20VC Michael Mauboussin on Good vs Bad Investment DecisionMaking Processes, How To Improve Your Process, How To Know When it Needs Improving and The Single Biggest Mistakes People Make In Their DecisionMaking Process

In this episode, venture capital decision-making processes are scrutinized with insights from Michael Mauboussin, head of Consilient Research at Counterpoint Global and author of "The Success Equation." Mauboussin discusses the nuances of luck versus randomness, the importance of aligning investment processes with a firm's edge, and the challenges of updating investment frameworks in a dynamic world. He also touches upon the episodic nature of venture returns and the impact of macroeconomic factors like interest rates on long-duration assets. The conversation delves into the value of persistence in venture capital, the significance of cognitive diversity in decision-making, and the benefits of maintaining a robust process to navigate market uncertainties. Additionally, Mauboussin reflects on personal investment mistakes, emphasizing the importance of focusing on business fundamentals rather than market volatility or macroeconomic predictions.

• The decision-making process in venture capital is viewed as the product of the firm.
• Continuous improvement of this process is crucial for success.
• Michael Mabusa, an experienced industry figure, shares insights on decision-making processes.
• The discussion covers when and how to change and improve these processes.

"Capital that our decision making process is our product."

This quote emphasizes that in venture capital, the way decisions are made is as important as the investments themselves, highlighting the need for refinement and improvement.

• Michael Mabusa is the head of salient research at Counterpoint Global.
• He is an author of three books, including "The Success Equation."
• His work and insights are highly regarded in the venture capital industry.

"Michael is head of salient research at Counterpoint Global. He's also the author of three incredible books, including my absolute favorite, the success equation."

This quote introduces Michael Mabusa and his credentials, setting the stage for his expertise in the field of research and decision-making within venture capital.

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• The platform offers a variety of brands and operates globally.
• Gifting made easier without needing physical addresses, using emails or DMs.

"Open helps companies of all sizes deliver better gifts and they make it super easy."

This quote highlights the significance of corporate gifting and introduces Open as a platform that simplifies the process.

• Angellist simplifies the complexity of fund management.
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• Angellist Stack is a new product for founders to incorporate and manage their startups.

"I love using the Angellist platform because it abstracts away all the complexity and operational burden of fund management."

This quote explains the benefits of using Angellist for fund management, emphasizing its role in reducing operational complexities.

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• Features include mobile optimization, email campaigns, and SEO tools.
• Offers a free trial and a discount for new purchases using a specific offer code.

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This quote introduces Squarespace as a comprehensive solution for businesses to establish and manage their online presence.

• Michael's job involves working on investment processes, research, and external engagements.
• He describes his role as focused on input (research) and output (communication).
• The job allows him to explore interesting topics and contribute to the firm's success.

"My job is really three parts. One is to work with our team on investment process."

This quote details the three-part nature of Michael's role, emphasizing the importance of investment processes in his work.

• Luck is defined by three conditions: occurrence to an individual or organization, potential for good or bad outcomes, and the reasonable expectation of different outcomes.
• Randomness is a system-level concept, whereas luck is individual-level.
• Michael provides a classroom coin toss exercise to illustrate the distinction between randomness and luck.

"Randomness would be at the system level and luck would be more at the individual level."

This quote clarifies the difference between randomness and luck, with randomness affecting the entire system and luck impacting individuals within that system.

• People struggle with attributing outcomes to skill or luck.
• Activities vary in the degree of skill and luck involved in their outcomes.
• Misattribution occurs when people cannot accurately place activities on the luck-skill continuum.

"Our minds are not particularly good at sorting out where that activity is on the luck skill continuum."

This quote points out the cognitive challenge people face in determining the role of luck and skill in various activities, leading to misattribution of outcomes.

• Venture capital showcases high persistence in returns, indicating skill.
• Success can lead to preferential attachment, which may enhance a firm's reputation and attract more opportunities.
• There's a debate on the individual versus firm-level contributions to success.

"Venture is particularly interesting. One of the measures of skill, for instance, is this concept of persistence."

This quote discusses the unique nature of venture capital, where persistent success is often seen as an indicator of skill, unlike in other asset classes.

• A good investment process should align with the investor's perceived edge.
• Processes vary greatly and should be tailored to the investor's strategy.
• The process should evolve over time, maintaining core standards but adapting as needed.

"The key is that there is no one size fits all for process, I think, but rather that you want to make your process congruent with your perceived source of edge."

This quote advises that investment processes should be designed to align with the investor's competitive advantage, underscoring the need for a personalized approach to decision-making.

• Emphasizes the importance of having a flexible yet repeatable decision-making process.
• Stresses the need for updating frameworks and mental models to reflect changes in the world.
• Highlights techniques to manage or mitigate bias within decision-making.
• Discusses the optimal number of people for decision-making, suggesting three as an effective number.
• Points out that a group of three allows for a balanced discussion and a majority vote without being destructive.

"But mutable is, hey, the world changes, and we need to make sure that we're updating our frameworks and mental models to accommodate that."

This quote underscores the necessity of adapting decision-making frameworks to evolving circumstances.

"Three is a really good number for decision making because it's an OD number. Right."

The quote explains why three is an effective number for making decisions, as it allows for majority decisions and encourages discussion rather than heated debate.

• Identifies deviation from the established process as a common mistake.
• Notes that biases, such as overconfidence and confirmation bias, can negatively impact decision-making.
• Discusses the subcomponent of overconfidence, which is overprecision.
• Explains how confirmation bias leads to seeking information that confirms pre-existing beliefs, thus skewing the decision-making process.

"One is a deviation from what you say you're trying to do."

This quote highlights that straying from the intended process can lead to poor decision-making.

"The other one is just letting biases creep into what you're doing."

The quote points out that allowing biases to influence decisions is a common error in the decision-making process.

• Questions the effectiveness of thesis-driven investing due to the risk of confirmation bias.
• Suggests using signposts to validate or challenge investment theses.
• Recommends writing down specifics with probabilities and having stop points for reevaluation.
• Proposes using a "decision buddy" for accountability and honest feedback.

"How do you think thesis driven investors can not fall victim to confirmation bias?"

This question addresses the challenge of avoiding confirmation bias within the context of thesis-driven investing.

"The key, Harry, is to do the work up front, essentially, and think through the potential alternatives."

The quote emphasizes the importance of thorough preparation and consideration of alternatives to mitigate confirmation bias in investing.

• Discusses the importance of team size, cognitive diversity, and meeting management for effective decision-making.
• Highlights techniques to encourage the expression of diverse viewpoints.
• Mentions the concept of psychological safety, where team members feel encouraged to share differing opinions.

"So it's very much good hygiene demands that leaders of teams figure out ways to surface alternative points of view."

This quote stresses the responsibility of team leaders to create an environment where different perspectives are valued and explored.

"The leader of the team puts into place these mechanisms to make sure that alternative points of view are serviced."

The quote reinforces the idea that leaders must actively implement strategies to ensure all voices are heard, fostering psychological safety.

• Describes the use of isolated document sharing to allow team members to express their views freely.
• Discusses the pre-mortem technique as a way to anticipate potential issues with an investment.
• Suggests that these methods help surface risks and facilitate open discussion about the viability of investments.

"I send out a word doc the night before. So it's all in isolation."

The quote describes a practical technique for ensuring that team members can independently contribute their thoughts without influence from others.

"We pretend we made the investment, it's now a year from now or two years from now, and this investment's turned very sour."

This quote explains the pre-mortem technique, which involves envisioning a failed investment to identify potential risks and issues beforehand.

• Discusses the need to revise investment processes in response to changes in the world.
• Mentions the concept of being an "appropriate Bayesian" to update views based on new information.
• Provides an example of how the rise of intangible investments requires an updated approach to evaluating company value.

"The fancy term is to be an appropriate Bayesian, which is I have a prior view of the world. As new information tumbles in, I revise my view in the proper direction and the proper magnitude."

This quote introduces the Bayesian approach to updating beliefs and processes based on new evidence.

"I need to update my views. I need to update my process to accommodate the nature of the new investment."

The speaker acknowledges the necessity of adapting processes to keep pace with evolving investment landscapes, such as the shift towards intangible assets.

• Emphasizes that all investments ultimately come down to discounted cash flow (DCF) analysis.
• Suggests focusing on the basic unit of analysis, which is how a company will make money.
• Discusses the role of optionality in venture investments and the conditions under which it becomes significant.
• Reinforces the idea that even with high uncertainty, the underlying economics driven by cash flows are central to valuation.

"The value of any financial asset is the present value of the cash flows."

This quote distills the essence of financial valuation to the present value of expected cash flows, regardless of the asset type.

"It all boils down to the same thing at the end of the day."

The speaker concludes that despite the complexities and uncertainties of venture investing, the fundamental principle of valuation remains cash flow-based.

• Acknowledges the high levels of uncertainty in early-stage investments.
• Questions the usefulness of DCF models for startups that have yet to determine their revenue models.
• Suggests that rigid adherence to traditional valuation models may lead to missed opportunities in venture capital.

"Is there a point in actually doing these models or even thinking in this way when it could actually lead you to say no to some of the biggest companies?"

This quote challenges the practicality of traditional financial models in the context of early-stage venture investing, where uncertainty is the norm.

• The venture capital approach often follows a "build it and they will come" philosophy, where monetization is secondary to user acquisition.
• Early-stage companies may lack revenue but possess potential for future monetization, similar to Google's early days.
• The majority of venture capital investments lose money, but a small number yield high returns, thereby balancing out or surpassing losses.
• Investments in startups are considered positive expected value despite high failure rates due to their potential for substantial returns.

"The majority of investments lose money, right? But a handful of investments make so much money that they more than make up for everything else, right?"

This quote highlights the high-risk, high-reward nature of venture capital investments, where the majority fail but a few succeed significantly, justifying the investment strategy.

• Academic research on venture capital and buyout investments shows a skewed distribution of returns, with few investments driving the majority of gains.
• Venture capital involves understanding the payoffs and accepting that most investments will not yield financial returns.
• The analogy to horse race betting illustrates the shift from frequent small wins to infrequent but large payoffs, reflecting the venture capital mindset.

"It's not how often you make money that matters, it's how much money you make when you're right."

This quote emphasizes the importance of the magnitude of successful investments over the frequency of successful outcomes in venture capital.

• Increased capital supply in venture capital leads to heightened competition and higher valuations, potentially diminishing returns.
• The episodic nature of venture capital returns is characterized by short periods of high returns followed by normalization.
• The shift in exit strategies, with fewer companies going public, affects how venture capital returns are realized.

"Anytime you see capital flowing into something, you should worry about returns."

The speaker warns that an influx of capital into venture capital could lead to diminished returns, similar to public market trends.

• Exiting positions in successful companies should be based on assessing their maturity and value.
• A small percentage of companies drive the majority of stock market value, suggesting a strategy of holding onto winners.
• Portfolio sizing varies between spreading investments across many companies to betting on a small, concentrated number of high-potential startups.

"So that's the argument for latching onto the winners and holding on to them forever."

The speaker discusses the strategy of holding onto winning investments for the long term, given their disproportionate impact on returns.

• Young investors should focus on their investment process and business analysis rather than getting distracted by price swings or macroeconomic events.
• Historical perspective is crucial, as dramatic market events often seem less significant in hindsight.
• Understanding the cyclical nature of market volatility and maintaining a long-term view is essential for investor resilience.

"The key is, are you sticking to your process and trying to think about things the right way?"

This quote advises young investors to remain committed to their investment strategy and process, rather than being swayed by market fluctuations.

• The speaker acknowledges current global challenges but points out that similar disruptions have occurred throughout history.
• The instability caused by health pandemics, political conflicts, and wars is not unprecedented, and the world has previously overcome such events.

"But on some level, we've seen versions of all these things in the past."

The speaker provides reassurance by reminding that the world has faced and survived various crises before, suggesting resilience in the face of current global instability.

• Volatility in the last 10-15 years, including the financial crisis, is less extreme than the volatility seen in the 1920s.
• Historical context suggests that current market conditions are not unprecedented.

"Go back and look at volatility and you see that the volatility we've seen in the last ten or 15 years, even including the financial crisis, doesn't hold a candle to the volatility we saw in the 1920s."

This quote emphasizes the importance of historical perspective when evaluating financial market volatility, indicating that recent market swings are not unique when compared to past periods like the 1920s.

• Public markets are experiencing a reshuffling of value, with debate over whether current valuations represent a new normal or a temporary downturn.
• The buoyancy of previous market conditions is questioned in light of more recent valuations.

"Everyone's like, I can't believe it. This company is four and a half x ARR. What is going on?"

The quote reflects confusion or surprise in the investment community regarding current company valuations, particularly when compared to past market conditions.

• Covid-19 presented significant challenges for companies, with demand fluctuations and management difficulties.
• Even seasoned management teams and major companies like Walmart, Target, and Amazon struggled to navigate the pandemic.

"Covid was a huge challenge for a lot of companies. Right? In other words, there was. For many young companies, there was demand pull forward."

This quote highlights the impact of Covid-19 on business operations, specifically the challenge of managing unexpected demand shifts.

• The concept of implied duration in equities is crucial, affecting sensitivity to interest rate changes.
• Younger companies with future cash flows are more vulnerable to interest rate fluctuations.
• Real interest rates have swung significantly, impacting all asset classes in 2022.
• Companies with pricing power can mitigate the impact of nominal rate increases.

"When you have long duration equities, there's no place to hide."

This quote explains that companies with cash flows expected in the distant future are particularly exposed to interest rate changes, affecting their equity valuations.

• Evaluating whether a company creates a consumer surplus is essential for assessing its resilience to economic changes.
• Companies that provide significant value beyond their pricing have more flexibility and can maintain customer satisfaction.

"Are they delivering a good or service that creates consumer surplus?"

The quote suggests that a key factor in a company's ability to withstand economic shifts is its ability to create value for consumers beyond the cost of its goods or services.

• The book "Expectations Investing" offers insights into how market expectations affect investment decisions.
• Historical interest rates are compared to current rates to assess the normalcy of current market conditions.

"Historically, both real rates, even nominal rates, but real rates are way below where they've been historically and probably where they should be."

This quote discusses the relationship between historical interest rate levels and current rates, indicating that current rates may be returning to a historical norm.

• The book "Consilience" by E. O. Wilson is highlighted for its focus on the unification of knowledge across disciplines.
• Bill Gurley's investment success is attributed to his intellectual curiosity, understanding of return on capital, and grasp of increasing returns in economics.

"Consilience is about the unification of knowledge."

This quote explains the significance of integrating knowledge from different fields as a means to address complex problems, as discussed in E. O. Wilson's book.

• Curiosity is identified as a personal strength, driving continuous learning and research.
• A tendency toward abstraction is seen as a weakness, with a need for more grounded approaches.

"Curiosity probably is my answer to that."

The quote identifies curiosity as a key personal attribute that contributes to ongoing learning and intellectual engagement.

• The best investment advice received is the reminder that circumstances are temporary, emphasizing the need for emotional equilibrium.
• Investment mistakes are acknowledged, with the understanding that they offer valuable lessons.

"This, too shall pass is the best investment advice."

This quote conveys the wisdom of maintaining perspective during both good and bad times in the investment world.

• Emphasis on the importance of sleep and exercise for cognitive function and overall performance.
• Maintaining a consistent routine is easier post-child-rearing, with a focus on 8 hours of sleep and daily exercise.

"I'm very religious about 8 hours and try to really stay on that program."

The quote underlines the speaker's commitment to getting sufficient sleep as part of a healthy lifestyle that supports cognitive performance.

• Success is defined by the ability to do what one loves and contribute positively to the world.
• The concept of input and output is crucial, with teaching as an additional outlet for knowledge sharing.

"I love what I get to do, and I'm very know Dennis lynch is the guy that runs our team at counterpoint Global."

This quote reveals a sense of fulfillment derived from professional activities and the opportunity to work with respected colleagues.

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The quote highlights the convenience offered by Angellist for entrepreneurs in managing various aspects of their business.