Stamina is one of the most underrated advantages in entrepreneurship. In a world where people start quickly and quit quickly, simply staying in business can dramatically tilt the odds in your favor.
Looking at all cases of long-term business success that I have observed in my life, a common underlying philosophy seems to be: [in Hindi] “Dhande mein tike raho” (focus on staying in business).
Phases of a business lifecycle
As any person who has ever started a business knows, the first order of business for an entrepreneur is finding product-market-fit – making something people want and are willing to pay for.
Once product-market fit has been established, the next order of business is to make it profitable, Phase 1 of which is unit economics profitability on an immediate basis:
(1) Positive gross margin, by selling something for more than the cost of goods sold ➡
(2) Positive contribution margin, so all variable costs incurred per unit are recovered, and eventually ➡
(3) Positive net margin, so both variable costs and an allocated share of fixed costs/ overheads are covered.
Phase 2 of profitability is making the business P&L profitable, so generating operating profit that covers all fixed costs of the business, and eventually, net profit (or PAT).
Phase 3 of profitability is generating free cash flow – the ultimate goal of any business, and the ultimate dream of any entrepreneur.
The core currency of business
Starting from the pre-PMF phase till the free cash flow phase, the drivers of success in each phase are very simple:
Retain & grow existing customers.
Find new customers.
Keep accessing capital to continue the journey (retained earnings, equity, debt).
If you think about it, the intangible currency that drives all the above is “trust”. As existing customers spend more time using your product/service, assuming they are happy with it, their propensity to stay & grow with you keeps increasing with each year.
Multiple human biases like commitment bias, consistency bias and behavioural inertia end up reinforcing this customer stickiness, as long as you keep delivering what you promise.
Similarly, the more time you spend in the marketplace, the likelihood of new potential customers hearing about you, particularly from your existing customers, keeps going up.
Finally, we always hear that capital chases returns. In reality, capital chases “risk-adjusted returns”. The more time you spend in the marketplace, the higher your trust is within the ecosystem, which reduces the risk perception around your business among capital providers.
That’s why banks prefer lending to businesses with established histories. The same reason is why VCs and PEs tend to track founders & companies for months before investing in them. It’s also the reason why institutional LPs can sometimes take years to build comfort around a GP, but once they back a team, they keep doubling down on them across multiple fund vintages.
So, “trust” is the key currency that businesses need in order to continue making progress across various phases of their lifecycle.
Competition
In addition to Customers and Capital, businesses also need to worry about Competition. Ultimately, customers are evaluating multiple options in the marketplace, and the business that ends up winning their vote is the one that is uniquely differentiated against competition.
This is where “staying in business” provides rich dividends, especially in the present age of fast-food entrepreneurship and role-playing founders.
The cost of starting any business & getting some early traction has gone down significantly, courtesy of technology. Therefore, any serious entrepreneur should expect the top-of-funnel competition in the pre-PMF phase to keep increasing each year.
However, the faster people are starting companies, the faster they are tapping out of the game as well. So, as your business continues chugging along and moving across the lifecycle phases outlined earlier, you will see a steep drop-off in competition at each phase.
Therefore, just by merely surviving, your odds of the marketplace self-selecting you as one of the few viable options keep going up.
Compounding
The key idea is positioning oneself to harness the power of compounding by staying in business. If you look at the most successful family businesses globally as well as major startup success stories across geographies, the reality is that it takes a decade to get it right and create a foundation, and then another decade to dominate the market and reap the rewards.
Most people don’t have the enthusiasm, energy and a mission-driven mindset to endure such long journeys. For founders, stamina is one of the proverbial low-hanging fruit that can help you massively tilt the playing field in your favour over the long term.
I particularly found the part on what Ed calls “defense” highly intriguing – he says: “It just takes one weak link to finish you off”. Essentially, my understanding is that among other things, defense involves avoiding a bunch of things that when done repeatedly, could essentially wipe you out (as in, you die!).
Ed gives the example of “a terrible skiing accident” but other things that come to mind include say helicopter rides, binge drinking, bungee jumping, living next to a dangerous turn on a busy street etc. While the probability of death in a one-off instance of these games might be low, when done repeatedly, the chance of death becomes non-trivial due to repeated exposure.
Nassim Nicholas Taleb calls this concept Risk of Ruin, and I remember getting blown away when I read about it for the first time in his books ‘Skin in the Game‘ and ‘Antifragile‘. So much so that Ruin has become an essential mental model in my toolkit both personally and as an investor.
In particular, I love 2 specific examples of Ruin that Taleb frequently cites:
The Casino Experiment – let’s say we know that 1% of all gamblers playing at the Casino win. So for every batch of 100 gamblers that visit the Casino daily for 100 consecutive days, we know that each day, 99 will be wiped out and 1 will walk away with money. Now take a different case – one gambler visits the Casino daily for 100 consecutive days. In this case, his probability of getting wiped out at some point is 100%.
Russian Roulette (quoting Taleb directly here) – “Assume a collection of people play Russian Roulette a single time for a million dollars –this is the central story in Fooled by Randomness. About five out of six will make money. If someone used a standard cost-benefit analysis, he would have claimed that one has 83.33% chance of gains, for an “expected” average return per shot of $833,333. But if you played Russian roulette more than once, you are deemed to end up in the cemetery. Your expected return is … not computable”.
Taleb calls the former case where different groups do an activity, and probabilities and expected values are computed “in average”, as Ensemble Probability whereas the latter case of a single person repeatedly doing an activity across time as Time Probability.
As common sense would tell us, Ensemble Probability represents a mathematically driven, academic (almost artificial?) scenario analysis, whereas Time Probability represents how we as individuals get exposed to risk in real life.
Time Probability suggests that there is an underlying Risk of Ruin in many more things & activities in real life than our brains can cognitively appreciate in the thick of the action.
Over the years, as I have read/ listened to more thinkers across fields, many of them highlight this same concept of avoiding Ruin in their own words. Examples include:
It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent. – Charlier Munger
Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average. – Howard Marks
The 1st rule of investment is don’t lose money. And the 2nd rule of investment is, don’t forget the 1st rule.– Warren Buffett
[Paraphrasing]“Arithmetic returns are false hopes; the truth lies in geometric returns” / “Profit is finite. Risk is infinite”. – Mark Spitznagel
Essentially, all these quotes are pointing to the same underlying idea:
The most important force that governs life, be it in health, relationships or portfolios, is compounding.
Given its cumulative nature, the optimal strategy for enabling the magic of compounding is combining avoidance of ‘Ruin’ (going to zero/ total destruction) with ensuring ‘Survival’ over a long enough period of time.
Life is cumulative. It unfolds in a geometric progression and therefore, the timing of your initial wins has a major impact on future outcomes down the road.
Met someone earlier this week who has had a bunch of major outcomes as an angel investor. This sparked my curiosity and I asked him about his backstory and career trajectory. Turns out these venture outcomes were a result of a series of parlays and things coming together over a decade-and-a-half:
He was early at a leading startup in the mobile supercycle, which was acquired by a BigTech in a marquee transaction. He continued at the BigTech for a few years (which in hindsight, was still relatively small at that stage), thus rapidly compounding both his net worth and network.
His spouse was an early engineer at a now-leading BigTech, then left to become an early engineer at a startup that was acquired in another OG marquee transaction. Through this journey, she also built a deep relationship with one of the OG Tier 1 venture firms in the Valley.
The couple used the capital acquired from this track record to start writing angel checks. Alumni of all the companies they worked at gave them access to some of the best deals.
The guy also went on to join a venture firm later, which further added to his creds and network.
Essentially, as a direct outcome of their early individual successes, this couple benefited from a self-compounding flywheel of relationships and capital. Pooling these assets as a married-team further magnified their impact. To their credit, in addition to being highly capable, they had the hustle, risk appetite, and foresight to keep taking shots at various opportunities that came along their way.
Btw, this story is not that uncommon in Silicon Valley. Though the extent of financial outcomes might vary, I know of many such stories where people have benefited from similar flywheels in their tech careers. In fact, this is one of the things that makes the Valley a unique place as there is an adequate density of talent, capital, networks, positive intent, and implicit trust within a small geographical region, which enables such flywheels to take shape in people’s lives. PS: I had written about this idea in my post ‘The Success Flywheel‘.
This story also highlights the importance of something I think about a lot, even from reflecting on my own career – there is a massive advantage to putting points on the board early on in life.
Life is cumulative. It unfolds in a geometric progression and therefore, the timing of your initial wins has a major impact on future outcomes down the road.
Mark Spitznagel, famous tail-risk trader and Taleb’s Partner at Universa, talks about this concept in the context of financial portfolio management and risk mitigation in his book ‘Safe Haven‘.
We are not a casino, or a portfolio of our distribution of possible simultaneous returns. Rather, we are one wager compounded through time. We only get one chance, and, if we shine a bright light on that, we will avoid many mistakes—start thinking about the right things, with a better internal valuation metric: making sure this chance maximizes its chance.
The idea is simple but powerful – having early wins enables the player to parlay the fruits of that win into the next opportunity while also having a long enough time runway for significant geometric compounding.
Being in the right zipcode like Silicon Valley in tech or NY in finance, also provides a large enough sample set of opportunities for continuous parlaying as well as high rates of compounding given the inherent leverage in these ecosystems.
This idea also makes the case for why students try so hard to get into Ivy Leagues, or why VCs try their best to get into prominent logos early in their track records. It also frames the competitive advantage folks get by starting as a fresh undergrad Analyst at Goldman, engineers who joined Google in the mid-2000s straight out of college, or those in their 20s joining OpenAI right now. The difference in getting these early wins starts showing up a decade later when the slope of the curve of these folks is markedly steeper than those who didn’t.
Of course, logging early wins isn’t by itself a sufficient driver or a definite leading signal of holistic success later in life. Everyone has their own unique journey and has to walk their own path. Still, given the sheer leverage these early points provide, it’s worthwhile to have this at the back of your head while executing your career strategy.
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Be it venture capital, public markets or real estate, “when to sell?” is an important question that both individual and institutional investors face.
Is it better to keep taking chips off the table? Or is hold-forever the right mindset? The journeys of Sequoia, USV, Berkshire and Brookfield give us some clues.
Yesterday at Primary’s NYC Summit, Fred Wilson (Managing Partner at Union Square Ventures) said something really interesting (and controversial) about venture firms that held on to their winners post-IPO in the recent cycle:
Their limited partners should fire them. They should never give them another dime. It is irresponsible what they did in my opinion.
Fred Wilson
Reading this argument brought me back to a question I think about often as an operator-angel – when is the right time to sell? In fact, I am faced with this dilemma right now wherein I might have an opportunity to exit a 2014 vintage investment. So, I guess it’s timely for me to attempt a deep-dive into this question, and analyze what the best investors across asset classes have to say on this topic.
A. Venture Capital
Clearly, Fred Wilson believes that venture firms should keep taking chips off the table as and when opportunities arise during late-stage financing rounds, and then cash out completely post IPO. Here’s an interesting excerpt from one of his posts on this topic:
Taking money off the table is smart portfolio management. It is very different from selling your entire position, which could be brilliant but is equally likely to be a mistake. Selling a portion of your position, returning a multiple or two (or eight) of the fund, and holding on to the balance works out for you no matter which way the position goes in the future. If the position blows up, you got a lot out and booked a huge gain. If the position goes up significantly, you make even more money on the part of the investment you retained. If it goes sideway, you got a little bit out early. It is a win/win/win pretty much every way you look at it.
However, another OG VC – Doug Leone of Sequoia, has a different view. This is what he said on this pod with Jason Calacanis (paraphrasing):
It’s way tougher to go from 0 to $5Bn market cap than it is to go from $5Bn to $20Bn market cap.
There was significant upside created post IPO in companies like Yahoo, Google, ServiceNow and Facebook.
By holding for the long term, it’s a win-win-win for founders, LPs and Sequoia.
Doug Leone (Sequoia)
In fact, Sequoia started an evergreen fund in 2021 where the goal is to partner with entrepreneurs for 25 years, from idea to IPO and beyond. Here’s the firm’s stated thinking around evergreen hold periods for generational companies:
Selling your winners and holding your losers is like cutting the flowers and watering the weeds.
Peter Lynch/ Warren Buffet
The gold standard in public markets investing is inarguably Berkshire Hathaway. Let’s look at the hold periods of some of its top holdings as per the 2022 Annual Letter:
1/ Coca-Cola – first started buying in 1988, and completed its purchase in 1994. Since then, annual cash dividends from Coke have increased from $75Mn in 1994 to $704Mn in 2022. The value of Berkshire’s investment has grown from $1.3Bn in 1994 to $25Bn in 2022, accounting for ~5% of Berkshire’s net worth.
2/ American Express – completed its purchase of Amex shares in 1995. Since then, annual cash dividends from Amex have increased from $41Mn in 1994 to $302Mn in 2022. The value of Berkshire’s investment has grown from $1.3Bn in 1995 to $22Bn in 2022, also accounting for ~5% of Berkshire’s net worth.
Berkshire holds winners for extraordinarily long time periods, and benefits from their compounding, like no other investor on the planet. The 2022 Letter has an interesting para on this philosophy:
So till now, Sequoia, Peter Lynch, and Warren Buffet all seem to be in the hold-forever camp. Intrigued enough? Wait till you see what the world’s best investor in real assets (real estate and infrastructure) has to say on this.
Anyway, one of the core principles that Bruce talks about is investing with a mindset to hold assets forever. He cites an example of investing $432Mn in a marquee downtown NYC office building in 1996. Brookfield held it for 21 years, over 4 business cycles including 9/11 and the ’08 financial crisis, ultimately selling it for ~$2.2Bn in 2017. Note that this doesn’t account for additional returns created via using leverage for this asset and rental income.
Bruce says that when you invest with a hold-forever mindset, you automatically start looking at the asset’s long-term fundamentals, rather than what will happen to it next year or who will pay up for it later.
Cool – so we now have multiple OGs across asset classes in the hold-forever camp. From Sequoia in venture capital, Warren Buffet and Peter Lynch in public markets to Bruce Flatt of Brookfield in real assets.
D. Where I Stand On This
Based on personal experience as well as observations, I firmly lean towards hold-forever as a default mindset. Here are the reasons:
1/ Motivates fundamental analysis – as Bruce rightly said, a cross-decade hold mindset ensures that in the beginning itself, an investor will be prompted to think deeply and rigorously about the long-term future of the asset. Otherwise, there is a risk of investing with a ‘passing-the-buck’ mindset (expecting someone will be willing to pay a higher price for it in a few years) without building a strong investment thesis.
2/ Be on the right side of Power Laws – business outcomes across most contexts are driven by Power Laws, wherein only a few assets end up becoming winners in any portfolio. Therefore, adequately compensating for all the losers, such that the overall portfolio drives superior returns, requires milking the few winners as much as possible.
3/ Room for compounding – it’s important to hold assets long enough for this 8th wonder of the world to do the work for you. Studying the journeys of the best investors in history across asset classes, it becomes clear that compounding is really the true force that drives superior returns. As Bill Miller says – “the key to returns in the market is Time and not Timing”.
Am seeing the power of compounding in my own angel portfolio where the 2014-16 vintage companies have now hit strong product-market-fit and I expect a bulk of returns in these companies to be rear-ended. Check out what Susa Ventures has to say about its learnings from winners across vintages:
While I am philosophically in the hold-forever camp, I do believe a framework is needed to ensure rigorous thinking on a deal-by-deal basis, especially to catch edge cases where applying the default philosophy might, in fact, be sub-optimal. These could include either (1) luck-driven/ speculative upside cases (eg. a previously unknown crypto token hits unjustified all-time highs) or (2) scenarios with potential Risk of Ruin (eg. having an inordinate concentration in a single stock).
Inspired by Nick Sleep’s** decision-making framework on when to sell (via Mohnish Pabrai), here’s a set of proposed questions an investor can look to answer while making a sell decision:
1/ What is the ultimate destination? – Is there enough growth runway still left in front of the business? What does the business look like in another 10/20/30 years?
2/ Is the business getting better? – How are the operating and financial metrics trending? In particular, is its competitive advantage getting stronger?
3/ Have any of the fundamental assumptions underlying the original investment thesis changed in any way? – Is the market shaping up differently than expected? Have new competitors entered the space? Is a new technology disruption around the corner?
4/ Is a sale going to serve any other strategic purpose besides the quest for returns? – Are there any time-critical professional or personal requirements that need this capital? Is there an opportunity cost case to be made?
5/ Is the valuation egregious? – Is the asset at the peak of a hype cycle? Is the price at crazy levels that are unlikely to be seen again for several years?
Rather than giving a binary yes/no answer (real-life deal situations are rarely binary anyway), this framework should help in figuring out which side to lean on and in what proportion. Ultimately, one has to use judgment to arrive at the final decision.
A disclaimer…
My stance as outlined above applies more to the context of personal investments. In the case of managing other people’s money, various considerations related to fiduciary responsibilities kick in. My sense is Fred Wilson’s argument as outlined earlier is more focused on the latter.
F. Summarizing
Fred Wilson’s stance of de-risking via routinely taking chips off the table is a safe and conservative strategy that makes a lot of sense for most investors out there. But as many OG investors across asset classes have shown, generating outlier returns with generational impact requires going all-in and holding the winners for decades. Essentially, one has to become a smart gardener that only cuts the weeds and lets the flowers grow.
**If you enjoy reading investor letters, the Nomad Partnership Letters by Nick Sleep and Qais Zakaria are a must-read. FYI Nomad was one of the best-performing investment partnerships for 15 years starting in the early 2000s.
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