The most critical thing for every startup is to be doing one thing uniquely well, better than anybody else in the world.
All businesses must create a moat to be sustainably profitable. Unfortunately, sometimes a business that creates new value is not able to capture any of that value in a sustainable way, and the only beneficiary of the business is the customer. One of the best explanations of this value-capture point comes from Charlie Munger’s fantastic “Worldly Wisdom” essay:
There are all kinds of wonderful new inventions that give you nothing as owners except the opportunity to spend a lot more money in a business that’s still going to be lousy. The money still won’t come to you. All of the advantages from great improvements are going to flow through to the customers.
2. “Maybe we focus so much on going from 1 to n because that’s easier to do. There’s little doubt that going from 0 to 1 is qualitatively different, and almost always harder, than copying something n times.”
And even trying to achieve vertical, 0-to-1 progress presents the challenge of exceptionalism; any founder or inventor doing something new must wonder, “Am I sane? Or am I crazy?”
Doing something that has never been done before is genuinely hard enough that many people consciously or subconsciously would rather chase the tailpipes of others than genuinely innovate “from 0 to 1.” Failing conventionally, rather than succeeding unconventionally, is unfortunately the path chosen by many people. Progressing from 1 to n will not generate a new business with a grand slam outcome.
Maybe they grow at 50 percent a year, and it compounds for a number of years. It could be more or less dramatic than that. But that model—some substantial period of exponential growth—is the core of any successful tech company. And during that exponential period, valuations tend to go up exponentially.
It is nonlinear phenomena, the ones that drive the grand-slam financial outcomes, that a venture capitalist needs to be successful. Straying too far from a nonlinear phenomenon like Moore’s law can be harmful to a venture capitalist’s financial health. Moore’s law is not the only phenomenon with an exponential arc, but it is an important one. Sam Altman has explained an important reason why people tend to not understand the power of a nonlinear phenomenon: “The hard part of standing on an exponential curve is: when you look backward, it looks flat, and when you look forward, it looks vertical.” Few things in life are exponential, so it is relatively easy not to see or understand the impact of something nonlinear when it happens.
4. “If you’re going to start a business, you might as well try to start one where, if it works, it will be really successful, rather than one where you’re competing like crazy with thousands of people who are doing something just like you all the time.”
The prime territory for finding mispriced convex outcomes with the potential to produce a grand slam is not where thousands of other people are looking. The second point Theil is making here is that if you are going to swing the bat, you may as well have the potential for a very significant positive outcome. These two points are simple but often overlooked.
If you must have a down round, it’s probably best that it be a really catastrophic one. That way, a lot of the mad people will be completely wiped out and thus won’t show up to create more problems, while you start the hard task of rebuilding. You should never have a down round. If you found a company and every round you raise is an up round, you’ll make at least some money. But if you have a single down round, you probably won’t.
Thiel is saying that there are many angels investing today who can mess up a capitalization table via a poorly priced valuation. A down round happens when a business raises capital at a lower valuation than that of the previous round. In a down round, some investors will often get a larger number of shares based on antidilution provisions in the contracts used in the previous round. This dilution can lower the incentive of employees and founders to stay with the business.
7. “A robust company culture is one in which people have something in common that distinguishes them quite sharply from the rest of the world. If everybody likes ice cream, that probably doesn’t matter … you also need to strike the right balance between athletes (competitive people) and nerds (creators) no matter what.”
8. “VCs rely on very discreet networks of people that they’ve become affiliated with. That is, they have access to a unique network of entrepreneurs; the network is the core value proposition.”
Personal networks of all kinds matter more than ever as the world becomes more and more digital. Your personal network of individuals and organizations can grow in power and value in just the same way. More than ever, success begets success. This happens because connections create what Nassim Taleb calls optionality. Taleb has said, “Optionality can be found everywhere if you know how to look.” Living in a city, going to parties, taking classes, acquiring entrepreneurial skills, having cash in your bank account, and avoiding debt are all examples of activities that increase optionality. Working purposefully to develop your network can pay big dividends.
9. “The founders or one or two key senior people at any multimillion-dollar company should probably spend between 25 percent and 33 percent of their time identifying and attracting talent.”
10. “Hubris is an issue at every one of these Silicon Valley companies that are successful.”
It can be hard to know a lot about one area, and even more so about many areas, yet still be modest enough to admit that you do not know everything. The venture capitalist and author Morgan Housel absolutely nailed it when he wrote, “There’s a strong correlation between knowledge and humility.” Charlie Munger has said that he seeks “intellectual humility” and has pointed out that “acknowledging what you don’t know is the dawning of wisdom.” The Internet bubble in particular was a period of time during which many otherwise smart people made boneheaded mistakes owing to hubris. As Warren Buffett has said,
The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities ¾ that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future ¾ will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.
You cannot do better than average by being average. If you cannot be courageously contrarian, you cannot possibly beat the market average as an investor. It is the existence of a gap between expected value and market price that should drive investment decision-making. If your views reflect the consensus of the crowd, you are unlikely to outperform a market since a market by definition reflects the consensus view. However, bucking the crowd’s viewpoint is not easy in practice since the investor is fighting social proof. In many cases, following the crowd makes sense. Sticking with the warmth of the crowd is a natural instinct for most people.
12. “Bad VCs tend to think that all companies are created equal, and some just fail, spin wheels, or grow. In reality, you get a power-law distribution.”
Thiel believes that you can’t play “small ball” (i.e., win with just singles and doubles) in venture capital and succeed financially. He advocates a swing-for-the-fences approach that seeks grand-slam outcomes.