The core investor’s playbook.
Who would want to invest in an opportunity that was more likely to fail than succeed? In most fields of investing, including real estate, the answer is nobody. But for venture capitalists, it is a different story.
“We are in the business of being embarrassed,” says Jim Goetz of Sequoia, one of the most distinguished venture capital firms.
In their field, most investments are unlikely to succeed. But those who do are likely to be big winners, or rather, extremely big winners.
As Bill Gurley of Benchmark has said, “Venture capital is not even a home-run business. It’s a grand-slam business.” It is the very rare, but very high-scoring moments that count.
Returns in venture capital follow a power-law distribution, with the majority of returns concentrated in a small percentage of companies. This means the challenge for venture capitalists is to be ambitious enough, according to Sebastian Mallaby, who has written a history of venture capitalism called The Power Law.
Invest too timidly and you will be backing ideas that others can imitate, limiting long-term profitability. It is the job of a venture capitalist is “to look over the horizon, to reach for high-risk, huge-reward possibilities that most people believe to be unreachable,” says Mallaby.
To back such ambitious and high-risk ventures, investors need to be willing to risk failure. This might not come naturally to many people. The best operators have thoughtfully designed their investment processes to overcome loss aversion.
At Sequoia, for example, partners presenting an opportunity include in their investment memo a description of the company’s growth assuming everything goes perfectly. “We need to be comfortable to say out loud what might be possible,” says Jim Goetz. The investment process needs to be explicitly focused on the upside. Combined with intelligent thinking about position sizing, this has proven to be a successful formula.
The key lesson for those in real estate is that successful investing requires careful consideration of the appropriate risk appetite and the deliberate calibration of mindsets and investment processes.
