20VC The Memo Bill Gurley, Doug Leone, Keith Rabois; Investing Lessons from Prior Busts, How Their Investor Psychology Changed, What Can Be Applied To Today's Market

Summary Notes


In this episode, the host Harry Stebbings explores the cyclical nature of markets and the lessons learned from past downturns with insights from seasoned investors such as Bill Gurley, Doug Leone, Jim and Arthur of Accel, and Keith Rabois. They discuss the importance of maintaining investment momentum, realistic valuation, and managing reserves during busts. Mark Carney, former governor of the Bank of England, delves into the implications of rising interest rates on risk assets and the need for planning for potential failures. Michael Eisenberg emphasizes the constant nature of innovation despite market cycles, while Sonali De Rycker and Oren Zeev share the significance of partnering with entrepreneurs and learning from past crises. Fabrice Grinda concludes by highlighting the resilience and growth potential of the technology sector, regardless of macroeconomic conditions.

Summary Notes

Market Cycles and Investor Mindset

  • Market cycles often include periods of inflated confidence, termed "bubbles."
  • The withdrawal of confidence can lead to rapid price collapses.
  • Many current investors and founders are experiencing their first professional market downturn.
  • The episode aims to share wisdom from experienced investors on navigating market busts.
  • Bill Gurley and Doug Leone, among others, provide insights based on past market cycles.

"Every once in a while there's what we call a bubble where people say, well that's invincible. It can only go up. When that confidence is withdrawn, then the prices can collapse."

This quote underscores the nature of market bubbles where assets are perceived as infallible and their value only appreciates. The quote also highlights the vulnerability of such confidence and the potential for a market crash when that confidence is lost.

Venture Capital Inherently Cyclical

  • Bill Gurley discusses venture capital's inherent cyclicality with macro experts Howard Marks and Stan Druckenmiller.
  • The venture industry experiences significant gains before market resets.
  • Conservative venture strategies do not work; investors must "play the game on the field."

"It struck me, it really landed for me. And there's an old saying in venture capital that the way to protect yourself against the downside is to enjoy every last bit of the upside."

Bill Gurley reflects on the cyclical nature of venture capital and the necessity of fully capitalizing on the positive phases of the cycle to mitigate the impact of the inevitable downturns.

The Reality of Boom and Bust

  • Doug Leone of Sequoia acknowledges the inevitability of market fluctuations.
  • Sequoia conducts exercises to evaluate the resilience of investments against market crashes.
  • Boom and bust cycles serve as reality checks and prepare investors for future downturns.

"Boom and bust inject a sense of fear to balance, a sense of greed, a sense of reality, and it just grounds you, and it gives you the experience and the strength to overcome the next bus that we absolutely know is coming."

Doug Leone emphasizes the balancing effect of boom and bust cycles, suggesting that they instill a healthy sense of caution and ground investors in reality, ultimately strengthening their ability to navigate future market downturns.

Adjusting to Market Turns

  • Jim and Arthur, founders of Excel, have experienced five market cycles.
  • They advise holding on during market upswings and being realistic about market turns.
  • Quick adjustment to market changes is crucial to minimize damage.
  • Discipline in exiting investments at the right time is learned through experience.

"My only advice is be a realist and recognize that when it turns, it's not always obvious that it's turning. But be a realist and start to look for when it really has turned, and then adjust quickly."

The quote from the founders of Excel advises investors to maintain a realistic perspective and to be prepared to act swiftly when the market shows signs of a downturn, highlighting the importance of recognizing and responding to market shifts.## Market Valuation and Potential Contraction

  • The market is currently at a valuation of three to five times the peak ever before.
  • There is a significant potential for market contraction.
  • It is important to analyze portfolios for overvalued assets and consider divesting.
  • Valuations at 100 times revenue are unsustainable and likely to revert to the mean.

"Price to revenue of companies, three to five x, where we were at the peak ever before, so that leaves a lot of room for contraction."

This quote highlights the current high valuation of companies in the market and suggests that there is a significant risk of a market downturn.

"I mean, everything reverts to the mean at some .1 hundred times revenue is just not sustainable."

The speaker emphasizes the unsustainability of extremely high revenue multiples, implying that such valuations will eventually normalize.

Investment Strategy Across Market Stages

  • Investment strategy should vary by market stage: seed, growth, and intermediate rounds.
  • Seed investments are favorable with the right team and vision, regardless of market cycle.
  • Growth investments should be made with caution, focusing on appropriate pricing due to a limited window of opportunity.
  • Intermediate rounds (Series A, B, C) require careful return calculations and an understanding of founder expectations and valuation adjustments.
  • Consider the future funding landscape for a company and the milestones needed to attract other investors.

"I would invest in seed companies with the right team, with the right vision, all day, every day, in any cycle."

This quote demonstrates the speaker's confidence in investing in early-stage companies with strong teams and clear visions, despite market conditions.

"In the growth rounds, I absolutely would only invest in things that are priced appropriately because you really do only have a two or three year window."

The speaker stresses the importance of prudent investment in growth-stage companies, highlighting the short timeframe for realizing returns in this phase.

The Impact of Market Experience on Investment Decisions

  • Experience with market cycles can influence investment behavior and expectations.
  • Younger venture capitalists may have a skewed perception of the market, believing that valuations only increase.
  • Real returns are distinguished from paper returns, which may not be realized without savvy selling strategies.
  • The ability to distribute returns is crucial in validating investment success.

"Both Peter and I figured out this market was crashing last summer and we really tried to stop people from investing at ridiculous prices."

This quote reflects the speaker's market foresight and attempts to mitigate overvaluation by advising against high-priced investments.

"The problem for younger vcs over the last three or four, maybe even five years, is with everything inflated, most of that inflation is paper, not real."

The speaker points out the potential misconception among less experienced investors regarding the true value of inflated assets.

Historical Market Crashes and Lessons Learned

  • The speaker has experienced various market crashes and financial crises, which have shaped a sober perspective on market highs and lows.
  • Leverage should be used cautiously to avoid being overwhelmed by unexpected market shifts.
  • Historical events have proven that markets are cyclical, with periods of creative destruction and valuation adjustments.
  • Governing laws of nature and economics ultimately balance the market, despite periods of perceived new paradigms.

"You mentioned too, there was a whole bunch of other stuff that's kind of fed into my perspective."

The quote suggests that the speaker's market view is informed by a history of witnessing various market events and their impacts.

"While you may be super smart, smartest people in the world get carried out if their models are wrong or if an unexpected thing happens and they can't chart an exit path."

Here, the speaker warns against overconfidence in market models and the importance of having an exit strategy in the face of unforeseen events.

Comparison of Past and Present Market Conditions

  • The current market is compared to past events, with distinctions drawn between sudden shocks and gradual valuation stretches.
  • The speaker differentiates between episodic market jolts and the current situation, which is likened to the dot-com bubble's valuation stretch.
  • The role of liquidity and the Federal Reserve's actions in shaping market conditions is highlighted.
  • The current market is characterized by the Fed's tightening of monetary policy and the challenge of supporting high growth valuations.

"I think the difference between this and say, 87 and 97 with LTCM is that this is not a shock, this is not an episodic jolt."

This quote contrasts the gradual nature of the current market situation with the sudden shocks experienced in previous market crises.

"It's the combination of the Fed taking the air out of the balloon of liquidity, and then you have this valuation extremes, particularly in growth, that very hard to support with valuation models."

The speaker attributes the current market conditions to the Federal Reserve's reduction of liquidity and extreme growth valuations that are difficult to justify.

Planning for Market Downturns

  • Planning for potential market downturns is essential for financial stability.
  • Borrowing against assumed continuous capital gains can be risky.
  • Investors should consider the implications of significant value drops in their holdings.
  • The market can remain irrational longer than one can stay solvent, underscoring the need for prudent management.
  • Rising interest rates are expected, which will have implications for market dynamics.

"One of the lessons of a boom, which you've only seen the boom side of, not the bus side of, but what happens in a boom is that there's big capital gains."

The quote emphasizes the need to be cautious during boom periods and to consider the potential for downturns.

"The market can be wrong longer than you can stay solvent."

This quote is a reminder of the importance of financial prudence and the potential for the market to defy expectations for extended periods.## Impact of Interest Rate Increases on Markets

  • Interest rates hikes lead to amplified impact on risk assets.
  • Discount rates on risk assets increase more than the bank rate.
  • Price adjustments occur if income from assets doesn't rise correspondingly.
  • Riskier assets are more affected, potentially leading to a pullback.
  • Pullbacks do not signify the end but can establish a new baseline for growth.

"Well, what tends to happen when interest rates increase is that there is an amplified impact on the interest rates of risk assets or the discount rates on risk assets."

This quote explains that when central banks raise interest rates, the effect on riskier assets like stocks or cryptocurrencies is more pronounced than on safer assets. The discount rates, which are used to value these assets, increase by a larger margin than the actual increase in bank rates.

"You could crypto various defi applications in that camp. They've had a very large run up."

The speaker is categorizing cryptocurrencies and decentralized finance (DeFi) applications as risk assets that have recently experienced significant price increases, suggesting they may be more susceptible to pullbacks when interest rates rise.

Investing Mindset During Boom and Bust Cycles

  • Innovation continues through boom and bust cycles, offering investment opportunities.
  • Best investment times can be during busts, where maintaining a constant investment pace is crucial.
  • Downturns require understanding the impact on reserves, founder psychology, and investor behavior.
  • Predicting future valuations is uncertain, and busts bring unknowns and unpredictability.

"But it turns out that the best time to invest is when it busts."

Michael Eisenberg highlights that downturns can present the best investment opportunities, as asset prices may be lower and there is less competition for deals.

"There's a lot of unknown and uncertainty and bust."

This quote captures the challenges that come with investing during a market downturn, emphasizing the unpredictability and the need for caution and strategic thinking in reserve management and support networks.

Reserves Management in Venture Capital

  • Reserves management is more of an art than a science, with no clear formula for success.
  • Single-stage funds may reduce risks associated with reserves and signaling during downturns.
  • Psychological impact of busts is significant, and having capital on hand can provide a competitive advantage.
  • Being opportunistic with reserves can benefit companies during tough times.

"Reserves is an art and not a science."

Michael Eisenberg suggests that determining how much capital to reserve for future investment is not a precise process and requires judgment and experience.

"Busts are psychologically impactful far more than they're financially impactful."

This quote emphasizes the psychological toll of market downturns on founders and investors, which can be more significant than the financial impact, highlighting the importance of being prepared and opportunistic.

Continuous Investment and Partnership

  • Continuous investment is crucial, especially during uncertainty.
  • Partnering with entrepreneurs is key, particularly when mixed messages are prevalent.
  • Confidence and a strong partnership approach are essential for venture capital funds to survive and thrive.

"The minute you lose your confidence, you lose your right to exist."

Sonali Derika stresses the importance of maintaining confidence and continuing to invest, regardless of market conditions, to remain relevant in the venture capital industry.

"It's your partnering mindset. You have to partner with your entrepreneurs."

This quote underscores the importance of building strong relationships with entrepreneurs, especially when they are receiving conflicting advice and facing challenging times.

Lessons from the Dotcom Crisis

  • Each crisis is unique and presents different challenges and opportunities.
  • Drawing parallels from past crises can help, but each situation requires a tailored approach.

"First of all, I think every crisis is different, just like every war is different."

Doug Leone shares his perspective that while there may be lessons from past crises, each one has distinct characteristics that require a unique approach to investor psychology and strategy.## Overcoming Past Failures

  • Every deal made in 1999 was unsuccessful, with a 0% success rate.
  • The key to recovery was not dwelling on past mistakes and focusing on future opportunities.
  • The first successful deal after the failures was Audible in 2002.
  • The advice is not to over-obsess about failures but to help positively and focus on what's ahead.

"Every single deal that I did in 1999 tanked was a bad deal. Every single deal is 0% success."

This quote highlights the complete failure of investments made in 1999, emphasizing the severity of the situation.

"So don't over obsess about saving. It would be my advice, by the way, it's a good advice regardless of crisis."

The speaker suggests that one should avoid fixating on failed ventures and instead move forward, which is applicable in any crisis.

Probabilistic Outlook on Future Outcomes

  • The speaker presents three potential future economic scenarios: optimism, stagnation, and worsening conditions.
  • Assigns probabilities to each scenario: optimistic outcome (20%), great stagnation (60%), and more pain (20%).
  • Believes that despite past economic downturns, investing in technology has historically been a winning bet.
  • For early-stage investors, current negative macroeconomic conditions are less impactful.
  • Important considerations for investors include ensuring follow-on capital and reasonable valuations.

"I can make a reasonably compelling argument or case that we have three outcomes ahead of us, and I can make a good argument for all three of them."

This quote introduces the concept of considering multiple future economic scenarios and the ability to argue for each one's plausibility.

"The last 200 years have been a history of technological innovation that has led to improvements in the human condition over the last 200 years, despite world wars, the Great Depression, and frankly, even the last 40 years of, like, Black Monday, the massive recession of 81 82, a recession in 92, a recession in 2001."

The speaker reflects on the historical trend of technological progress leading to overall human improvement, despite various economic crises.

"The most interesting companies in the last decade were all created in the seven, nine recession. Uber, Airbnb."

This quote illustrates how successful companies can emerge from economic recessions, using Uber and Airbnb as examples.

The Resilience and Potential of Tech Investments

  • The speaker's personal net worth is heavily invested in early-stage startups and technology.
  • Tech companies are seen as having the ability to grow dramatically and possess pricing power.
  • Inflation impacts tech companies differently, with the potential for increased pricing rather than just decreased future cash flows.
  • Current market conditions may lead to fewer exits and lower valuations, but the speaker remains committed to tech as the preferred investment sector.

"My personal net worth is still 60%, basically early stage startups, because they can grow very dramatically."

The speaker shares their personal investment strategy, which heavily favors early-stage startups due to their growth potential.

"I think tech companies have pricing power."

This quote suggests that technology companies have the ability to set prices and potentially benefit from inflationary environments.

"There's no place I would rather be other than tech."

The speaker concludes with a strong endorsement of the technology sector as their chosen investment focus.

Reflection on Podcast and Sponsor Messages

  • The host reflects on the wisdom shared in the podcast and the body of work built over time.
  • The host invites listeners to share their thoughts on the episode.
  • Several sponsor messages are included, promoting products and services related to health, equity management, and financing solutions.

"It was also quite a humbling episode for me, hearing some of those incredible people share their wisdom and just realizing the body of work that we've built over time here at 20 vc."

The host expresses gratitude and humility for the insights shared by guests on the podcast and the evolution of the podcast itself.

"Do let me know on Twitter at Harry Stebings but before we leave you today..."

The host encourages listener engagement and introduces the transition to sponsor messages.

The quotes from the sponsor messages are not provided as they do not pertain to the key themes and ideas discussed in the main content of the podcast.

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