Recently listened to an insightful Origins Podcast episode with Alec Litowitz, founder of Magnetar Capital and previously founding partner of Citadel.
Alec drew a fascinating distinction between “Uncertainty” and “Risk” and explained how people often confuse the two. PS: I can clearly see that this framing has emerged from his extensive experience in public markets.
Risk is something where the possible outcomes and their probabilities are both known eg. what number is likely to come up when you throw a dice. Because the odds are relatively known, risk can be priced.
The other end of the spectrum is where both outcomes and probabilities are unknown – these are Taleb’s Black Swan events like COVID.
In the middle of both is Uncertainty – where outcomes are known but probabilities are unknown. This is where most of life unfolds eg. going on a date, hiring an employee, etc.
Any new early-stage business operates with uncertainty, not risk. And the main job of a founder is to resolve this uncertainty to discover probabilities of possible outcomes of the business that can then be priced.
In other words, a founder’s job is to convert Uncertainty to Risk, which can then be priced and bet big on by capital providers.
Btw, founders do this by following the classic YC/ Lean Startup approach of fast & iterative feedback loops aimed at making something people want. As simple as that.
For founders, this is an important framing for fundraising and managing runway. You should be very clear about the exact derisking milestones that need to be achieved with each capital raise. Also, articulating that to investors during fundraising helps build extra confidence that the capital will be used well.
Also, this is a good behavioral heuristic too that can help reduce the pressure on founders during fundraising. Every investor will have their own threshold of the current level of uncertainty that they are willing to tolerate. So, a “No” should be taken as a reflection of their appetite, rather than a personal reflection on the founder.
Of course, with every incremental unit of de-risking, your business gets closer to meeting this tolerable threshold of uncertainty, which will ultimately reflect in your fundraising conversion rate going up.
Hence, it’s important to survive long enough to be able to demonstrate adequate de-risking such that access to capital and other resources like talent keeps getting easier with time. This is the driver of compounding in progress that we often see with businesses once they have product-market-fit.
For businesses, this uncertainty resolution is an infinite game, an ongoing journey. That’s why various parts of the capital stack exist – angels, VCs, PE, public markets, debt providers, etc. Each has a mandated uncertainty threshold that they like to operate at, and therefore, are likely to become participants in a business only when that threshold is reached. This will also reflect in how they do asset allocation & portfolio construction.
Taking my own context, this concept of resolving uncertainty also applies to emerging managers who are relatively early in their journeys (Funds I-III). GP fundraising is a slow burn, extremely long enterprise sales process. Following this framework of trying to reduce as much uncertainty on multiple fronts related to the Fund can perhaps help sustain multi-year momentum through this grueling process.
Alec mentions that the ultimate uncertainty resolver for a GP is DPI – it converts all the uncertainty into cash. And this is the reason why he pushes all his portfolio GPs to get into DPI as quickly as possible.