December 16, 2008

Heading to Abilene?

So I’m a huge fan of a good story.  And I also love thinking about how decisions get made in organizations.  Put the two together and I’m hooked; you had me at hello – or in the case of the Abilene Paradox, you had me at “hey, y’all.”

For those of you who don’t know the Abilene Paradox, it’s a management parable about a family in a dusty Texas town that ends up traveling fifty miles to Abilene for dinner because nobody spoke out against taking a trip that none of them had wanted to take, not even the person who had halfheartedly suggested they go to Abilene!

It’s an interesting story because businessfolk are constantly making group decisions.  And in a rush to make choices, these founders, GPs, LPs,CEOs, or whatever often seek to avoid the discord that can lengthen or even derail the decision-making process.  But in seeking to tamp down possible conflict, these choice-makers typically fall victim to the ever-lurking, insidious evil of groupthink. 

And over the course of a year, a team can make hundreds of decisions.  Since strategy is an integrated set of informed choices that lead to timely action, decisions build on themselves and all of a sudden the failure to speak up in even the smallest of debates can have repercussions that resonate over time.

In a tough economy the cost of poor choices is higher, since capital is scarcer and sand slips inexorably through the hourglass.  Precisely at the time when people should be emboldened to speak up, the opposite seems true.  The pendulum swings from greed to fear and people are motivated by trepidation, insecurity, timidness.  Upward feedback can take on a rosier glow than usual.  There’s an old Japanese proverb that seems to encapsulate people’s fear during tough times: “the nail that sticks up is the one that gets hammered down.” 

You can also get the blowhards in downturns: the “often wrong, but never in doubt” crowd.  On the one hand, I love those cats.  They get stuff done and they're proud of it!  On the other hand, maybe Yeats was describing them when he said, “the best lack all conviction / while the worst are full of passionate intensity.”

But hey, it’s all self-preservation; people are hard-wired by millenia of evolution and decades of experience to act in certain ways in times of stress.  I can dig that.  Robust debate and intellectual honesty are actually pretty complicated and counter-intuitive.  Sometimes, it’s just easier to go along and get along.

So here’s my Christmas wish: forget the Wii Fit; all I want from Santa this year is for my GPs and portfolio company management teams to crank up the frankness a bit for 2009.  You guys are a pretty honest bunch to start with, no doubt, but maybe we all can make a New Year’s resolution of going out on a limb a bit more, while also cutting everyone else a little extra slack.  The quality of your debates and decision process may well prove to be the difference between an unwanted dinner date in Abilene and an invitation to ring a bell at 11 Wall Street.

December 4, 2008

Bad Drivers

I’ll never forget the day I told old man Moran that I wanted to go to college at Berkeley.  It was nineteen eighty-nine (a number, another summer) and I said it just to see if I could get a rise out of the oldster by naming a school as far away from Brooklyn as I could think of.  His craggy face crumpled up as if he’d suffered sudden-onset gastric distress and Moran (who’d left Brooklyn exactly once in his life to attend Basic Training before going island-hopping across the Pacific) spat: “Berkeley?  Berkeley?  That friggin’ place makes Woodstock look like friggin’ Parris Island.”


It’s a real shame that he passed a few years ago (rest well, sir,) because I would’ve loved to see the look on his face when I told him that I’d been invited to help teach a class at Berkeley’s Haas School (thanks, Terry!)  I would’ve made sure to tell the old man that people were nude moonbathing or some such nonsense.  He would’ve eaten it up.


Anyhow, the whole thing was a blast and the kids were pretty sharp.  The lesson for the day was (insert moment of reverence here): The Yale Case.  For those who haven’t actually seen the HBS case in question, it’s basically a 20-page precursor to David Swensen’s seminal opus, Pioneering Portfolio Management; it lays out how Yale was able to generate returns that became the envy of the investment world.


Of course, people read the case (or the book) and their response was: we gotta get us some of that illiquid private stuff!  You could say that the case study laid the intellectual groundwork for the PE boom.  But hey, I’m not complaining; after all, it laid the groundwork for me having a job . . . 


So there I was talking about how so many people had taken away the wrong message from the book.  The message wasn’t necessarily “do private equity” (or do anything else specific in the book for that matter),” but rather, the message was: “if you’re going to do any of this stuff, you’ve got to do it well!”  I mean, look at page 20 of the 2007 Endowment report.  Those cats added $11 billion over the trailing 10 years relative to their composite benchmark.  Now that’s execution!  And execution is critical because the meager (sometimes nonexistent) compensation you typically get for straying from plain vanilla US equity falls far short of compensating you for the risk, illiquidity, and brain drain of playing in those funky asset classes.


But then I started thinking about it and realized that for most people there’s no functional difference between, “do this,” and, “do this well.”  Why?  Because over 80% of drivers think they’re better than average on the road; most people have a positive bias to their self-image.  Come on, if Swensen can put up Top Quartile numbers, why can’t I?  After all, I’m good enough, I’m smart enough, and doggone it, people like me!


Of course, that’s private equity’s analogue to the preponderance of drivers thinking they’re better than the average bear: the comically-large cohort of managers who claim to be top quartile.  In fact, I’ve been wondering lately if someone should start a top quartile verification service that would provide seals of approval for pitchbooks (or maybe special gold stars to sprinkle liberally in track record sections of PPMs).  Not that it matters: the opportunity costs are so high (particularly today) that being top quartile likely won’t even begin to cover those high opportunity costs.


So the more I noodled on it, the more I thought that maybe Pioneering Portfolio Management should come with a disclaimer: don’t try this at home.  Of course, trying this at home was exactly what the next book was about.

November 14, 2008

An Open Letter

Dear Portfolio Company CEO,

Hi, my name’s Chris and I fund the folks who fund your
company.  I’m the money behind the
money.  I can’t remember if we’ve met,
after all, I’ve got several hundred cats just like you in my portfolio.  There’s a chance that we talked at your
backer’s last annual meeting; maybe I visited your factory; or perhaps I called
you for a reference check.  You may not
remember me, but I was the dude wearing the red t-shirt under my dress
shirt.  I took good notes during your
talk and told daffy stories during the breaks. 
Yeah, that’s me.

Anyhow, I wanted to drop you a note since I’m a bit worried
about you.  You see, the last time the
economy slumped, we LPs heard endless tales of management teams that just
couldn’t stay ahead of the game.  “We
discovered we had a bull market CEO on our hands,” was a common refrain.  “Those guys were a great growth team, but
when the going got tough . . .” 

It seemed like private equity funds went through CEOs like the
Yankees used to go through managers (although I’ll note that Stump Merrill couldn’t
have been fired fast enough, but that’s another discussion.)

So there I was, talking to my Operating Partner buddy,
Bruce, about this phenomenon and he made a clarifying point:  “Management is always an exercise in battling
entropy,” he opined.  “Order tends to
disorder and the application of energy is required to restore order.  It’s an immutable law of the universe and
it’s a law of management.”  Consequently,
he continued, “in tough times, the disorder comes at you a whole lot faster and
requires a lot more energy to manage.” 

I don’t think that it’s too much of a stretch to say that
energy is a function of time and people who are cavalier about time become
magnets for disorder.  It’s like Lucy and
Ethel in the chocolate factory: the conveyor belt speeds up and there’s just no
place for all those blasted bon-bons to go.

Indeed, the ingredients of any business are: ideas, people,
capital, and time.  And of those
elements, time is the most immutable, the most obstinate, the most
tyrannical.  They’re just not making any
more of it!

You have but one weapon against this cruel oppressor: focus.  
In  good times, managers don’t
have to focus as acutely because the creation of good stuff outstrips the slouching
to disorder.  The great all-weather
managers, on the other hand, have to focus because they realize that time is
really expensive and when the creation of good stuff slows, entropy lies in
wait.  Choose what to do and what not to
do.  Just choose quickly and be explicit
about your choices.

We’re all in this together. 
Your success becomes my success (less, ahem, the GP carry) and I’m
rooting for you.  You guys are the
beating heart of the entrepreneurial economy. 
You guys rock nonstop.  Stay focused
and be careful out there; you’re facing the greatest enemy of all: time.

Forging ahead,

Chris

November 2, 2008

Exercise Your Option: Vote

So the kids and I have this ritual on Saturday mornings: over to East Palo Alto to hit the Mac Shack for Egg McMuffins and then on to Starbucks to pick up some kind of grande dolceamericano venti halfcafnowhip with three shots for the wife, who’s back home getting a little extra snooze.  I have no idea what I’m ordering, but I order it nonetheless.  And I order in hopes of building some political capital with the honey.

Unfortunately, my capital depreciates like Lira.

(I should note that, after a few of these weekend frolics, the good folks of the Amex Fraud Department gave me a call to see if my card had been “compromised” because of all the activity in a hardscrabble zip code.  I appreciated the call but had to explain to them that that’s how I roll; I’m down with the EPA.)

So there I am at Starbucks, and ahead of us in line is a landscaper ordering a coffee for himself and a hot chocolate for his little boy.  And he’s ordering en Espanol, which I dig, since I love the rhythm and cadence of language, any language: the syncopated rat-tat of Spanish, the melodious sing-song of Caribbean French, the staccato chop-chop of the Slavics.  These folks are the singers of our songs, the songs of Our Republic.

Then my man is done ordering, and the barista asks his name and, for the first time, he speaks in halting but certain English.  In a startlingly full-throated voice he reports, “My name is DEM-OH-CRRRACY . . . my name is AH-MERRR-ICA.

Right on, brother.  Right on.

[Back to PE with An Open Letter to Portfolio Company CEOs later this week.]

October 16, 2008

Frankie Say: Relax (Don’t Do It)

The first time I saw a swan we were on a class trip to Central Park (Look, kids!  Nature!)  White and fluffy and graceful, that swan was nothing like the flying rats we had back in Brooklyn.  I remember, too, that our teacher said a pair nested every September over at the 79th Street Boat Basin.  I bet this year those swans are black, though.  After all, can there be any other explanation for daily market moves that look like annual returns? 

Of course, volatility decreases with the square root of time — but increases Pepto-Bismol sales exponentially — and spreads a pall over the land.  Go find a trader at day's end; they're a mess.  Better yet, go find a lender looking to make a loan to a PE-backed company.  Good luck: I'm told they've all called it a year.  Nor has the innovation economy been spared: even my neighbor here in Silicon Valley who's working on some cold-fusion, perpetual motion, flux capcitor gadget has his own personal raincloud nowadays. 

But I try to keep upbeat.  Isn't that my duty as an American (or is it to go out and shop?  I forget).  And I was doing a pretty good job of staying positive until my old buddy Copter called.  (Back in the day, we called him Copter because because he was unflappable, he had no flaps.  Get it?)  Anyhow, Copter lives the Wall Street life, complete with pocket square, and he rings me every now and again to take the pulse of an institutional (or as he would say, "institutionalized") investor.  And this time, after some chit-chat, he swooped in on me with some blood pressure-raising questions.

"So how do you think people are fixed for liquidity?" he asked.  "You think cats are going to start defaulting on capital calls?"

"Naaaah," I said.  "We're talking about professionals.  Things would have to get pretty extreme." 

"But what if it got to that?" probed Copter, "Would it make sense for funds to start pre-emptively calling capital to build a cash cushion in case people did default?"

And with those words, a wave of dread washed over me; I suddenly felt like the green-eyeshade bank teller who slides open his window only to be greeted by a line of angry depositors stretching out the door and around the block.  "Copter, you're talking about a run on the LPs.  That's madness!  You quit that right now!  Relax."

"Relax, don't do it?" Copter said.

"Yeah, relax, don't do it,"  I replied.  But quoting 80s songs felt kinda lame when talking high finance, so I decided to go for some gravitas and drop some B. Franklin on old Copter: "Remember, Slugger, LPs and GPs are partners in this thing and if we don't all hang together, surely we shall all hang separately."

"On that note, bruddah, I gotta go hang at Gotham Grill with my girly-girl," and Copter hung up the phone and whirred off into the New York night.

As I sat there in a vortex of prop wash a continent away, I was relieved to see a email from my buddy Peter that turned the day right around and contained some of the best advice I've seen so far.  Fabricated or not, I gotta say the screen below contains perhaps the best Bloomberg headline ever.  Forget the Fed, I got my bailout from the BOJ (that's Bank of Jamaica, not Bank of Japan):

Image001

[Hey, mon, if you created this and own a copyright – or if you're Bloomberg – and want this taken down, email me at the link above]