challenge.
- [65:42]
A
Yeah. Yeah, that's fantastic. What's your biggest investment pet peeve?
- [65:46]
B
When entrepreneurs say of competition, that's validating. When somebody sees news of a competitor and says, oh, you know, it's definitely validating of our market or something like that, I pull my hair out because I don't want you to find competition validating. I want you to find it infuriating. And that is me, you know, that's psychotically competitive. I want people to be ethical. I want them to be competitive with integrity, but I want them to compete ferociously. And I always felt the most productive late at night when other people were sleeping or I perceive them to be sleeping because I was up learning something. And I want our CEOs, hyper vigilant, to crush their competition and not finding it as validating.
- [66:29]
A
What's the riskiest thing you've ever done?
- [66:31]
B
There's physical risk, there's emotional risk. I mean, physically, whether it was surfing or snowboarding or rock climbing, there's things where you could have said risk if measured as permanent loss of X, which in the markets is capable capital, or in life is life. There's physical things like that. You know, I would say probably the biggest emotional risk was related to my growing up and my father and my parents split when I was very young. And the open, raw reconciliation with him and being honest about not wanting to be him and learning how to be a father and a husband by inverting him and being honest about that, that was probably a big emotional risk. Reputationally, I take a risk when I'm out there publicly, you know, speaking what I believe about whether it's, you know, Bridgewater or Dalio or Elon Musk, and, you know, that's going to backfire at some point.
- [67:18]
A
What teaching from your parents has most stayed with you?
- [67:21]
B
I think high expectations. I think my mother, I would come home with a test, 97, 98. And my two best friends growing up were a guy Jimmy, and a guy Adam. What did Jimmy get? What did Adam get? And it was just. It was never enough. And so I think that carries over for better or worse. I believe it better of super high expectations. It's what we do in our family that you can do better no matter what it is that you're doing. I think it carries over into our school at Coney Island Prep. Setting the expectations. Young kid, you're in kindergarten, first grade, fifth grade, you're going to college. So I think just the pressure of high expectations and ultimately that becoming self indoctrinated where you expect it of yourself when nobody else is watching.
- [67:58]
A
What information do you read that you get a lot out of that other people might not know about?
- [68:03]
B
I read voraciously. I read four papers in the morning. My wife jokes, because I read USA Today. And I do that specifically because I want to read what millions of Americans are waking up in Marriotts and being influenced about pop culture or what they should be watching or what cars they should be buying and that kind of stuff. And I read the FT and New York Times, and now I read the Post in Washington Post too, in the Wall Street Journal. But I have information anxiety. The idea that I would not know something in a conversation that somebody else brings up to me is like anxiety and inducing. So I read voraciously, but I also read things that are necessarily off the beaten path. You know, those are things like chemical engineering news and science and nature. And I literally have like this weird. I would say it's my one OCD thing. Sometimes you're flipping through a magazine, you skip a page. I'm like, oh, shit, you know what? If the secret to, like, the most important investment insight I'm going to have was on that page? And I go back, that's probably my one, like, OCD is the information anxieties. I want to read everything. And I read blogs and I listen to podcasts. I love your podcast. I feel honored to be on this. I learned so much listening to your guests. So, I mean, it's just. There's never ending learning. Right. Thanks.
- [69:02]
A
Yeah. How much time do you spend reading?
- [69:04]
B
A lot. Let's see, my day in the morning, I'm either taking kids. Like now we're in the summer, right? So I'm taking my kids to camp, but I take them to school every morning and mornings are with them. As soon as I drop them off, I've got 15 minutes between where I'm walking to a train station and then train station up. 15 minutes I'm sitting there and I'm listening to an audiobook. Then I'm on the train. I'm actually reading the physical book. Then I get out and I'm switching back to the audiobook. At night, I'm probably two and a half to three hours reading. And that does include the stuff in the morning for the newspapers, let alone all the content that is being Produced by the 120plus portfolio companies, CEOs and their insights and our team and the intel that we're gathering from all of our meetings. So it's an enormous amount. And the value, of course, is not in the reading, but then ultimately in the synthesizing and the pattern recognition and sometimes the time between information tidbit A and information tidbit Z could be six months. And then suddenly these two things click and you're like, oh, my God, there's some new insight.
- [69:56]
A
All right, Josh, last one. What life lesson have you learned that you wish you knew a lot earlier in your life.
- [70:03]
B
The same thing I value so much now, which is people that I would have been less bitter and resentful and jealous of rich people when I was growing up. It probably gave me the right chip on my shoulder because I wanted to be and have what they had and that was a great motivator. It made me very competitive. But I think I probably burned a lot of bridges and spurned a lot of people and could have been way less judgmental and appreciative of people at a younger age.
- [70:28]
A
Josh, as always, really appreciate the time. Fantastically rich conversation.
- [70:32]
B
Super privileged to be on. Thanks man.
- [70:36]
A
Thanks for listening to the show. If you like what you heard, hop on our website@capitalallocators.com where you can access past shows, join our mailing list and sign up for premium content. Have a good one and see you next time.
- [70:51]
B
All opinions expressed by TED and Podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.