Published in UT San Diego, March 9, 2015
I love leverage.
It was Archimedes who famously said, “Give me a place to stand on and I will move the earth.” This is a very important business principle. It is the mathematical principle behind every CEO who says, “We need to scale.”
What is leverage? While it kills me to quote Tony Robbins (I think he is a bit of an egomaniacal gasbag), nonetheless, he recently wrote a book, “Money, Master the Game,” in which he discusses the theory of “asynchronous risk” — which is a fancy way of saying that one should try to make bets where the upside is disproportionate to the downside. A positive outcome needs to have a multiplier effect.
And the key to this is leverage. How can I create a scenario where I risk one dollar and can only lose one dollar, while if things work out, I can make 10 dollars? In simple terms, this is the startup game, both from the perspective of the founder, as well as the venture capitalist. It is the power of founder common shares, as well as the investor who takes the very early seed round risk.
Now, the next question is: How can I stack the odds in my favor? And the answer is: I need information; I need to know more than the other guy.
In the Wall Street equity markets, this aggressive search for an edge might be touching on insider trading, but in the private markets, imperfect knowledge is my friend. I do not want a level playing field, I want an unfair advantage — and that advantage can come in myriad ways.
It can be the power of my investor, the size of the market, the first mover advantage, my advisory board, a customer already in hand, a computer scientist who is off the charts, the biggest war chest, a friend in high places, etc. Knowledge is important, but information is paramount.
It is the trick of seeing where things might go before they go there. Wayne Gretzky said it best, “I skate to the where the puck is going to be, not where it is.”
In an earlier incarnation, I was an active real estate developer. And in those days (the mid-80s) you could tie up a piece of land with a song and dance, with a small option payment coupled with the promise to pay later — you could “own” something without having to pay for it until a later date.
And it was during your due diligence period, the time allotted for figuring it out before you had to close, that you could get the unfair advantage. You could line up the community, the financing, the customers and the constructors and then, and only then, did you have to actually write the big check — of course, that would also be after doing a bit of hair cutting to the price. Every developer worth his salt had a hair salon and a sharp pair of scissors. Those days are gone, and that game is over.
But the equivalent exists today in the technology game. Asynchronous risk is what allows the venture capitalist to make 20 bets, lose money on 15 of them, break even on four and crush the ball on one — and the fund will do great. Strange as it seems, that is considered a business.
As J. Wellington Wimpy famously said, “I will gladly pay you Tuesday for a hamburger today.” Taken to its extreme, it presages the entire financial crisis.
Robbins interviewed 50 of the wealthiest people in America, and one principle stood out above all others: “Don’t lose money.” As simple as that sounds, we all know that our innate psychic makeup often leads us to do the opposite. We sell our winners and hold onto the losers — often to the bitter end, hoping they will come back — that the dogs will finally eat the damn dog food.
My own personal corollary comes from Bernard Baruch, who said, “I made all my money by selling too soon.”
The subtext of not losing money is to manage greed and its evil twin, fear. I like risk; it is my business. But I always think about the downside, I always leave a few dollars on the table after every negotiation. Unlike Wimpy, I will gladly let you have the hamburger today, and I will eagerly pay for it as well — as long as I can eventually buy the McDonald’s franchise on the corner.