Applying Buffettology to Venture Capital
Yesterday, I had the pleasure of meeting one of my favorite VC bloggers, Ho Nam, General Partner and co-founder of Altos Ventures on the famous Sand Hill Road in Menlo Park, CA. Ho's posts are always very insightful, thoughtful, and well-written --- full of inspirational or witty quotes, personal anecdotes, facts, and opinions supported by solid business fundamentals.
Ho's blog is the first I've seen that actively applies the principles of Warren Buffett and value investing to venture capital. This struck me as unusual. Why? Because they tend to be very different. It's like apples and oranges. Here are the major differences I see --
- Diversification - Where do you put your eggs? The conventional VC business model (which Ho calls "Venture Lotto") involves investing large sums of capital in a lot of different startups in hopes of one mega-hit (e.g. a Google) to cover all the other losses. On the flip side, Buffett follows the words of Mark Twain: "Put all your eggs in one basket, and watch that basket!" He prefers large, infrequent bets where the odds are in his favor.
- Time horizon - "Buy & Hold Forever" vs. "When Can I Cash Out?" VCs care a lot about exits and multiples. So does Wall Street. (This is only re-emphasized in the "Finance of Venture Capital" class I took at Wharton with Professor Andrew Metrick.) The numbers matter a lot more than the underlying business (the qualitative factors). Buffett, on the other hand, invests for the quality and long-term sustainability of the business based on economic factors, business model, strength of management, etc. Hence, his favorite holding period is "forever."
- Industry - What's your favorite? Buffett avoids technology completely. He sees the industry as "speculative" and doesn't believe anyone can "predict the future." As a result, he preaches investing in businesses you know and understand well or staying within your "circle of competence." Meanwhile, all the VCs in Silicon Valley largely invest in technology or just growth.
It was through reading Ho's blog and speaking with him in person that I've come to realize that these two camps are actually very similar. At the end of the day, there are common principles of what makes good, sustainable businesses. That being said, I feel Altos Ventures positions itself very well in terms of applying these fundamentals to its venture investments, focusing more on those "qualitative" factors and making more careful investment decisions rather than throwing money out randomly and "seeing what sticks."
What I really wonder, is how likely these kind of unique opportunities actually exist in today's world (compared to the time Buffett invested)? With the rise of internet, information and knowledge is much more readily available and more "free." Is it much harder to "know more than the market" compared to the past? While Buffett relied on his newspapers and didn't believe a computer program could make sound investment decisions, I would say that with the added aid of technology, it's now possible for a Buffett-type investor to not only acquire more information (e.g. interesting / niche content, annual reports, etc.) at a faster rate but also interpret that information. For instance, today's value investor may use software to draw diagrams on financial data and see trends (e.g. illustrating the facts on the computer) and then use the increased information (from news sources, blogs, etc.) to assess the qualitative factors of the business. This way the data reading and opinion formation of the investor is still separated.
- Technology and growth can be your "circle of competence." While these sectors have far more unpredictable futures, Ho pointed out that it is possible to be a true industry expert, understand the business, and see future trends. He pointed out the extraordinary track record of now angel investor Andy Bechtolsheim, one of the early investors in Google. Andy's hit rate beats that of many VCs. While this may be possible, I wonder if visionaries like Andy (and Steve Jobs) are the just the more exceptional and rare cases.
- Be interested. Curiosity is the first step. More important that "being interesting."
- Do more thinking. Ho tells me doesn't read blogs or newspapers that much anymore. "How often do we stop to just think?" he asked.
- Try to eliminate / cut down on the things that waste time. Ho tries to avoid constantly checking email. He hates his Blackberry at times.
Concluding Thought: Does a "good" business necessarily have to have "long-term" sustainability as Buffett seems to look for? What if you are just doing well in the shorter term (5, 7, 10 years out)? Perhaps things change because of consumer preferences or just some other disruptive technology. In other words, is it necessarily "evil" that people are overly concerned with exits (short term gain)?
technorati tags: ho nam, altos, venture capital, value investing, warren buffett, buffettology
