Elections and Domino Rally Business Models

600px-electoral_map_2012-2020-svgSo, over the last couple of days I’ve heard a bunch of people here in Silicon Valley talk about how we might abolish the Electoral College. It’s not an unreasonable impulse coming from people for whom Disruption is a religion – and who live in a state that voted two-to-one for Clinton.

But here’s the catch: in this sunny and magical land, we take for granted the ability to disrupt without asking permission of the disruptees. Unfortunately, the Electoral College isn’t some lumbering incumbent; it’s a structure codified in the Constitution. And the Constitution, while routinely ignored and sometimes trampled on, is very specific about how it might be amended, requiring three-quarters of states to give a nod.

And why is that a problem? Well, let’s look at the numbers. In the table I’ve enclosed at the bottom of this post I’ve compared each state’s population (as a percentage of the nation’s) with its percentage of electoral votes and defined this ratio as “Thump Value.” So a state like Colorado that has 1.67% of the nation’s Electors and 1.67% of its population has a Thump Value of 1.00. California, on the other hand, has 10.2% of Electors and 12.1% of population, resulting in a Thump Value of 0.84. At the other end of the spectrum, Wyoming has 0.56% of Electors and 0.18% of population, resulting in a Thump Value of 3.03.

Now, why does this matter? Well, as it turns out, there are 32, ahem, states (31 excluding DC, which isn’t a state to the dismay of some) with a Thump Value in excess of one. These guys are overrepresented in presidential elections relative to their population; their swagger comes out of the hide of the most populous states.

Since a “no” vote by a mere 13 states can shut any amendment down, it’s important to note that abolishing the Electoral College would mean that 20 states would be voting against their self-interest (some more than others, to be sure). In fact, 14 states have an electoral influence that’s at least 50% greater than their population might suggest.

So what does this have to do with venture capital? Well, I sat there pondering the odds of Wyoming’s delegation voting against their state’s interests at the Constitutional Convention. Then I got to thinking about Vermont’s odds, and North Dakota’s and Alaska’s and Maine’s, etc. And it reminded me that the joint probability of all these states voting against the status quo that granted them extra thump in presidential elections was the product of all their probabilities multiplied together, a pretty minuscule number.

This fundamental arithmetic of probabilities can be tough to internalize, even for savvy startup founders.  Every now and again, I find myself pointing people to Josh Kopleman’s seminal 2006 blog post, Domino Rally Business Models.  By way of quick summary, in this decade-old post Josh was bemoaning business models that required a bunch of disparate events to all turn out favorably for success to be probable. For example if a business required four things to happen, each with a probability of 75%, the odds of success for the business were about 30% (0.75 X 0.75 X 0.75 X 0.75 = 0.316); needless to say, rarely are the odds of any one thing happening that high.  Unfortunately, these Domino Rally business models, where success is predicated on a series of binary outcomes or big leaps, are endemic to venture. While companies that thread the needle can be rewarded handsomely, most entrepreneurs radically overestimate their chances of success because they think of risks individually, not in a compounded fashion.  Moreover, there are two kinds of risks: those you can mitigate and those you can’t.  As consumers of risk, we investors have to work really hard to mitigate those that are mitigable and get properly compensated for those that aren’t.  Founders may squawk, but we’re all well served to heed Buffet’s equation: Opportunity = Value – Perception.  Keeping the hype in check to maximize Opportunity around the fulcrum of value is one way to make chances of success higher than the chances of abolishing the Electoral College ever will be.

 

Thump Value by State, 2016

Share of Population 2013E

Share of Electors 2016

Thump Value

Wyoming

0.18%

0.56%

3.03

Vermont

0.20%

0.56%

2.81

District of Columbia

0.20%

0.56%

2.73

North Dakota

0.23%

0.56%

2.44

Alaska

0.23%

0.56%

2.40

Rhode Island

0.33%

0.74%

2.24

South Dakota

0.27%

0.56%

2.09

Delaware

0.29%

0.56%

1.90

New Hampshire

0.42%

0.74%

1.78

Maine

0.42%

0.74%

1.77

Montana

0.32%

0.56%

1.74

Hawaii

0.44%

0.74%

1.67

West Virginia

0.59%

0.93%

1.58

Nebraska

0.59%

0.93%

1.57

Idaho

0.51%

0.74%

1.46

New Mexico

0.66%

0.93%

1.41

Nevada

0.88%

1.12%

1.26

Kansas

0.92%

1.12%

1.22

Utah

0.92%

1.12%

1.22

Arkansas

0.94%

1.12%

1.19

Mississippi

0.95%

1.12%

1.18

Connecticut

1.14%

1.30%

1.14

Iowa

0.98%

1.12%

1.14

South Carolina

1.51%

1.67%

1.11

Alabama

1.53%

1.67%

1.09

Minnesota

1.71%

1.86%

1.08

Kentucky

1.39%

1.49%

1.07

Oklahoma

1.22%

1.30%

1.07

Oregon

1.24%

1.30%

1.05

Wisconsin

1.82%

1.86%

1.02

Louisiana

1.46%

1.49%

1.02

Washington

2.21%

2.23%

1.01

Colorado

1.67%

1.67%

1.00

Tennessee

2.05%

2.04%

1.00

Maryland

1.88%

1.86%

0.99

Indiana

2.08%

2.04%

0.98

Arizona

2.10%

2.04%

0.98

Missouri

1.91%

1.86%

0.97

Massachusetts

2.12%

2.04%

0.97

Michigan

3.13%

2.97%

0.95

Georgia

3.16%

2.97%

0.94

Virginia

2.61%

2.42%

0.92

New Jersey

2.82%

2.60%

0.92

Pennsylvania

4.04%

3.72%

0.92

Ohio

3.66%

3.35%

0.91

Illinois

4.07%

3.72%

0.91

North Carolina

3.12%

2.79%

0.89

Florida

6.19%

5.39%

0.87

New York

6.22%

5.39%

0.87

Texas

8.37%

7.06%

0.84

California

12.13%

10.22%

0.84

 

In the Time of the Gatsbys

img_4393So this buddy of mine, Peter Stein, is one of the best hedge fund evaluators I know and I once asked him how he knew to steer far clear of Madoff?
“Sometimes, returns can be too good,” he replied sardonically.

But it’s never been that way in Silicon Valley, a sunny and magical land where risk-adjusted return is impossible to calculate since risk is perpetually dialed up to eleven.

And in a culture steeped in selling the impossible, sometimes things go a little too far, which reminds me of another thing Stein, a veteran of ‘80s Tokyo and ‘90s New York, once cautioned me about long-running bull markets:

“The freaks come out in the late hours . . .”

When good times have been rolling for a while, capital gets cheap while time gets expensive. But as surely as the panic of FOMO eventually mellows to LIMTO — Lucky I Missed That One — these are the hours of shenanigans.

Indeed, an occupational hazard that we face is overexposure to lying and bullshit. And understanding the difference between those two is the subject of a great 1986 article, “On Bullshit” by Princeton prof Harry Frankfurt; he claims that a lie exists in the context of the truth; it just puts a negative sign in front of what’s real. After all, “it is impossible for someone to lie unless he thinks he knows the truth.”   Bullshit, in contrast, exists without any regard for truth: “the essence of bullshit is not that it is false, but that it is phony.” The bullshitter “does not care whether the things he says describe reality correctly, he just picks them out, or makes them up, to suit his purpose.” (Did Frankfurt perhaps gaze 30 years into his crystal ball and see a certain presidential candidate?)

On the other hand, I get to spend a lot of time with another type of fabricator: the Pollyanna.  Silicon Valley seems to be a magnet for them. While the liars and bullshitters that Frankfurt describes spin their webs to create an illusion of themselves in the world, Pollyannas don’t exist in the context of today’s truth, but relative to a vision of the World As It Might Be.

It seems like right now is one of those moments during which The World As It Might Be is starting to emerge. Someone once told me that the future takes longer to appear than you ever dream it will, but once it arrives, it happens really fast. The problem is that when things start moving quickly, people sometimes get sloppy and stop asking hard questions.

It’s no surprise then that during the last couple of years, we’ve seen the Absconding of Ifty, the Frolic of Rothenberg, and now the Invention of Asenqua. It makes one wonder: what else is out there that we haven’t caught? What other Gastbys are hiding in plain sight?

Secondhand Flowers

flowersOld O’Malley used to dispense sage advice from his stoop in Brooklyn. The smoke of cheap cigars and the cracking of the Yankee game on the transistor radio hung heavy in the humid night as O’Malley meted out wisdom like Aristotle under an olive tree. And one nugget that stuck with me through the years goes as follows: “never buy a girl secondhand flowers. The last girl may have enjoyed them, but your girl will just think of them as used up.”

So what does this have to do with investing? Recently, I was talking to someone about a company that was about to go public and they were lamenting the large discount to public comps implied by the bankers’ pricing guidance. Of course, IPO investors crave a first day pop, but the discount seemed to be bigger than they had seen lately. We wondered aloud why that might be? Lackluster aftermarket performance of last year’s IPOs? Higher perceived risk in the economy? Idiosyncratic risks of this company? And so on. This person also talked about how the bankers remarked that some private companies were pretty close to being overvalued relative to public companies, creating an inversion that would make any liquidity efforts tough.

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SuperLP Classics: DC-8s and Tigers and GPs! Oh my!

ShigaAs I crank up some posts (and other cool content) over the coming weeks, I thought I’d take the dog days of summer to repost some of my favorite stuff from years past.

I was inspired to look back to the story of Captain Asoh by Bessemer’s recent updates to its anti-portfolio.  I’ve always loved the honesty of BVP’s reflections and admire them for being so vulnerable in what can be such an ego-driven business.  Warren Buffett often says that there are no called strikes in investing, referring to the practice of a batter letting an unpalatable and often inconsequential pitch go by.  But in VC, our called strikes can feel like a called third strike.  With the bases loaded.  In the last inning.  Of the World Series.

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The Worst Meeting Ever

Head in HandsBrad Feld just gave me a shout out in his fine blog and I was touched because he has always been an inspiration to me. In the early days, there were a handful of folks who got me really excited about blogging to bring transparency to the voodoo that we do. There are too many people to acknowledge, but a few stand out: Josh Kopelman with his razor sharp insights was my first inspiration, David Hornik was saying some really thoughtful stuff with a really distinctive voice, Paul Kedrosky was using data in some really interesting ways, and Brad was bringing a real authenticity, in addition to intelligence, to his writing.

Indeed, authenticity became one of my critical evaluation factors during those heady days a decade ago.   After all, entrepreneurs were changing and so were venture capitalists.   Coming out of the Great Internet Bubble, founders and VCs were demanding a different level of accountability of each other.   Groups like First Round were talking about venture capital as a product with the entrepreneur as customer and the phrase “founder friendly” became almost cliché because every VC firm had adopted this catchphrase as part of their values. Underlying it all, however, was a tacit acknowledgment that venture capital is a multi-period interaction; in Silicon Valley, “you’re never on your way up or down, you’re always coming around.” In a world like that, inauthenticity can be an albatross, imposing costs that can be significant.

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