Sports And Humility

Sports can be a cruel teacher for even the best of us, as India’s recent heartbreaking defeat in the Cricket World Cup final showed. However, if approached with an open mind, there are none better ways of practicing and getting better at humility and grit.

One of the reasons I am a big believer in playing sports is because it’s one of the few things in life that forces a player to accept defeat with humility. Every sport is a microcosm of how life actually plays out – the best plans don’t work out, huge highs are quickly followed by huge lows, the Davids often end up beating the Goliaths, and given all this, the best players focus on process over outcomes (read my post: Conquering Uncertainty, Dhoni & Vinod Khosla Style).

The recent soul-crushing defeat of India at the hands of Australia in the final of the 50 overs Cricket World Cup was a perfect example. A rampaging team full of superstars, playing in home conditions and backed by the richest and biggest cricketing engine the world has ever seen, was comprehensively outstrategized and outplayed by a team that had most of its stars way past their prime, whose innate strengths were unsuited to the local playing conditions, and which had scrapped its way to the final.

Having grown up seeing many of the previous World Cups, 2003 in particular, there were a few things that were making me nervous about India’s chances even before the final game. Classical cricket analysts have always talked about the Law of Averages being particularly strong in cricket. Being a student of investing, I also believe in Mean Reversion and therefore, this Law resonates with me. India was coming into the finals with a 10-win streak, the longest winning streak ever at a World Cup. This stacked the Law of Averages against it, and ideally, I would have liked to see them have a bad game before the final.

There is another reason why India not getting challenged at all during this unbeaten run bothered me. Regular readers of my blog would know that I am a believer in overcoming failure via grit as being the #1 leading signal of success in life (read my post: Storyteller vs Scrapper Founders). As Mike Tyson’s famous quote goes:

Everyone has a plan until they get punched in the face.

Mike Tyson

Success in life boils down to having the muscle memory to throw counter-punches once your Plan A has failed. This is where most people give up. Unfortunately, in my experience, the only way to build this strong muscle memory is to go through repeated failures, to operate in scarcity, to be the underdog in the shadows, essentially – “to get repeatedly punched in the face by life”.

As opposed to India, which won 10 games on the trot with a specific Plan A largely working each time, Australia got punched in the face many times at the beginning stages of the World Cup. This forced the team to develop ways to counterpunch, even while dealing with unfamiliar playing conditions and a set of aging players. Having the agility to come up with Plan Bs and Cs on the spot during game time perhaps became a necessity rather than a luxury.

The beauty of adversity is also that it brings people together, creating deep bonds and trust under conditions of high pressure. Look at how Pearl Harbor united the US like never before, ultimately creating the likes of the Manhattan Project in record time. This is likely what happened within the Australian team too, unlike India, whose team dynamics never really got pressure-tested before the final.

Of course, teams can only overcome adversity when they have a basic foundation of grit in place. This is where the national sporting culture of Australia built over generations comes in. A healthy sporting culture gives importance to systems and processes, has a high tolerance for failure, and puts teamwork over individual brilliance. More importantly, the fans and general audience also imbibe this spirit, having the maturity to spot these aspects and applaud them over one-off wins and losses. This leads to the entire engine, from players and coaches to sporting boards and fans, being aligned on a particular philosophy of playing sports, what a company would call ‘Values’.

Admittedly, a lot of this analysis has hindsight bias and emotions baked into it. I don’t want to be too harsh on Team India, as they actually played superb cricket over several weeks, displaying strong leadership, courage, and individual brilliance. However, this unexpected defeat does highlight that more work still needs to be done in crafting the right sporting philosophy within the country’s national fabric. A set of values that frees players from the pressures of winning and losing, and rather than dealing with public expectations and the dreaded “what will happen if we lose?” fear, helps them unlock their individual skills while also bringing them together as a team to deal with unexpected punches in the face.

Closing out with another story. We attended the Thanksgiving Warriors vs Spurs game yesterday. As part of a youth program, my older son got the opportunity to do one post-game free throw on the Warriors court. He ended up missing the shot and spent the next few hours whining about it. As I comforted him while talking through how missing and making these key shots is the beauty of sports, it took me back to the World Cup final heartbreak that happened 8,000 miles away a week back. Hence, this post! And why I will continue to actively encourage my kids, as well as our entire household, to devote significant time and resources to the pursuit of sports.

PS: enjoy this awesome reaction from Giannis Antetokounmpo, star player of the Milwaukee Bucks, when a reporter asked him on his “failure” at winning the championship.

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One Person’s Conviction For Easier Fundraising

As a fundraising founder swimming in the rough seas of skeptical investors, sometimes all you need is a high-conviction intro from one sponsor to tip the scales in your favor.

As a venture investor, referrals from people in my network is one of my top channels of deal flow. There are hundreds of startups that reach out for fundraising discussions every month. Having someone you know vouch for a founder automatically gives initial comfort around taking a meeting.

Over the years, I have observed that these referrals fall into 3 categories:

1/ Weak intro: beyond being a friend, the referring person doesn’t know much about the founder’s idea or the reasons behind pursuing it. These referrers are usually the founder’s weak acquaintances and are only helping out with connecting to a bunch of investors.

While even a weak intro ensures that I pay attention to the startup, conversion to a live interaction is usually low.

2/ Warm intro: the referrer has deeply known or worked with the founder in the past, and has a fair idea about their personal mission, goals, and personality. Typically, these referrers are ex-direct managers, peers, college friends who have stayed in touch, and other direct collaborators. They might or might not have an understanding or appreciation of that particular startup idea but believe in the founder.

These intros are solid, especially as the founding team is the top-most investing criterion at the early stages. In most cases, I will typically schedule a 30 min. video call with the founder at the very least.

3/ Conviction intro: the referrer has spent significant time either organically or consciously, to develop a deep conviction in both the founder and the startup idea. These referrers are usually founder execs, senior operators, angels, and VCs.

In the best cases, the referrer is also showing skin-in-the-game via either investing significant money and/ or time in the startup.

Conviction intros are gold and a great signal of the quality of an investor’s deal sourcing. For almost all such intros, I end up scheduling a 1-2 hour deep brainstorming session to get into the weeds. Interestingly, by the end of these sessions, the judgment on whether to invest or not gets immediate clarity.

Adding more nuance

I would like to go one level deeper on Conviction Intros, and talk about what I call ‘One Person’s Conviction Intro’.

Those who regularly read my blog would remember the post ‘An Investing Framework to Find Startup Diamonds‘. In it, I talk about the ‘High-Signal-Non-Consensus’ quadrant where the best startups are to be found at the early stages.

Deal ScreenConsensusNon-Consensus
High-Signal🪙🪙🪙
Low-Signal
Consensus vs Signal 2×2 ©Soumitra Sharma

(4) High-Signal-Non-Consensus – these are the opportunities we as venture investors live for. They are highly non-consensus, with the investor-crowd struggling to access, understand, evaluate risk and build a positive view on them. Yet, these startups have high-quality leading signals, which could be external and/ or internal.

  • External – eg. a respected investor, sometimes a domain expert, has taken the time to evaluate & build high conviction around the company. Or a visionary customer is taking a bet, partnering with them in building the early product.
  • Internal – extraordinary founder-market fit eg. the founder has spent a decade just going deep in the field. Or a backstory that provides an authentic “why” behind pursuing this idea. Or an execution track record in the startup’s arc that is outstanding on important elements like capital-efficiency, iteration velocity or organic customer acquisition.

This quadrant is the hardest to source for and requires having a really differentiated network of relationships (for referrals) and a personal brand that attracts interest from these types of founders.

An Investing Framework To Find Startup Diamonds

As mentioned in this excerpt, the High-Signal part comes from someone credible putting in the effort to build conviction, demonstrating skin in the game via committing any type of valuable currency, and then risking their personal reputation to socialize the opportunity with their trusted networks.

This opportunity might still be Non-Consensus, with the investor-crowd struggling to appreciate it. Yet, this referrer (or perhaps ‘sponsor’ is a better word in this context) is willing to be contrarian and follow their own conviction built from first principles.

When this sponsor refers a deal to me, this One Person’s Conviction Intro sits at the peak within the universe of Conviction Intros, simply because it has a high likelihood of being a key to the High-Signal-Non-Consensus quadrant.

However, even an investor with the highest quality deal flow can only expect a handful of such intros every year. The reason is most founder execs and operators don’t have the time and/ or incentives to build independent conviction. And most angels and VCs tend to demonstrate herd behavior, preferring to lazily piggyback on the conviction of others versus taking the time to do independent thinking.

So, even though my investing style is predicated on searching for these intros, the world is supply-constrained with respect to them. However, what I can do is swing really hard when I do get a few of these fat pitches every year, and maintain discipline at all other times. Venture investing is a very forgiving game where one isn’t reprimanded much for the losers, as long as you get a few right in a big way!

For founders, getting warm intros to investors has now become common knowledge, and frankly, table stakes. However, what could give you an edge over hundreds of other fundraising founders is inculcating that one sponsor – someone who can build independent conviction on your yet-unvalidated startup, show skin in the game, and socialize their commitment to other investors.

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AI Musings #2 – OpenAI DevDay

Sharing some quick observations from the landmark, first-ever OpenAI DevDay’23.

Quick observations from Sam Altman’s opening keynote of OpenAI DevDay:

1/ Amazing GPT-4/ Turbo upgrades and new features announced. In particular, loved the ability to upload docs into ChatGPT. Also, the ability to choose pre-programmed voice modalities that sound significantly more realistic than any current digital alternatives.

Was also awesome to see Coke’s campaign that lets its customers programmatically create Diwali cards using DALL.E 3.

2/ The icing on the cake was the introduction of ‘GPTs’ or agents. Users can now build AI agents within ChatGPT that absorb a set of instructions and then take specific actions while leveraging the GPT-4 expanded knowledge base.

3/ Building GPT agents in natural language is the democratizing aspect of Generative AI and something that was missing in the earlier voice-to-action apps/ personal assistants in the mobile paradigm.

Sam’s natural language demo reminds me of all the bottlenecks we faced while building first-generation mobile search/ deep-linking at Quixey + all the work my friend, the late Rajat Mukherjee, did on voice-to-actions at Aiqudo. AI is on track to solve all those engg./ product challenges.

4/ OpenAI also showcased the GPT Store, which will feature the best GPTs built by developers on a revenue share model. This AI app store is a natural extension of the democratized-agent strategy.

5/ The developer Playground demo was really interesting, demonstrating capabilities like threading, function calling etc.

Essentially, any developer can now build agents within their app for their customers. These agents can have all advanced GPT-4 capabilities that power specific use cases like trip planning, navigation, splitting expenses etc., each of which is presently done by separate siloed apps.

Was awesome to see the demo agent communicate in a Jarvis-like voice modality.

6/ Finally, stoked to see the love Satya Nadella showed OpenAI and Sam during a friendly on-stage banter.

It looks like the OpenAI partnership has given a new lease of life to Azure and maybe even a game-changing competitive advantage against other cloud providers. In parallel to all the work that OpenAI is doing on the model side, Azure is building a new end-to-end, AI-native cloud infrastructure and compute stack to support the development and GTM of these efforts.

It was also heartening to see Satya underline security as one of the core focus areas for the partnership:

We are grounded in the fact that safety matters. Safety is not something you care about later but it’s something we do shift-left on.

Satya Nadella at OpenAI DevDay

My TLDR take:

The rollouts in this first-ever DevDay by OpenAI are clearly important milestones in this rapidly evolving space. AI is becoming easier to use, more powerful, and more accessible at an exponential pace. Personally, this is the first time I am seeing a potential v0.1 of what has been a larger-than-life but fuzzy vision of AGI.

Kudos to Satya and Microsoft for what’s turning out to be a generational business bet on OpenAI that frankly, seems to have caught the other Big Techs a bit flat-footed. However, expect strong responses from Google, Meta, and AWS in the coming months.

Finally, I have met many founders over the last few months who have been building nifty micro-products on top of OpenAI. A few of them have been touting how these are large, venture-returns opportunities. This DevDay has already shown how many of these startup ideas have already become point features within the OpenAI ecosystem.

This aggressive feature rollout by OpenAI once again brings to the fore strategic questions around moats, right-to-win, feature vs product vs platform, and access to 1st party training data. All this is significant food for thought both for founders and VCs.

As Big Tech, OpenAI, and other hyper-scalers like Anthropic continue to dominate the infra and model layers, for new startups, things like sharp domain expertise, deep understanding of specific customer problems, access to proprietary 1st party data as well as industry or audience-specific distribution channels, can become important sources of sustainable competitive advantage and drive a valid case for why a startup should exist.

Note: for more analysis on AI incumbents vs startups, check out ‘AI Musings #1 – How The Odds Are Stacking up?‘.

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Storyteller vs Scrapper Founders

At the seed stage, how does one distinguish between and evaluate the top-down ‘Storyteller’ vs the bottoms-up ‘Scrapper’ founder personas? And can one grow into the other?

At the pre-seed/ seed stage, I have generally observed 2 founder personas – the ‘Storyteller’ and the ‘Scrapper’:

A. The Storyteller

Extremely articulate at painting the vision and market opportunity. This persona typically comes from pedigreed educational institutions (hence, great communication skills). Often, they have been execs at large corporates, Big Tech companies, and/ or brand-name, growth-stage startups.

Courtesy of this top-tier background, this persona has a naturally strategic, top-down view of the market they are going after, including the “why now?”, secular growth trends, market gaps, competition etc.

This persona is also great at spotting and riding waves, and therefore, is often building at the edge of hot trends (eg. Web3 a few years back, AI now).

This persona has a thoughtful view of how the ‘company’ will scale in the coming years. Everything from hiring and global expansion to marketing and M&A. In general, this persona will talk more about the opportunity, market, growth and scaling, and less about getting the 1st customer, writing early code, design and other aspects of building.

It’s easy to visualize this persona as the Founder and CEO of a multi-billion $ company. Therefore, Investors love this person. Period.

B. The Scrapper

Natural tinkerer in a very specific space. Typically, this interest germinated during teenage or through college. In many cases, this interest was considered obtuse or nerdy by mainstream observers, and hence, this persona is relatively less understood, perhaps viewed as quirky and therefore, underestimated.

Their creative energy manifests in hacking software, teaming up with friends on specific projects, building products as a hobby, or doing side hustles on the weekend.

This persona typically doesn’t have much capital, nor are investors lining up outside their door. So either by choice or fate, there is no option but to build in scarcity.

In fact, this persona is less likely to view their work as a ‘company’. They have a deep and unending curiosity about something and just want to put it out in the world, hoping that maybe a handful of us will ‘get’ it.

This persona thrives in a bottoms-up view of their space – their eyes light up when discussing technology, code, features, users, and anything related to building. They suck at top-down, so-called strategic discussions of possible markets their work could serve.

It’s hard to visualize this person as the Founder and CEO of a multi-billion $ company. Therefore, Investors largely pass over this person.

C. The Scrappy Storyteller

The dream is to spot a founder who blends the attributes of the Storyteller and the Scrapper. Someone who can both build with their own hands, as well as explain with utmost simplicity and clarity, why what they are building matters to the world.

©An Operator’s Blog

As I was drawing this Venn diagram, the one founder who immediately came to my mind was Peyush Bansal of Lenskart. I still vividly remember him pitching to our entire investment team for Series A in 2011 – it was a poetic combination of Storytelling backed by Scrappy execution. Peyush stays as a gold standard founder persona in my head to this day.

So, how does one spot the Scrappy Storyteller? Anecdotally, I have seen a few contexts where this persona lives:

  • Fresh grads of good universities, with a builder DNA.
  • Repeat founder with sub-scale outcomes in previous startups and/ or ‘a point to prove’.
  • ‘Hacker’ personality with good communication skills and a high-potential side project.
  • Deep domain/ research expertise with commercial DNA, often building in university labs.
  • Solid professionals who are under-estimated or ignored as per mainstream social criteria.
  • First-time founder who is executing on fumes, clawing and scrapping to early customers.

Of course, these are just some examples from my lived experiences as a venture investor. The whole point that makes venture capital extremely challenging and exciting as a vocation is that there is zero predictability in where the best founders can be scouted. It’s like going on tiger safaris in India – you might spot one in the wild during the first trip itself, or it might take multiple trips over several years.

D. Can one persona gradually grow into the other?

While all investors are on a perpetual quest to repeatedly find the dream Scrappy Storyteller persona, the reality is most founders would be more indexed on one side, to begin with.

However, the beauty of entrepreneurship is that it’s an extremely long game of survival. Therefore, irrespective of the starting point, founders with a growth mindset can gradually evolve into incorporating the strengths of the other persona, becoming an ideal blend of the two over the journey.

So the key question then becomes – how does one spot which Storyteller can eventually transform into a Scrapper? Or which Scrapper can grow into a Storyteller?

Here are some heuristics I have been experimenting with:

1/ Storyteller ➡ Scrapper

It’s very hard to convert someone into a builder. It’s like what they say in cricket – you can’t teach a fast bowler to bowl fast. Either one has it or doesn’t.

If one hasn’t developed Scrappiness as a muscle through life experience, then the only way to develop it is to go through the fire during the startup journey and not give up while at it.

Surviving for long requires grit. And grit is an outcome of an underlying emotion, which is “How badly do you want to win?”. Whenever I meet a Storyteller, I try to spot signals that help me get conviction around this single question.

2/ Scrapper ➡ Storyteller

I believe that while Scrapping is a muscle that is built over many years via braving adversity and hardships, Storytelling is a learned skill that can be honed with expert coaching and practice.

In my own venture career both institutionally as well as individually, I have seen numerous examples of Scrappy founders gradually becoming awesome Storytellers. More global exposure, as well as tools and guidance provided by VCs, really helps in this.

However, while the odds of a Scrapper becoming a Storyteller are generally positive, one still needs to evaluate how quickly and to what quality can a particular founder evolve?

In this regard, I have come to look for the following signals:

  • Basic communication skills – like command over the language, elementary articulation, clarity of thinking, logical thinking, creating arguments, and basic persuasion skills. It’s like scouting for fast bowlers in Pakistan – if the kid is bowling fast bare feet, with a tennis ball on an uneven dusty playground, the raw material is there for a premier fast bowler.
  • Coachability – self-awareness to recognize personal gaps, humility to seek solutions from experts, listening skills to assimilate feedback, and courage to work on it and become better.

E. The key message

As individuals, we all have our strengths and weaknesses. Ideally, we should choose to play games in life where our natural strengths give us an ‘edge’. Entrepreneurship is the toughest of such games. If you do choose to play it, I believe it’s important to have the self-awareness to map your gaps, and the growth mindset to work on them. If one can follow this approach and survive long enough in the game, success is almost inevitable.

PS: this post is a result of a recent brainstorming session over WhatsApp with my friend and deep tech VC Arjun Rao of Speciale Invest. Thanks so much for your thought partnership in framing this 🙏🏽

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India Startup Valuations, Corporate Governance, And Other Good Stuff: Notes From The Recent Trip

From valuations drastically coming down and hard questions around SaaS, to the unlock of INR LP capital and rise of deeptech – sharing candid notes from my recent India trip.

Just came back from one more of my quarterly trips to India. Based on meeting scores of founders, investors, and operators, here are a few interesting insights on the current state of the Indian startup ecosystem:

1/ 4-6 quarter lag between US and Indian private markets

There appeared to be investor consensus that the real shakedown in overfunded/ overvalued tech startups in India hasn’t really started yet. Most VCs believe that 2024 will be brutal for many of their portcos that are on the wrong side of things and are, therefore, expecting brutal downrounds and recaps.

Given that the US private market correction started sometime in mid’22 and is still ongoing (eg. Convoy, a digital freight brokerage last valued at ~$3.6Bn, recently shut down reportedly under stress from creditors), there seems to be a significant lag between the US and Indian private markets.

With US VCs expecting startup shutdowns to peak in 2024, assuming the above lag, we are potentially looking at a weak fundraising environment in India continuing deep into 2025.

For India-based founders, this underlines the importance of having enough runway to tide the next couple of years out.

2/ Current fundraising environment is worse than I thought

Over this trip, I heard of at least 10 deals falling through at the final legal documentation stage. Anecdotally, I could identify a couple of reasons:

  • Smaller funds are facing capital call challenges with LPs, given tough global macros and general pullback from venture as an asset class.
  • The bar for financial diligence has really gone up. Funds are willing to walk away if even a few issues crop up in the typical Big 4 fin DD. A common issue I heard is a founder signing a term sheet on the claim of say $1Mn ARR, and post-fin DD, true recurring revenue as per accounting standards turns out to be $200k. This is a deal-killing red flag!

3/ Valuations have significantly compressed

Based on triangulating numbers from convos with multiple investors, these are the generally prevailing valuation ranges for each financing stage right now in India.

Note:

(1) These numbers are highly anecdotal and will vary a lot case-by-case depending on sector, team, and traction. However, I validated these broad ranges from multiple Indian VCs.

(2) Am also including a comparison with current US benchmarks as per Carta.

Pre-Money Valuations (as of Oct’23)IndiaUS
Pre-seed$3-5Mn$5-10Mn
Seed$5-10Mn$10-25Mn
Series A$10-20Mn$25-70Mn

What’s striking to me is how compared to the US, the valuation ramp with each stage of maturity is relatively low in India.

4/ The rise of Rupee denominated capital in venture

I remember the Managing Partner of the VC firm I used to work for more than a decade back, having a strong thesis that similar to China, India’s venture ecosystem will truly be unlocked by the participation of domestic capital pools. On this trip, I saw encouraging green shoots of this view, with Family Offices like the Mariwalas and Hindujas allocating to venture capital both actively and passively.

One interesting trend here is how the younger, next-gen heirs to these family businesses want to play an active role in working alongside the new crop of Indian founders. I sensed a passion and excitement in their approach, which transcended from startups being mere wealth management or portfolio allocation decisions.

To me, unlocking INR LP capital is a hugely encouraging trend and one that will make the local innovation economy more resilient to geopolitics and global shocks.

5/ Deeptech becoming a mainstream venture theme

Deeptech seems to have transitioned from being a fringe venture theme for many years, to now being one of the core theses of all mainstream VCs. Peak XV’s latest Surge batch is dominated by AI and deeptech, Accel is running an Industry 5.0 program via its Atoms accelerator, deeptech specialists like Speciale Invest and Pi Ventures are busier than ever, and I heard of many investments in-process in the semiconductor space.

The cornerstone of my investing thesis is – “India started by exporting software services in the 90s-early 2000s. It then moved up the value chain to become the global hub for software products/ SaaS from the mid-2000s till 2020. Over the next 20 years, India will move even further up the value chain and export cutting-edge innovation to the world”.

This time, I saw strong signs of this thesis on the ground in India.

6/ Corporate governance clean-up in progress

It was clear that both founders and investors are owning up to the corporate governance mishaps over the last year. The problems have been recognized, accountability taken, causes diagnosed, and learnings accepted and assimilated. I heard many instances of deep clean-up happening within companies, right from the board to the lower operating levels.

I see this as a major growing-up moment for the Indian venture ecosystem as a whole, and post this clean-up, everyone will be better off for it. I expect a whole crop of young founders and venture investors to emerge battle-hardened from these experiences, and from here on, focus their energies on building generational companies.

7/ Hard questions being asked of application SaaS

Similar to the sentiment at Bessemer’s recent Cloud100: Rise of SaaS in India Brunch 2023** in SF, Indian VCs are now starting to ask some hard questions about competition and product differentiation to application SaaS startups.

The Zoho playbook worked in the early 2000s. The Freshworks playbook worked in the 2010s. In this rapidly changing, post-AI world, whether these old paradigms are still applicable needs to be questioned and discussed in an intellectually honest way.

**Key SaaS takeaways from this event here.

8/ Very early signs of the domestic B2B software opportunity

While the India cross-border SaaS opportunity is now well established, I am also hearing scattered anecdotes of startups going after large ACV, domestic B2B opportunities. While VCs continue to be generally bearish on domestic B2B software, founders have started taking note of the journeys of the likes of Perfios and Netcore. Some of these companies have shown that though it takes time, it’s possible to build large ($100Mn+ ARR) domestic software product businesses.

In fact, over the last year, I have seen several enterprise startups reach $3-10Mn ARR by serving large Indian customers. Maybe it’s time to be more open-minded and take a nuanced view of the domestic B2B software opportunity?

9/ Tech-enablement of legacy domestic verticals

Applying technology to improve the growth and efficiency of legacy verticals like construction, procurement, automotive parts, logistics etc. is emerging as a key business opportunity. While horizontal B2B commerce platforms like Udaan, OfBusiness, and Moglix are already mainstream, am also seeing the rise of a new set of more specialized, vertical platforms.

These are really large TAM opportunities given the amount of GMV that changes hands in the brick-and-mortar portions of the economy. As India grows from a $3.5Tn to a $10Tn economy, the tech-enablement opportunity in these broader spaces will grow even faster.

10/ Didn’t see a clear thesis on AI

While almost all Indian VCs are deploying in AI startups, I didn’t hear any clear thesis or POVs from most of them. Not to be too harsh on them as barring the emerging hyper scalers like OpenAI and Anthropic, the early stage AI scene is pretty fuzzy even in Silicon Valley. PS: check out my recent post ‘AI Musings #1 – How The Odds Are Stacking Up?.

11/ Promise of IPO’ing in India

I heard distinct excitement around the potential of late-stage startups doing IPOs in the Indian market. Over the last couple of years, Indian public markets have shown a strong appetite both for tech growth stocks as well as small to midcap SMB stocks.

I spoke to a founder who recently listed his tech services company at a relatively small scale. His experience in managing the compliance and related overheads of running a publicly listed company in India has been fairly smooth so far. In fact, he has enjoyed both interacting with and learning from well-prepared large institutional investors.

Similar to INR LP capital, unlocking domestic public markets for IPOs of new-age companies will be a huge boost and de-risker for the local innovation ecosystem.

Other memorable moments

LetsVenture, my very first angel investment, completed 10 years. I still remember the first brainstorming session with the founders when it was just an idea on a blank sheet. The company has since emerged as the leading infrastructure layer for private market investing in India. I am in awe of the tenacity of Shanti Mohan (Co-founder and CEO), and how she has selflessly contributed and fought for organizing private market investing in India. PS: some special moments at the celebratory dinner with early backers – Subrata of Accel, Sharad Sharma of iSpirt, and others are here.

LetsVenture’s achievements over the last decade

I was also on a panel at LetsIgnite with one of my oldest friends Anirudh Singh (Avataar Ventures), alongside Vishesh Rajaram (Speciale Invest) and Uday Sodhi. It was an unfiltered discussion on everything from portfolio construction, diversification, and power laws to entry prices and exit approaches. It was also the first time I presented my investment strategy to any external audience, so this particular event will always stay close to my heart. PS: some key insights from the panel are here.

LetsIgnite’23 panel on venture portfolio construction

Towards the end of the trip, I partnered with my friend and collaborator Arjun Rao (Speciale Invest) to do a closed-door, no-holds-barred type session with select infrastructure SaaS founders in Bangalore. The main theme was the US-India corridor. I like to keep these sessions very raw, no-gyaan, only brassstacks around operating and financing challenges that US-India enterprise founders are dealing with daily. PS: some key takeaways from the session are here.

Closed-door session on US-India corridor, in partnership with Speciale Invest

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Views On India…From A Belgian

Over a breakfast of dosa and piping hot filter coffee in Bangalore, here’s what a total stranger from Belgium told me about India.

On my recent trip to Bangalore, I ended up sharing a breakfast table with this fine Belgian gentleman. He works for a Belgian vegetable oil company and has been sourcing ingredients from India for more than 20 years.

Basically, he is the first Belgian I have ever spoken with in my entire life. On top of that, he is as far away from my world of US-India tech startups and venture capital as one can imagine. Being the collector of obtuse insights and mental models that I am, I started asking him questions about his experience and observations over 2 decades of coming here.

Here are some quick scribbles from the conversation that you might find interesting:

1/ Hubli

The first thing he mentioned was that he spends a lot of time sourcing from Hubli. During this trip, he was surprised to see a startup incubator on one of the local roads.

Even as someone who spends a lot of on-ground time covering the Indian startup ecosystem, this was an eye-opening observation for me. It just goes to show how deep the pan-India social buy-in into startups has gradually become.

2/ Professionalism

He mentioned how in his initial years of sourcing from India, he felt like his suppliers were these small, unorganized, and resource-poor family businesses. He was sourcing from what he saw as a largely poor country.

Over the last 2 decades, he has seen how the same suppliers have become more professional, their manufacturing floors have become more sophisticated, and now, he feels they are comparable to similar businesses in China and SE Asia.

This was heartening for me to hear. SMBs are the backbone of India’s economy and key to its resilience. Improved productivity in this part of the economy will unlock a lot of value that will also percolate down much better.

3/ Flexibility

Given rising global risk and uncertainty (eg. the Ukraine war near his region), having supply chain optionality has become more important than ever before. This person wants a sourcing network that is spread across multiple suppliers in different countries and is, therefore, resistant to global shocks.

He believes this trend is going to significantly benefit India, given it is one of the few countries globally that has scale in manufacturing capacity. While European and Chinese suppliers tend to operate in ‘boxes’ with rigid rules, he loves that Indian suppliers tend to be more flexible, thinking on their feet and problem-solving on the fly.

In my eyes, while the Indian business hustle (‘Jugaad’ mindset) is key to survival amongst a web of local complexities and inefficiencies, it has been a liability in terms of doing business with the world.

However, combine this hustle with strategic thinking, focus on quality, and a strong work ethic – and Indian entrepreneurs can create magic!

4/ Perception

He mentioned that very recently, a major national newspaper in Belgium published a story talking about the decline of China and predicted that India would be the next global powerhouse. It was essentially prompting Belgium to do more business with India.

However, he has also seen the flip side where there is a negative legacy perception around doing business with Indian companies, particularly across Europe and even in Asia. Apprehensions like nothing will get delivered on time, quality will be inferior, manufacturing guidelines won’t be followed etc.

He felt that for India to take its rightful place in global trade, its businesses need to make a conscious effort to break this perception.

I see similar biases at play all the time even with respect to the Indian tech and venture ecosystem. Things like:

“India can only do IT services and can’t produce a global software product company” – Freshworks changed that.

“India is the back office of the world and can’t do real innovation” – Chandrayaan, Covaxin, and Brahmos are changing that.

“Indian tech companies can’t dominate in developed markets” – Paytm’s Japanese product is already amongst the top payment apps in the country.

“Indian airports are the worst in the world” – check out New Delhi T3 and Bangalore T2.

We are now sitting on a generational opportunity to break these biases in almost every vertical. As a venture investor, one of my core thesis is around breaking the bias that “India can’t export cutting-edge innovation”. I see companies like Flytbase, Playto Labs, and Tydy in my portfolio that make me believe!

Closing thoughts

So, my main takeaway from this convo with a Belgian stranger, over a plate of dosa and piping hot filter coffee, was this – India is changing…fast, and everyone globally is noticing it and experiencing it. We are, however, fighting against legacy perceptions, and it’s our collective responsibility to proactively change that by delivering the highest quality in whatever touch points each of us has with the rest of the world.

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How Much To Bet On A Deal?

Say you are managing a corpus of $100 and intend to invest it across a portfolio of ‘N’ bets, how should you determine the size of each bet?

The Kelly Formula, as outlined by the famous math professor, investor, and gambler Ed Thorp, shows us a path.

One question that I have been studying for a while now is how to most optimally bet on a given deal? Public market investors call this ‘position sizing’ – say you are managing a corpus of $100 and intend to invest it across a portfolio of ‘N’ bets, how should you determine the size of each bet?

A. Nuances for every strategy

Based on studying how some of the best public market and venture investors approach position sizing, it’s clear to me that, like most things in life, it’s part art and part science.

Every investor will have their own nuanced perspective on this topic based on their individual ‘strategy’. This includes the following aspects:

1/ Asset class

Publicly listed stocks are liquid and play in a mostly-efficient, no information-asymmetry market. On the other hand, venture capital is perhaps the most inefficient market, governed by intense power laws and extreme loss ratios.

In a totally different game, real assets generate cash flows and are, therefore, conducive to debt financing that improves levered-equity returns.

2/ Beliefs and personality

Warren and Charlie believe in buying extraordinary businesses at fair prices. Joel Greenblatt believes in special situations. YC and 500Startups believe in the ‘Moneyball’ style of venture investing. Benchmark and Kleiner Perkins believe in the classical, craftsperson style of venture capital. Brookfield believes in buying high-quality real assets on a value basis.

3/ Circle of competence

Often called an ‘edge’ or ‘competitive advantage’. Peter Thiel and Vinod Khosla understand revolutionary technologies better than others. Li Lu gets China more than Western fund managers. Berkshire is unique in its understanding of insurance businesses.

4/ Selection criteria

Don Valentine, Founder of Sequoia, famously said that “great markets make great companies”. Keith Rabois of Founders Fund has a founder-driven investing style where he looks to figure out whether this founding team can build an iconic company that changes the world.

Public market OG Chuck Akre’s investment criteria are captured in the ‘three-legged stool’ – (1) extraordinary business, (2) talented management, and (3) great reinvestment opportunities and histories.

5/ Portfolio construction

On the public market side, Charlie Munger’s Daily Journal Corp has a super-concentrated portfolio of 4 stocks (~40% Wells Fargo, ~40% Bank of America, ~15% Alibaba Group, and the rest is U.S. Bancorp). Bill Ackman of Pershing Square has a classical, concentrated ’10×10′ portfolio that presently includes 8 stocks, with each position being 10-20% of the portfolio. Seth Klarman of Baupost Group is comfortable with a bit more diversification, owning 28 stocks at present with the largest holding at ~15% portfolio, and a bunch of positions in the single digit % range.

In venture capital, given its high-risk profile, the importance of diversification is generally well-understood. Yet, firms exhibit significant variance in their approaches to portfolio construction. While the likes of Brad Feld and Mark Suster believe in taking 30-40 shots even from reasonably large $300Mn+ funds, Mike Maples Jr. of Floodgate believes that a typical venture portfolio becomes statistically diversified at 12 companies, and beyond 25, there is no incremental value from excess diversification. Miriam Rivera of Ulu Ventures has studied data from LPs and concluded that even the best VCs have ~4.5% picking skills and therefore, a portfolio of 70-100 shots at goal is needed. Finally, an accelerator like YC funded 229 startups in just one Summer 2023 batch.

So, as we can see, position sizing approaches can vary dramatically based on the investing context and strategy being followed. But are there any broad rules and heuristics that can be useful for any investor out there?

B. The Kelly Formula

John L. Kelly was a researcher at Bell Labs in the 1950s. He developed a mathematical theory on how to bet most-optimally from a finite bankroll, in favorable gambling games.

Without going into the mathematical details of it*, here’s the basic idea behind the theory as explained by Rob Vinal of RV Capital in his H1 2023 Investor Letter:

The basic idea is that the greater the upside relative to the downside, the more an investor should bet. However, if there is a probability of a total loss, the bet size should be zero as the product of any series of numbers with a zero in it is zero.

Rob Vinal

*For those who are mathematically inclined, check out a couple of old must-reads by the famous math professor, investor, and gambler Ed Thorp – The Mathematics of Gambling and The Kelly Criterion and the Stock Market.

Based on studying the Kelly system, including commentary on it from the likes of Ed Thorp and Rob Vinal, here are some key rules that any investor should be aware of while position sizing for any strategy:

1/ Play only when you have an advantage

Here’s how Ed Thorp describes it:

The Kelly system calls for no bet unless you have the advantage. Therefore, it would tell you to avoid games such as craps and slot machines. However, if you have the knowledge and skill to gain an edge in blackjack, you can use the Kelly system to optimize your rate of gain.

Ed Thorp

Warren Buffet’s ‘Circle of Competence’ rule is also a play on this idea. To have the best odds of winning, choose a game you have an edge in and choose to play at the table with weaker players.

TLDR: focus on identifying your edge before thinking through bet sizing.

2/ Avoid the risk of ruin

In repeated games (say a coin toss) where there are some odds of a total loss (eg. heads you win, tails you lose), if you bet everything in each turn knowing that you have an edge in each turn (say you have odds of 0.52 for getting heads in each turn), as the number of turns ‘N’ increases, the probability that you will be ruined tends to 1 or certainty.

In the Kelly system, you never bet everything in a single turn so the chance of ruin is zero.

3/ Bet more when asymmetricity is high

The Kelly formula tells us to bet large where there is a big asymmetry between upside and downside. Conversely, it shows that if the risk of loss is too high on a single bet (eg. in Roulette), it’s too dangerous to bet a large fraction of your bankroll.

The former scenario is the method that top-value investors follow – betting a big proportion of the fund (10-20%+) on each high-conviction, high-quality business with a large margin of safety. Case in point: Berkshire has ~50% of its publicly traded portfolio in Apple.

We don’t put the most money into things that are going to give us 7-10x returns. We put the most in positions where we will never lose money.

Joel Greenblatt

Conversely, the latter ‘Roulette’ insight is the method venture capital investors follow while investing in extremely high-risk startups. They play on the right side of the power law curve – assembling an optimally diversified portfolio of high-risk, high-reward bets; and deploying enough capital in each bet so as to ensure enough ownership per company such that if and when it wins, it wins big enough to compensate for all the other losses in the portfolio.

4/ Value of holding cash

By using concepts like bankroll, betting small portions of it at a time, and not going broke, the Kelly formula also subliminally suggests the value of always holding cash in the portfolio.

Berkshire is famous for holding significant amounts of cash ($100Bn+ in recent years) on its balance sheet at all times.

We believe in always having cash. There have been few times in history where if you don’t have it, you don’t get to play the next day.

Cash is like oxygen. It’s there all the time but if it disappears for a few minutes, it’s all over.

Warren Buffet

Holding cash also helps in going on offense when unforeseen crises like the dotcom crash or GFC occur. As asset prices crash, these become once-in-a-lifetime opportunities to deploy capital.

C. Incorporating special considerations

While following the above heuristics from the Kelly criterion, it’s also important to keep some room to account for special considerations in your personal context. Eg. Rob Vinal keeps some buffer in case LPs want to withdraw money on short notice:

RV Capital H1 2023 Investor Letter

D. Closing Thoughts

Position sizing is both an art and a science. Having a well-defined view on it that is congruent with your overall investment strategy is crucial for any investor.

As you think through its nuances, it’s useful to keep in mind the guardrails that the Kelly formula tells us. The Kelly heuristics guide us towards the most optimal, risk-adjusted path for generating returns in probabilistic games like investing while avoiding the risk of total ruin.

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AI Musings #1 – How The Odds Are Stacking Up?

From OpenAI getting close to $100Bn valuation and Anthropic partnering with Amazon, to Google and Meta doubling-down on their LLMs faster than ever before, the AI chess game is getting more intriguing by the day.

In this post #1 of the ‘AI Musings’ series, I share a few running thoughts on the odds for each category of players.

**This is the first post in a series called ‘AI Musings’ that I hope to write regularly over the next few months. The idea is to periodically analyze major developments and milestones in AI, both from a startup and BigTech perspective.

Frantic activity around AI continues in the US. Just in the last week, OpenAI is looking at a $80-90Bn valuation for a secondary sale of existing employee shares. Even as Anthropic announced a strategic collaboration with Amazon last week, which includes up to a $4Bn investment, there is news today of the company raising another $2Bn from Google and others at a $20-30Bn valuation. This is a 5x jump from its last round valuation in March.

Greylock has gone AI-first with its newest early-stage fund. The Nvidia stock continues to rip (read my post on how it illustrates The Bunches Principle). Dharmesh Shah (Co-founder and CTO of Hubspot) is back to coding and selling, building ChatSpot over a weekend of hacking as a first step towards making his CRM AI-powered.

Amidst all this action, I have been meeting academics, founders, investors, and BigTech operators working on the frontiers of AI, trying to refine my hypothesis on the space. Here’s a working version of some of my thoughts:

1/ High confidence that AI is real and here to stay

Though the space is definitely in a financing hype cycle, to me, it’s now beyond doubt that AI as a platform shift will be transformative for the world. Unlike Web3, progress around AI has been driven by large tech companies since the very beginning. These companies are much too shrewd and tracked to spend significant resources on something that is merely a low-probability moonshot. Therefore, they have been focused on driving real commercial value from LLMs from Day 0.

OpenAI first launched ChatGPT on Nov 30, 2022. The fact that Generative AI capabilities are already integrated into mainstream products like the MS Office suite, Google Search, LinkedIn, Notion etc. in less than a year just goes to show that this particular platform shift is happening significantly faster than the Internet, Mobile, and Cloud.

Another confidence booster for me personally has been the commercial revenue traction of AI-native hyper scalers. Here are some numbers based on my research:

CompanyStartedLatest Valuation Current Revenue Traction (Est.)Source
OpenAI2015~$80-90Bn, reported as of Sep’23$80Mn est. MRR (~$1Bn annualized), reported as of Aug’23Reuters
Anthropic2021~$20-30Bn, reported as of Oct’23$200Mn proj. revenue in 2023, reported as of Sep’23 Information
Cohere2019~$2.1Bn, reported as of Jun’23Sub $50Mn proj. revenue in 2023, reported as of Aug’23Industry Sources
Hugging Face2016~$4.5Bn, reported as of Aug’23$30-50Mn est. annualized revenue, reported as of Aug’23Axios

These are tangible business revenues generated from enterprises, SMBs, and individual developers as customers. And the ramp-up over the last 12 months is astonishing. Honestly, looking at the depth of commercial traction these hyperscalers are showing, the valuation numbers don’t look entirely out of whack.

2/ Large incumbents are highly likely to capture disproportionate value from AI

About 9 months back, when Google’s stock was tanking as a reaction to ChatGPT’s growth and OpenAI’s partnership with Microsoft (a botched Bard demo made things worse!), I asked this simple question:

In hindsight, this was a very pertinent question to ask. As various BigTech-AI hyperscaler partnerships are playing out, it’s becoming clearer that large incumbents are strongly positioned to capture a significant portion of market value created from AI. They have a unique combination of the following:

  • Chips and cloud computing infrastructure to train and deploy foundational models, as well as build custom applications that are reliable, safe, and secure.
  • Distribution reach to get Generative AI in the hands of exponentially more customers.
  • Capital to place bets on AI hyper scalers and align with them to leverage their core strengths around faster and more disruptive innovation.

Bill Ackman, who runs Pershing Square and is one of the top-performing hedge fund managers, has been doubling down on Google since its price hit the $80-90 range post-ChatGPT. Here’s his rationale on why Google is strongly positioned in an AI world:

Bill Ackman’s (Pershing Square) pitch on Google’s positioning in AI

Based on my conversations with senior AI operators at the likes of Google and AWS, I believe the AI manifestations we are currently seeing in their mainstream products are not even the tip of the iceberg. Think of them as small experiments or POCs. The depth and range of their pipeline of AI capabilities are beyond regular imagination.

Btw, I am a believer in Bill Miller’s thought – “The economy doesn’t predict the market. The market predicts the economy. Going by how BigTech stocks are ripping amidst a rather cool economic and market environment, the wisdom of public markets also suggests that these incumbents are poised to reap huge dividends from AI.

So, amidst all the noise and hype, if you are trying to figure out a simple, risk-adjusted way to benefit from this AI platform shift, here’s a thought to consider:

3/Early-stage startup plays are still fuzzy

After spending significant bandwidth meeting AI founders, I am seeing that, as opposed to the BigTech and AI Hyperscaler plays, there is significantly more fuzziness in the early-stage ecosystem (and rightfully so!).

Inspired by the recent SaaStr session between David Sacks (Craft Ventures) and Jason Lemkin, here are my running thoughts on 3 categories of AI startups:

(I) Infrastructure

These include LLMs and other aspects of foundational AI infra. This bucket is really challenging to invest in simply because:

  • Building AI infra requires deep technical chops and/ or very specific prior experience, ideally in a particular set of companies. These teams are rare, extremely hard to source, and often get spotted very early by the likes of Sequoia and A16Z.
  • AI infra startups require large amounts of capital and therefore, need major VCs to be in them from very early on. In other words, these companies are hard to bootstrap, and funding them requires playing a very different kind of game that’s hard for a small check writer to play.

(II) Classic vertical SaaS with AI capabilities

The hypothesis here is that given AI is a massive platform shift, does it create new gaps in existing verticals like healthcare, education, sales, customer support etc. that a fresh generation of AI-first startups can exploit?

The hurdle I face while evaluating these startups is – why wouldn’t an existing growth or late-stage company just leverage AI as a new capability in their existing product suite? Incorporating AI features into an existing installed base (eg. what Microsoft is doing with OpenAI) seems like a superior ROI proposition compared to taking a brand-new product to market.

If this generalization is indeed true, it definitely raises the bar for this bucket. However, again to think out loud, there are some contexts where there could be a real commercial case for new AI-powered vertical software. For eg.:

  • Legacy verticals where fewer growth-stage startups of the prior generation have entered – say transportation? Or construction? The argument here is that it’s easier to beat old incumbents by using AI as tech leverage, compared to other late-stage startups who might be equally good at incorporating it.
  • Verticals where brand new paradigms are opening up, which will change the game itself – given winner-takes-all dynamics in tech, most incumbents are hard to beat at their own game. But, if the game itself changes (often due to a tech inflection), then David has a better chance against Goliath (read my post “David (Microsoft) vs Goliath (Google)“). Eg. using AI in genomics, drones, automotive etc. to solve problems and deliver work in totally new ways.

(III) Job co-pilots

The hypothesis here is that AI will spawn a generation of job-specific assistants called co-pilots, that will make a specific job more efficient and effective. So everyone from a doctor and lawyer to CFO and marketer will have a co-pilot that does everything from workflow automation to insights generation, all in a conversational UX.

This seems to be an extension of the productivity-software thesis that many VCs followed over the last 5 years. Sounds interesting and plausible, though I am still not able to build conviction on what a winning company in this space could potentially look like, how it would need to be capitalized and built, and whether it can generate venture returns.

I am learning new thesis, approaches and frameworks every week, especially related to the early stage startup plays in AI. More to follow in AI Musings #2…

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How Much of Success is Skill vs. Luck?

Is our life a game of Chess or Monopoly? Can we use our skill to control outcomes, or are we at the mercy of luck?

I layer the work of Michael Mauboussin on top of my own life experience, to understand modern reality and suggest ways we can tilt the playing field in our favor.

Since entering 1st grade, my older son has been really into two different kinds of games – Chess and Monopoly. As expected, I am his default opponent whenever he feels like playing either one. Especially on weekends, when he assumes I have nothing better to do anyway!

Anyway, I have noticed an interesting behavioral pattern over many weeks of playing. While my son hates losing in general (need to rewire him on that), he is relatively calmer in accepting defeat at Chess. But when he gets defeated at Monopoly, he totally loses his marbles.

After experiencing several instances of this behavior, I had to ultimately sit him down and explain how Chess is a game of skill while Monopoly is a game of luck. Of course, it’s hard for a 6-year-old to understand the difference, but I think he got the gist of it when I told him the difference between thinking through a Chess move and rolling the dice in Monopoly.

This explanation seems to be working so far. While it helped restore a much-needed weekend peace in my household, it also brought me back to the ‘Skill-Luck Continuum’ framework by one of my favorite finance practitioners, academic and author Michael Mauboussin. Both as a parent and venture investor, I feel this is a good opportunity to do a refresher on MM’s work untangling skill and luck, as well as apply his lens to my own life experience.

Key Source – The Success Equation: Untangling Skill and Luck by Michael Mauboussin (Talks at Google, July 2014).

A. Definitions

Straight out of a dictionary, skill is defined as the ability to use one’s knowledge effectively and readily in execution or performance. Essentially, having perfect skill means the ability to re-create the same performance each time across repeated rounds of a game.

Luck, on the other hand, is much harder to define. The dictionary defines it as a force that brings good fortune or adversity or favoring chance. However, I like the 3 conditions outlined by Mauboussin, that need to be satisfied for luck to be at play:

1/ Operates for an individual or organization.

2/ Is either good or bad.

3/ It’s reasonable to expect that a different outcome could have occurred.

An awesome thought test by MM for this is – “Can you lose this game on purpose?”. If it’s 100% yes, it’s perfect skill. If not, there is definitely some luck involved.

B. The Continuum

All outcomes in life are a mix of skill and luck. So all professional and personal games that we play can be plotted on a skill-luck continuum, with the extreme left being 100% skill and the extreme right being 100% luck. Anything in the middle is a blend.

C. Insights from the Modern World

MM highlights the following insights regarding the interplay of skill and luck in today’s world:

1/ Outliers require both extreme skill and extreme luck – that’s when the likes of Michael Jordan, Bill Gates, and Warren Buffet become what they did.

2/ Mean-reversion* – on the 100% skill side, there is no reversion to the mean. On the 100% luck side, there is a complete reversion to mean.

*Mean-reversion means an outcome that is far from average will be followed by an outcome with an expected value that is closer to the average.

3/ Paradox of skill – in the modern world, as skill improves, the role of luck becomes even more important. Across diverse areas such as sports, business, and money management, it has been observed that the difference between the very best player and the average player has been steadily going down compared to the previous generation. For eg., in the Olympic marathon, the time difference between the 1st place and the 20th place has come down from ~39 mins in 1932 to 5-7 mins as of today.

Standard deviations of baseball batting averages, managers generating excess returns over the benchmark, and the quality of physical or digital goods have all been steadily declining.

Absolute skill has never been higher while relative skill has never been narrower, thus increasing the role of luck in the modern world.

4/ Convexity in payoffs – convexity means for a small change in quality, there is a huge change in payoff. From tennis grand slam prize money to Big Tech market caps, the modern world is littered with winner-takes-all dynamics wherein the gap between the payoffs of the #1 and #2 ranked players is really wide, even though their absolute skills are relatively similar.

D. Suggested Approaches For Skill vs. Luck Games

MM recommends the following two approaches for each end of the continuum:

1/ ‘Practice’ for skill-heavy games

This is where Malcolm Gladwell’s famous 10,000 hour rule applies. More inputs lead to better skills that in turn, are directly correlated to better outputs.

2/ ‘Process’ for luck-heavy games

You can’t improve your luck, you can only manage it. The idea is to focus on what’s in your control.

A good way is to design a process that improves your odds, and play only when you have an ‘edge’. For example:

  • In poker, place small bets most of the time to avoid ruin, but go all-in when the hand is strong.
  • Choose to play only against weak opponents.
  • When faced with a strong opponent, change the rules of the game (see my post on AI wars ‘David (Microsoft) vs Goliath (Google)‘).
  • Iterate by running small experiments (check out the Business Model Canvas by Steve Blank).
  • Invest in inefficient markets.
  • Have an adequately diversified portfolio.

E. Applying to My Life Experience

Let me plot various games from my own life on MM’s skill-luck continuum:

1/ Writing

In any creative field, it’s extremely hard to pick winners. J.K. Rowling was rejected by multiple publishers. Classics like Star Wars and Jurassic Park initially struggled to get greenlit by studios for several years.

An exec at Time Warner had this to say during a guest lecture in MM’s class at Columbia Business School:

We have no idea what’s going to be a hit. We try and run numbers, or apply formulaes, but we really have no idea whether it will work.

Exec at Time Warner

While writing as a creative art is mostly a skill, luck also plays a role in what eventually becomes popular. For eg., even an average work of a popular author will generate more sales than the great work of an unknown author (check out my post ‘The Success Flywheel‘ for more on this phenomenon).

My approach: focus on Practice. Put in reps and continuously learn from observation and feedback.

2/ Venture investing

Classic early-stage venture capital (in today’s terminologies, that would be anything from pre-seed to Series A) is ruled by power laws (see my posts ‘Conviction vs Randomness in Venture Investing‘ and ‘Only Need To Get a Few Right!‘ on this). Given the high levels of uncertainty at this stage of company building, the eventual outcome is a widely distributed set of probabilities. Ergo, picking is really hard.

Data also corroborates this view. In this Venture Unlocked podcast by Samir Kaji, Miriam Rivera of Ulu Ventures cited data from Horsley Bridge that shows for the absolute top-tier of funds like Sequoia and Benchmark, a mere 4.5% of their companies have generated ~2/3rd of all their returns.

Of course, the track record of funds like Union Square Ventures and Benchmark where they have repeatedly beaten benchmark returns across decades of multiple vintages, also suggests that some VCs have more skill than others.

If I had to put venture capital as an industry on the continuum, I would give a higher proportion to luck relative to skill in the blend.

My approach: focus on Process. Respect power law. Identify and double-down on your ‘edge’. Take enough shots at the goal. Ensure asymmetric upside (when you win, you win big).

3/ Public market investing

I have no hesitation in calling myself, as well as many of my successful peers, major beneficiaries of the post-’08 ZIRP decade. For cusp Millennials like us, our peak career years coincided with a never-seen-before era of loose monetary policy, leading to a worldwide economic boom and asset inflation. I am not sure if I will see another decade where the economies of the US, China, and India are all ripping at the same time.

Of course, there was still some skill at play wherein a few were better positioned than others to take advantage of this wave, and they did. But still, a rising tide lifts all boats, as everyone who worked in tech over the last decade would testify to.

With respect to public markets, I totally agree with what Howard Marks says in his 2014 Memo ‘Getting Lucky‘:

But in investing, it’s hard to know what will happen and impossible to know when it will happen. Many things influence performance other than (a) investors’ hard work and skill and (b) the market’s dependable discounting of information about the future. Luck-randomness, or the occurrence of things beyond our knowledge and control – plays a huge part in outcomes.

Howard Marks (Getting Lucky)

So, while the inherent randomness in the world ensures that successful investing requires significant luck, a skillful investor is right more often, over a long period of time.

My approach: focus on Process. Acknowledge how hard it really is to beat the index. Respect randomness. Act as a permanent owner of businesses. Benefit from compounding. Remember that you only need to get a few right.

4/ Parenting

This is the hardest game to analyze. As parents, we all strive for control – the ability to craft, almost guarantee, our kids’ destiny. We read books, talk to other parents, listen to podcasts, hound teachers, and constantly iterate on what is and isn’t working. We continuously gather skills and tools in our yearning to discover the ‘playbook’.

The reality, however, is much harsher. There is no playbook for nurturing humans. There is just too much unique context, too many variables, too many uncertainties, too many externalities – basically, too much randomness. In this dynamic, it’s essentially a fool’s errand to predict anything.

I loved a thought that I recently read on X, and which was also echoed by a few other parents in our school community – “parents can only hope to give a modicum of downside protection to their kids. They can’t guarantee the upside”.

Approach: focus on Process (and Philosophy). Acknowledge the uncontrollables. Let it be organic.

F. TL;DR

Layering the work of Michael Mauboussin on top of my own life experience, here’s what I am netting out to on this topic:

  • All games in life are a blend of skill and luck.
  • The modern world is highly random and the future, for the most part, is unknown and unknowable.
  • Ergo, barring a few specific games, most of modern life is highly influenced by luck.
  • On top of this, payoffs are getting increasingly convex, courtesy of power laws.
  • Given these realities, an effective approach to life is to focus on the ‘process’ over outcomes (see my post ‘Conquering Uncertainty, Dhoni & Vinod Khosla Style‘).
  • Work to discover your ‘edge’ and back it up with deliberate execution that tilts the odds in your favor just a little bit each day.

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Why The Instacart IPO is More Significant Than You Think?

A Consumer Internet company, operating in the cut-throat Grocery vertical, going public in a tough macro environment, amidst a widespread venture downturn and without a prominent AI narrative – Instacart’s recent IPO contradicts every mainstream belief.

The long-awaited Instacart IPO finally happened on Tuesday, Sep 19. The offering price was $30 a share, valuing the company at ~$10Bn on a fully diluted basis. This was a significant mark-down from the $39Bn valuation that private market investors ascribed to the company in early 2021 at the peak of the post-Covid tech cycle.

Given this is the first IPO of a notable venture-backed company since Dec 2021, I would like to share some nuances that other analysts and media reports might have missed, and which strongly underline the significance of this event in the current venture downcycle:

1/ Consumer Internet IPOs are tougher to pull off – compared to asset-backed brick-and-mortar industries, as well as enterprise software, Consumer Internet companies find it harder to go public given their business models don’t lend themselves well to sustainable profitability.

While these companies do show growth and scalability, they suffer from high marketing costs. The underlying metric that’s commonly used for this is Customer Acquisition Cost (CAC). Consumer Internet companies have high CACs, driven mainly by costs of FAANG distribution channels and discounts/ promotions to entice customers.

Public markets essentially evaluate companies on profitability (starting with EBITDA, but ultimately on Earnings), leading to Free Cash Flow (FCF). That’s why the standard valuation methods for public companies are the Price/Earnings Ratio (P/E) and Discounted Cash Flow (DCF).

Given the low or non-existent profitability of Consumer Internet companies, it becomes hard to robustly value them. That’s why they get held to a higher bar in public markets, as we have seen with the likes of Uber and Airbnb in recent years.

In that regard, it’s much more commendable when the management teams of say Instacart or Robinhood pull off an IPO vs. a Monday.com or Freshworks, given the default odds are stacked against the former.

2/ Bonus points for delivering a new IPO story in a tough space like Grocery – Several aspects make Grocery incredibly challenging as a space. It’s highly competitive with large incumbents (Walmart, Whole Foods, Target, Kroger, Costco etc.) coexisting with regional, mid-sized chains (Trader Joe’s, Ralphs, Gus’s Supermarket etc.) and mom-and-pop stores (eg. ethnic grocery stores like Asian, Indian, Mediterranean etc.). These players compete in an environment that is a lethal combination of low growth and low margins.

Historical US Grocery Sales (Source: Aswath Damodaran)

If one were to think of a legacy vertical that can be fruitfully disrupted by tech, Grocery wouldn’t even make the shortlist of most analysts and investors. That Instacart pulled this off and on top of it, also delivered a liquidity event, is a humongous achievement.

Source: Aswath Damodaran

3/ A venture-backed IPO amidst super-tight macros – while fighting against the above odds, what makes this event even more significant is that it has been pulled off in a high-interest rate environment driven by a hawkish Fed, an IPO window that has been pretty much closed for typical venture-backed models since late 2021, and where late-stage private companies are hurting from inflated last-round valuations, weakening customer demand and lack of profitability (refer my post ‘When will the next venture bull run begin?‘).

To choose this environment to go public in shows real courage, and I congratulate the management team and shareholders for this brave call.

4/ Pulling off a non-AI IPO in 2023 – Instacart closely followed on the heels of the chip design company Arm’s IPO. Given AI is seeing a hype cycle right now, the outperformance of Arm’s IPO was expected. But kudos to Instacart for pulling off an online grocery IPO when the only thing investors seem to be wanting right now is AI.

5/ Setting strong precedence for prioritizing liquidity for employees – Interestingly, only ~8% of Instacart’s outstanding shares were floated in this IPO, with ~36% of those sold coming from existing shareholders. In the words of the company’s CEO:

“We felt that it was really important to give our employees liquidity. This IPO is not about raising money for us. It’s really about making sure that all employees can have liquidity on stocks that they work very hard for. We weren’t looking for a perfect market window.”

Fidji Simo, Instacart CEO

This is an amazing stance taken by the company. As someone who has both founded and worked in early-stage startups, I have seen how demotivating holding illiquid stock can be for employees. In fact, this has been one of the major ecosystem-wide downsides of tech startups staying private for longer during the ZIRP decade.

Instacart has demonstrated that rewarding employees via liquidity events is at least as important as generating returns for VCs on the cap table and that it is the responsibility of Boards and management teams to make it happen.

6/ Proving that entry price mattersWSJ recently wrote about how almost all growth-stage investors in Instacart are at a loss on the IPO offering price. An even more insightful analysis was put together by the ‘Dean of Valuation’ – Aswath Damodaran, Prof. at NYU.

Source: Putting the (Insta)cart before the (Grocery) horse: A COVID Favorite’s Reality Check! – by Aswath Damodaran

This analysis shows that at the offering price, only the Seed, Series A, and Series B investors are sitting on substantial profits that also beat the S&P500 benchmark returns during their respective hold periods. Series C onwards, none of the investors have beaten comparable benchmark returns, with the late-stage rounds in 2020 and 2021 sitting on substantial haircuts.

While a common VC narrative is that “irrespective of the price, the only thing that matters is getting into the best companies”, my own experience is contrary to this (I wrote about it in my post ‘An angel’s struggle with entry valuations‘).

The actual returns profile of various types of VCs and Growth Investors who invested in Instacart at different stages of maturity and valuations provides more evidence for this age-old wisdom of OG investors like Buffet, Munger, and Howard Marks.

Source: Random Thoughts on the Identification of Investment Opportunities, by Howard Marks (1994)

Sobering thoughts for Instacart’s way forward:

As an active participant in the venture ecosystem, while I am wholeheartedly celebrating Instacart’s IPO and the way it has overcome all the above odds, it’s important to acknowledge that the business faces significant risks going forward.

1/ Market share – will it be able to grow, or even retain market share, as traditional grocers expand their online shopping experiences?

2/ Topline metrics – Instacart’s AOV has been pretty much static at ~$100 over the last five years. Given grocery is a low-margin business, it will also find it hard to significantly increase its take rate from the current ~7.5% levels*.

Further, while Covid saw a massive spike in customers leveraging online grocery, it seems that the use case seems to be settling down at relatively lower levels of purchase frequency.

Given these dynamics, what are the levers at Instacart’s disposal to improve its cohort metrics?

*As a comparison, Airbnb and Doordash have much higher take rates at 14% and 11.79% respectively. These reflect the higher operating margin profiles of the underlying businesses (both hospitality and restaurants operate in the ~15% range).

3/ Bottom line metrics – Instacart’s Selling Cost (Marketing + Incentives and promotion) as % of Revenue has been steadily going up (from ~12% in 2020 to 24.50% in 2022).

Though its customer retention is strong, will the company be able to convince these customers to buy more frequently, as well as keep attracting new customers, without a commensurate increase in CAC?

4/ Talent – While it’s tempting to perceive an IPO event as the finish line, it’s rarely so. In fact, as Yahoo, Google and Facebook have shown in the past, exponentially more value gets created in the years post-IPO, compared to pre.

This especially applies to Instacart, where the IPO valuation is much lower than the last private round, and therefore, much work needs to be put in to generate returns for these late-stage investors. See the amount of post-IPO heavy lifting that the likes of Dara at Uber and Brian Chesky at Airbnb have had to do to create shareholder value.

From here on, Instacart will need to ‘grow up’ as a public company and attract a fresh set of talent that can design & execute its next phase of growth. Will it be able to create a culture and working environment that can help achieve this?

All in all, Instacart’s IPO being a milestone for Silicon Valley is beyond doubt, especially considering the tough macroeconomic and venture environment over the last year. But I can also say with equal confidence that a lot of value still remains to be captured by the company, and the next few years are going to be a tough execution grind for the management team.

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