How To Invest In Startups

It is easy to invest in startups today.

It is really hard to make a living doing it.

I think the real question in 2020 is ‘Should You Invest In Startups’. I will likely tackle this question in a few upcoming posts. Because it has been so rewarding for me, I think everyone should be allowed to invest in startups, but there are a lot of caveats.

Sam Altman has a great post on ‘How To Invest in Startups‘, which everyone should read. Books can be and are written on the subject, but Sam’s short post gets to the heart of how to attack investing successfully.

I especially like this part:

Great founders are the key to great startups. One way to do really well as a startup investor is to get good at predicting who is going to be great before they are—the market rewards finding great but inexperienced people. You can also do well by investing in people who are already proven, but the price of the shares you buy will reflect that.

So how do you identify future greatness?

It’s easiest if you get to meet people in person, several times. If you meet someone three times in three months, and notice detectable improvement each time, pay attention to that. The rate of improvement is often more important than the current absolute ability (in particular, younger founders can sometimes improve extremely quickly).

The main question I ask myself when I meet a founder is if I’d work for that person. The second question I ask myself is if I can imagine them taking over their industry.

I look for founders who are scrappy and formidable at the same time (a rarer combination than it sounds); mission-oriented, obsessed with their companies, relentless, and determined; extremely smart (necessary but certainly not sufficient); decisive, fast-moving, and willful; courageous, high-conviction, and willing to be misunderstood; strong communicators and infectious evangelists; and capable of becoming tough and ambitious.

Some of these characteristics seem to be easier to change than others; for example, I have noticed that people can become much tougher and more ambitious rapidly, but people tend to be either slow movers or fast movers and that seems harder to change. Being a fast mover is a big thing; a somewhat trivial example is that I have almost never made money investing in founders who do not respond quickly to important emails.

Also, it sounds obvious, but the successful founders I’ve funded believe they are eventually certain to be successful.

In addition to learning to predict who will become great founders, you have to be at least okay at predicting what markets will be good.

Startups are likely to happen in many more industries—startups can win wherever costs can be low and cycle time can be fast. Startups do particularly well in industries with rapid technological change, because their fundamental advantages over large competitors are speed and focus. A higher rate of change gives startups more opportunities to be right and the large competitor more opportunities to stumble.

Like the founder, and like a company, what you should care about is the growth rate and eventual size of a market (I don’t know why most investors are so obsessed with the current size of a market instead of how big they think it will be in ten years, but it’s an opportunity for you).

The best companies tend to have the courage to lead the market by a couple of years, but they know the secret for telling the difference between a real trend and a fake trend. For a real trend, even if there aren’t many users, they use the new platform a lot and love it. For example, although the iPhone was derided for not having many users in its first year or two, most people who had an iPhone raved about it in a way that they never did about previous smartphones.

The very best companies tend to ride the wave of a new, important, and rapidly growing platform.

The spectral signatures of the best companies I’ve invested in are remarkably similar. They usually have most of the following characteristics: compelling founders, a mission that attracts talented people into the startup’s orbit, a product so good that people spontaneously tell their friends about it, a rapidly growing market, a network effect and low marginal costs, the ability to grow fast, and a product that is either fundamentally new or 10x better than existing options.

You should try to limit yourself to opportunities that could be $10 billion companies if they work (which means they have, at least, a fast-growing market and some sort of pricing power). The power law is that powerful. This is easy to say and hard to do, and I’ve been guilty of violating the principle many times. But the data are clear—the failures don’t matter much, the small successes don’t matter much, and the giant returns are where everything happens.

Because everyone in Generation Z has a smartphone and their own social networks, we should be exposing them to the idea and lessons of investing, not just in public markets but in their own networks and products they use and the people they think can be great.

Some Good Reads…My Kingdom For Better Sleeps!

Happy Saturday everyone.

I read some great pieces this week that I wanted to share today.

The first is from Matthew Ball who writes about media and gaming and I link to often here. This current piece is titled ‘The Metaverse: What It Is, Where to Find it, Who Will Build It, and Fortnite‘.

Next up is Chris Dixon at A16z who is a great investor and writer and this current piece is titled ‘Inside-Out vs. Outside-In: The Adoption of New Technologies‘.

Morgan Housel has another great piece titled ‘Risk is What You Don’t See‘.

I talk about sleep a lot both in everyday conversations and on this blog. It is a trend that everyone seems to be trying to cash in on. I continue to follow the two public stocks that are pure sleep plays – Resmed and Inspire Medical (I still own Inspire Medical and sold Resmed too soon). Both stocks seem to go up every day likely because there is just a lack of supply of pure play sleep stock supply.

Enter The Casper IPO, which will likely be marketed as a sleep company. Professor Galloway is out with his usual charm and wit, cutting it down before Goldman and Casper get a chance to tell you about it. A fun and on point read about the IPO.

Have a great weekend.

OK Google OK Apple OK Banks OK Trump….

Then there were three…

Google quietly joined Apple and Microsoft today as having $1 trillion market caps. Really incredible.

Apple is the largest company in the world nearing $1.4 trillion. I really liked this piece by Above Avalon which considers ‘The Big Questions Facing Apple‘. Have a read.

The Orange Julius tax cuts have been very good to the banks

Visa and Mastercard have quietly chugged along in the face of Bitcoin:

Fat Nixon has whined his way into impeachment became a meme as usual…

Impeachment has been very good for the stock market.

I think the Senate trial may surprise a few traders.

The Investor’s Fallacy

Good morning…

First off…Ellen and I are watching the documentary ‘Cheer’ on Netflix and it is great.

Second…I have NO idea what the S&P will do this year. I get the question all the time and I never try and guess and it really does not matter (unless it drops 50 percent like 2008) and there will be plenty of time to recognize that and get out.

That said… The last time the S&P 500 was lower during an election year with the President up for re-election was in 1940 (h/t Ryan Detrick)

Which brings me to this excellent post by Nick Magguilli titled ‘The Investor’s Fallacyand that the markets are never due for anything.

The gist (though you should read it all and check the charts and data):

Assume I flip a coin 5 times and get the following result (let H = heads and T = tails):

HHHHH

What is the probability that my sixth flip is also a heads (H)? Assuming the coin is fair (equal likelihood of heads and tails), you already know that the answer is 50%. Because coin flips are an independent process, prior flips have no bearing on future flips.

But it doesn’t feel that way does it? Even if you understand the basics of probability, after seeing five heads in a row, it can feel like a tails is “due” even though you know better. This feeling is known as the gambler’s fallacy and explains why it is hard for humans to understand random processes.

Investors have a similar problem when it comes to thinking about future market returns. I call it the investor’s fallacy. But what makes the investor’s fallacy more difficult than the gambler’s fallacy is that markets are not an independent process. What happened yesterday can affect what happens today. This explains why the very best days in the market and the very worst days tend to occur near each other. The same logic goes for what happened last week, last month, or last decade.

Because of this interdependence of market returns, it is easy for investors to convince themselves that markets can be due for good or bad years. And with the stellar performance in U.S. markets over the previous decade, it feels like a correction is warranted. However, if you examine the data you will realize that this thinking is just as flawed as the person expecting a tails after seeing five heads in a row. There is little to no relationship between prior 10-year returns and growth over the next 10 years.

Have a great day.

Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For full disclosures, click here.

Fintech On Fire…No Surprise To Us Here

What a great time to be a long fintech….

Yesterday Visa bought Plaid for $5.3 billion (read about it here). I did not see Visa coming for this one and likely Mastercard was a bidder themselves leading to the big number (both Visa and Mastercard were investors). Here is Visa’s deck on why they did it and its worth a read for any fintech investor.

A quick perspective on what $5.3 billion means to Visa – one quarter and half of EBITDA….Visa has a 450 billion market cap.

I have a few friends that were seed investors that made whopping returns which is a reminder of why seed investing is so thrilling and fulfilling.

I am glad I waited an extra day to write about the acquisition because Ben Thompson made my job easier with his breakdown of the deal.

So far 2020 is shaping up like I predicted here

The big question all predictions must answer in 2020 is ‘Can Fintechs Really Beat Banks‘?

I personally think we will see a lot more acquisitions (mega and small) as the banks come to terms with the 60 million accounts outside their direct reach.

This big fintech acquisition comes on heels of Schwab’s acquisition of TD Amritrade and Paypal’s $4 billion Honey acquisition(this is a good read).

What does Plaid do you ask?

My friend Julien has a simple and smart explanation from last year.

I’ve been focused on fintech for a long time and I doubt I would have invested in Plaid’s 2012 seed round if offered because I was too busy armchair quarterbacking Yodilee (who were the leader at the time). In 2012 I was telling Yodilee that they were missing the boat by not working closer with startups like Stocktwits to make the service more affordable and ubiquitous. I was early but could sense the consumer fintech explosion. Yodilee was too slow to move and Plaid moved in quickly helping companies like Robinhood and Venmo grow really fast.

Note – Yodilee did sue Plaid for patent violations.

By 2015, I was well aware of Plaid and asked my friend Matt Murphy to make an intro to the founders – to see if we could invest – which he did:

In 2015 Yodilee did get bought by Envestnet ($ENV) for $590 million. Not horrible, but not $5 billion. By the way, Envestnet closed today at all-time highs and is a stock I have followed but not owned.

Plaid executed near perfectly from the start. The timing of their launch and their plan could not have been better as consumer fintech began to explode.

I became cynical towards Plaid when Goldman Sachs made a $44 million series B investment back in 2016. Obviously, this was a great/shrewd investment by Goldman, but I hated the idea of old school banking getting involved with Plaid so early. Here we are in 2020 and we are in the inevitable phase of all this fintech activity.

Ben Thompson’s summary which I linked to above sums it all up for Visa:

This hints at the best case scenario for Visa from this acquisition: a new financial network, with Visa at its center, transforming the consumer financial services industry just as the credit card transformed the consumer retail industry. If that happens, it’s not out of the question that such a network will be so superior to today’s means of moving financial information and data that the company will be able to charge an ongoing toll, instead of simply a set-up fee (and, perhaps, share it with the banks).

The worst case scenario, meanwhile, will see Plaid’s creaky approach deliver barely good enough service to fintech applications in the U.S., with nothing near the reliability or profitability of Visa’s credit card network. Which, from Visa’s perspective, is not a problem either!

Visa will also be able to help Plaid expand internationally, including to more favorable markets like the U.K. and E.U. At first glance, open banking might seem to be a problem for Plaid, but the truth is that screen-scraping is not a long-term solution, and developers will still prefer to use one well-built API that abstracts away thousands of financial institutions instead of re-inventing the integration wheel.

And, most importantly from Visa’s perspective, the credit card business is not going anywhere — if anything, it’s getting stronger. Companies like Stripe are making credit cards more useful in more places, while Apple is making it even easier to use credit cards both online and offline. It is tempting to look at how payments work in countries like China, but that ignores the path dependency of one market using cash until recently, and the other receiving unsolicited Bank Americards 51 years ago. Once a job is done — and credit cards do their jobs very well — it takes a 10x improvement to get users to switch, and, in a three-sided network, that 10x is 10^3.

I used to own both Visa and Mastercard but now just own Mastercard. I can’t be the only now thinking that if I were to just own one of these great stocks, Visa now has a more interesting network and platform opportunity.

Pooping Secured!

On November 22nd I walked into the Emergency Room and by the 24th I was ‘Praying for a Poop‘.

Just yesterday, I realized that the poops were coming regularly again.

Last week I went for a 10 mile bike ride and had no pain. That was a few months ahead of the plan I had for myself. My surgeon says the wound is 85 percent healed. The last 15 percent will take another year.

I will now deal with the Crohn’s diagnosis but for now, it sure feels great to be on the other side of mending. I am working (if you can call what I do work) and even enjoying a few meals. So far, sushi (rice), raw vegetables, popcorn and Mexican food are out of my food rotation because they make me feel awful.

I can live with that.

I am grateful for all the patience shown by my family, partners, LP’s, friends and customers as I lay on the couch and could not do much of anything.

I am wrapping up a heavy few weeks of antibiotics that am hoping to be infection free in my gut.

I have this new perspective that comes with being sidelined, and some funny stories.

Thanks again for sticking with me, the notes of support and following along.

Momentum Monday…Too Easy?

As a reminder, Marketsmith (by Investor’s Business Daily) is now a sponsor of the weekly show. All the charts you have been seeing in the videos and will continue to see are from Marketsmith. They are offering my readers a three week trial for $19.95. Click this link if you would like to try it out.

Happy Monday.

Earnings season starts this week and as always the big banks lead things off. I expect the bullshit to be thick.

Ivanhoff and I did our usual tour of the markets and not much has changed. Technology leads. You can watch/listen here. We share a bunch of new ideas and catch up on the trends that have been working for us.

Most noteworthy to me were the defense stocks hitting more all-time highs.

Absent from the defense stock all-time high list is Boeing. I loved Bob Lefsetz’s riff on the company and the 737 Max.

Have a great week.

The State of The Venture Market

While I have not been on the road for seven weeks, I continue to do Zoom calls with founders pitching interesting seed stage opportunities.

But from what I read, I can sense the venture markets changing a bit.

Tomasz Tunguz has a post titled ‘The Health Of The Venture Market in 2020‘ that is worth a read and has great charts.

The gist:

We are 12 years into the longest bull market in US history and this bullishness has powered the venture market. Investors deployed $117 billion in 2019 up from $106 billion in 2018.. This market has grown 20% over the last five years. It’s been go, go, go for nearly a decade.

However, Q4 2019 saw meaningful dip from Q3, but it’s too early to say whether it’s an aberration, or the beginning of a longer-term trend.

He closes with…

Looking at where we are in terms of valuations, round sizes, total dollars deployed, and almost every other metric, the venture market today is at least close to if not the most ebullient venture market on record.

So, when does it change? No one knows. The sentiment in the valley continues to be positive and until investor confidence changes, I don’t foresee the trendlines deviating materially.

There are certainly more questions being asked of technology than in the past. There is broad anti-tech sentiment in politics and in popular culture. Softbank’s turbulent 2019 was one of the key topics of the year. Gross margin was the defining characteristic of successful IPOs, and direct listings certainly made a splash last year.

The real and more important question is what to do in this market. That answer never changes: build businesses prudently and finance them when you can at reasonable valuations so the company can grow into them over time.

Midas Venture Investor Bill Gurley is a little more direct in his Twitter feed commenting on the changes we are seeing at the Unicorn level of Venture Capital…

At Social Leverage, we invest early, generally the first money in and as a lead investor. We did not forsee an era of Softbank Vision Fund mucking up cap tables and turning later stage companies that had a lot of exit opportunities into binary outcomes of IPO or death.

I imagine some early state venture firms might try and contract for ‘Softbank’ type behavior in the future, but right now I believe it makes more sense to talk about the what if’s of later stage capital and success with the founders and make sure everybody is on the same page thinking about what success would look like at later stages.

Have a great Sunday.

Some Market Stats That Made Me Go Hmmm…

Some of you are getting bounced when you reply directly to my posts via the email you get. I am looking into that with Campaign Monitor. In the meantime, you can just always reply and use my email howard at lindzon dot com.

Some of the economic stats I see about the US are really incredible. There have been 111 consecutive months (9+ years) of jobs growth, by far the longest streak in history.

Meanwhile, while an orange person take a bow for Dow 29,000, The Gold ETF has matched the Dow ETF in returns since 1998.

When it comes to investing in our 409k, if we wanted to keep up with the returns Fat Nixon expected us all to have, we all should have been invested in Palladium:

Meanwhile it’s getting cheaper and cheaper to kill Americans with Sugar:

Yes Tesla is at all-time highs which seems to upset more people than please…if you are one of those people (usually over 60 or thinks P/E matter), cover your eyes for this next chart:

Finally today…growth vs value is hitting levels not seen in 18 years:

I think Boeing analysts are calling Boeing a value stock by the way…

Have a great weekend.

My 409K is Lagging ….

Yesterday I was at the doctors and got a call from Max that he was involved in a car accident on his way to work. He sounded calm and I asked him if he was hurt. He said no. He Facetimed me the damage and scene to show that it was not his fault (which it was not) and I headed over to the accident scene.

An older woman had run a red light, causing a young man to swerve all the way across the intersection to try and avid hitting her, to only hit my son Max who was on his way to work. Luckily for Max he was just starting to accelerate from the green light and the car hit the front of his car.

I spent the day with Max waiting out the police report, the gathering of insurance and for Max to file his report with the insurance company. The tow truck took Max’s (and Rachel’s) car to the collision centre and our insurance allowed max to rent a car while he waits for his car to be fixed. It was a good lesson for Max on the dangers of driving and also patience.

I share this story so everyone hopefully drives just a little bit more carefully today.

Speaking of careful…

I have been too careful with my Apple position.

Today it closed near $310 and nearly 1.4 trillion.

In the last year it is up nearly $600 billion (or one Facebook).

Here is the one year chart—

Last December I was becoming the Apple fund as I bought it each 10 points as it dropped to $160.

This year I have been a little too quick to sell sone of those shares at $260, $270 and $280. It is still my largest dollar single stock position.

Above Avalon spends a lot of time covering Apple the company and had a great piece on their $500 billion 2018.

Last week I shared a great piece on the ‘art of not selling‘ that people loved. I agree with the premises in the article, but I still have my personal risk profile and comfort level that I stick too and as Apple grows to over 20 percent of my stock portfolio, I sell some. Obviously I would be wealthier if I had let Apple become 100 percent of my portfolio the last 10 years, but last December would have felt like hellduring the 50 percent drawdown and who knows if I would not have panicked and sold my shares on all the negativity in the moment.

The art of not selling and the power of compounding are important tools and guidelines to help you build your own risk profile.

Investing is very hard and is also very personal.