E372: Why the Best Venture Investments Look Wrong Early

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27:31Get started today. It was a surprise beat. You also tried to convince your brother, your dad, your mom. I tried to convince my dad to put his Roth IRA into Crocs. He's like, you're crazy. And that was my first conviction bet where nobody else around me would do it. So I was like, I'm just going to do this myself. I know this company. I've been following every single news article of this company for like 10 years. So I probably know it better than a Wall Street analyst at this point. And I asked my brother, who was in investment in banking at the time to pull up reports or like what was the research and there wasn't any great reports on it like there was no great equity research you could check facts at whatever Bloomberg nothing phenomenal no deep dive I was like I could write this and so yeah I did it and it worked and it was even funny like it wasn't just one quarter like there were a couple of quarters back to back where they kept having surprise earnings and then CNBC all the analysts started picking up you start seeing coverage of this company like very widespread coverage and like that's when I sold them like that's when I'm exiting the position and that was my first I kind of made up this thesis called cultural arbitrage.

28:26So you're arbitraging your knowledge of culture. It's no different than understanding behavior. And I think this translates to VC really well, because similarly to the equities market, where there are areas or sectors that get a lot more attention in certain quarters, it's very similar in venture capital, where I think there's almost a narrative of the quarter. We're talking about this in 2024. There was a JP Morgan healthcare conference and they talked about AI. And like overnight, okay, there was a market map from one of the tier one VCs and a blog post saying healthcare AI is the next thing.

28:58Every healthcare AI startup six months before that was raising, you know, their first round at a$10 million valuation. All of a sudden it was a 25, 30,$40 million valuation. So just because the narrative was brought up on LinkedIn and in blog posts, it wasn't like any meaningful change had happened besides the topic was hot and trending, the valuations 2, 3, 4x'd, which just shows like, you know, and the companies that I've been building had been building two years prior. It was just that it was their time to get that narrative premium. And I'm sure some people were constantly making a momentum trade, but most of them were not realizing or didn't realize they were just part of this mimetic behavior.

29:35Yes, exactly, exactly. It is mimetic behavior. And what was interesting to me is in every single quarter, there's some sort of narrative that proliferates in venture capital. And 99 % of investors, it's like sheep, or lemmings, they call it, will concentrate in that category. And right now, probably the narrative is, oh, Claude is going to take over everything. There's memes everywhere saying, I don't want Claude to come for my company. Please don't come for my payroll company. Please don't come for my fintech company. And then the reality is we have a company that we invested in that where the buyer is not only a big investor and owner in Claude, but what they said was, I don't know if I should go into specifics, but anyways, we have a company that is a applied application layer startup.

30:18And while everyone's saying that no one's going to buy SaaS anymore, SaaS is dead. It's all about horizontal AI. This, you know, they have a pilot. Well, they have a pilot with a Mag7 company. Essentially that buyer said, hey, if you go horizontal, we don't want to work with you. We actually want a point solution that works because Claude is great. We almost have to buy it like from a marketing standpoint for, you know, every single Fortune 500 company as in like Mag 7 company needs to be showing that they're investing in AI. And of course, they eventually will be completely AI first. They're tech companies.

30:47But in reality, in practice, what people want is point solutions that actually work. And so if you can give me a vertical solution end to end that works, like I will pay for it. And so that just contradicts, you know, SaaS is dead. And I guarantee right now, everyone's saying Claude is going to kill all SaaS, SaaS is dead, blah, blah, blah. One company in the next month, I would not be surprised, a month or two, will do$600,$700, a billion dollars of revenue as an application layer startup. And I guarantee you every single VC will change their tune completely and start doing more of those. And then the narrative will be, no, no, no, AI actually makes so many advancements.

31:17It's not about the horizontal models. It's actually about application layer. That's the next investment opportunity, right? Like whatever the zeitgeist of the quarter is. In 2022, when ChadGPT first came out, and remember, I invested in Hugging Face in a prior job. So I am of this kind of mentality. anyone that's a hugging face investor believes that the models will over time be commoditized. And you could actually argue this is a bit of a stretch, but you could argue they already are. Like they are a public good already. If you think about who's backing these models, it's, you know, they're funded heavily by VCs.

31:46The VCs are funded by endowments. There's like sovereign funds across the world that are heavily invested in the VC funds that then invest in the models, which then give you like a free credit tier to use compute. And so you could argue some of the models are already commoditized. But let's say you believe that reality, where does value at the application layer. And I'll never forget that right after TIEGPT came out, all VCs said, we don't invest in chat GPT rappers. Like that was a strong statement that sounded really good. Like there's no moat here. Yeah, so memeable, there's no moat here. Even I remember like Sequoia had this big presentation.

32:17It was on YouTube, like infrastructure is all about infrastructure. And literally one year later, that Sequoia had that same presentation. It wasn't just Sequoia, every single firm, every single tier one saying all value accrues to the application layer. because Harvey, you know, there were all these app, Cursor, all these applications were taking off. And now you see people swinging right back to saying, oh, Cursor, the business model, the unit economics don't make sense. We're out on Cursor. And so how can you have be an early stage investor investing in companies with 10, 15 year life cycles and be this wishwashy on your opinion?

32:46It's kind of going back to your point, like you don't have a strong enough bottoms up thesis on the world to withstand. And it just shows like the state of venture capital today, where narrative is driving and it's all reactionary top down investing. And that's why you see what what are in any hype cycle you see what happens it's like all the capital concentrates into the winners because people don't have the guts to make their own decisions and i joke it's like you're when i tell my founders when you're pitching a vc you're actually pitching their chat gpt so like you might as well just put invisible text in your deck that's convincing the vc because they're not reading it they're putting into the chat gpt take and that's the state of the world we're in and investing where everyone is just giving us the consensus take and so of course People are getting surprised that all the capital is concentrating in the same companies.

33:29Well, if you're putting all your research through your opinions, your chat, GBT, it's going to tell you what has the most data and what's the most the loudest, most memeable thesis. And that's what you're going to end up investing in. It makes this thought experiment, which is in the world of full AI knowledge and commoditized AI. Where is the alpha going to come from? And it reminds me of this dinner at a three and a half hour dinner with one of the chairmen of the largest investment banks is off off the record. and he said, I like to invest into things that are boring and hard. And I'm like, holy crap, that is the best definition of alpha I've ever heard.

34:00And if you start double-clicking on that, you think, what is hard? Well, hard is anything that's not chat GPT-able. You mentioned the Crocs, you know, knowing fashion, knowing what your friends are doing. It's certainly differentiated and some would argue hard. You mentioned before we started recording that you hang out with people in Bushwick to figure out what the next strand is. I would argue that that's hard. And then two is boring. in this case, it's very boring to invest in a fundamentally good company that not everybody's fucking around. And it's the opposite of boring is exciting or sexy.

34:31And what is the most exciting and sexy thing in venture? It's trying to get into these mega rounds, where just having access and getting into these rounds itself makes it a quote unquote good investment. Although you'd probably argue that in most of these cases, especially in the very large rounds, that that's just beta. It is beta. And especially if so much of the dollars are going into it, you're probably getting exposure to it in other ways already. That's just a normal retail investor. The way I frame it is early stage investing. I mean, I love that. So boring and hard. And I've definitely done all of those.

35:00I mean, girl beer is, it's so hard to do a beer company. You're selling to two buyers because you have a distributor and a retailer. It is, do not recommend anyone jumping into that business. So like investing in those types of companies, those founders work really, really hard. They can't even compete. I mean, you have to travel around the country meeting with distributors, people who don't have college degrees like you are really all kinds of characters there's a full stack of people but you still have to maintain an online presence and brand and pitch vcs so you're kind of wearing a lot of hats it's very difficult so yeah i do agree hard and boring you'll never have competition there the way i think about it is early stage and it depends but early stage venture to me is all about taste now even the tech bros have like memed that word to you know which which sucks because it's a very good word but let's rephrase it as you need to have your own point of view like that that's really it who are you paying to get a point of view from, right?

35:48And then on the late stage, it's about sales. So it's access sales, right? So working for someone like Kevin Durant does give you that access because - So it's reverse pitching. 100%. Green Engine, Anthropic, OpenAI, SpaceX, none of these companies go out and pitch VCs. They all get pitched. Correct. So one is sales, one is taste. So if you're going to play, and I think the biggest challenges happen, or at least when I see my peer group struggling, it's because they're not playing the game they're supposed to be playing. So they're playing the sales game in early stage venture, which means they're concentrating in like really kind of like overhyped deals, trying to play a sales game where there's no reason for that company to be valued the price.

36:20You don't want to be in a bidding war with something just because there's a bidding war. You want to be in a bidding war because it is actually outperforming or actually something amazing. It's the other side of that JP Morgan 2024 trade, which is two weeks before the conference. It was the same exact company. It was valued at$10 million. Now it's valued at$30 million. Two weeks later, there's more hype around it, but it doesn't make a fundamental different business. So you're either underpaying or overpaying, depending on when you're investing. Right. 100%. That goes back to this narrative premium, like thinking about where you are in this.

36:47If you had to have a chart overlay being like, where is the narrative on top of this business? And are we at the top of it? Are we at the bottom of it? Are we at the top? And there'll be ups and downs in every company, right? Like there's times where sectors go. I mean, in the public markets, you see it. You'll have companies taking a hit for three years, everyone writing it off. Google is a great example of that, right? So many people wrote off Google. I wouldn't bet against Gemini, right? Like, let's see what happens. And so I think, yeah, on the VC side, there's sales and taste and taste is really what where there is alpha, where there is edge.

37:15And you get the taste, at least in my opinion, from really investing bottoms up, but then investing early. So when you're somebody's first believer, you get this insight. And this is what we like to do. It's very similar to what you said in the beginning with Stanley, his quote of putting 20. Was it him? Yes, Stanley, Drunken Miller, invest and investigate. Right, invest and investigate. So it's like you put in that early stage checks. You have street cred for the life of the business. you're taking the risk. And then when it's working, or actually the second time I like to invest, I like to do two investments.

37:42First is, you know, first money in. And the second time is every single company has this inflection point when something goes wrong. So it's like, I mean, in the most tragic of cases, somebody passes away, a co-founder passes away in a more mild case, you know, or co-founder split. I'm in a more mild case. It's like the market is reacting. There's a political thing that happens. There's a scandal. There's always something or some technology trend comes and that nobody believes that the business can, you know, whether it's like what happened with Salesforce and all the AI, all the AI narrative.

38:10And there's always an opportunity to double down when again, nobody is believing in the company. It's no longer hot. It had its golden moment. It became a unicorn and people forgot about it. Although I'd argue in many ways there you're re-underrating. So yesterday I had an interview with Hans from Notable Capital and he invested into Anthropic, which I'm also an investor in. He invested two weeks after DeepSeek. So if you rewind back to DeepSeek, people are like, holy crap, do the large LLMs have no value? Right. And he invested two weeks after that. What does that mean? He had a fundamentally rooted thesis.

38:43Now, including the emergence of DeepSeek, he and his team had to fundamentally re-underwrite, is Anthropic valuable? Now, obviously, it's become extremely valuable since then. But it wasn't obvious at the time to anyone that didn't do the work there. Yeah, you're right. Hunter and Satya from Homebrew, they told me this. A while ago, I'll always remember, they're like, every round you need to ask yourself of a company, are you a buyer or seller? And to your point earlier, I think you are right that even venture, though it's not liquid, there are still a lot of opportunities to continuously re-underwrite.

39:13And the only way you can actually ask yourself, are you a buyer or seller, is one, if you have enough information on the company, which I would argue you only really get unbiased information if you're there from the beginning. Otherwise, you're always getting some, you know. Some sales pitch. Some sales pitch, some version of it. And even though, no matter what, when you're an investor, you're not a founder. So you're still getting some, but that's the closest you can get to source of truth. And I think that's what I realized about myself. I love, like, I really, really love being at that source of truth.

39:39Like, I want to be, I will never pay for something where I don't really understand. I would rather sit it out. And that's, like, something I feel strongly about as I build my firm and just my own investment philosophy. Is there an opposite of a narrative premium? It's a narrative discount. It's a company that's fallen out of favor in a way. An example of that. Yeah. One of our, actually our first, first company that we invested in out of Spice, that was the formation check almost, was into a startup called Beehive, which is a creator economy startup. And they're now, you know, they are a newsletter platform.

40:12They work with some of the biggest publishers in the world. They have raised capital from Lightspeed, NEA, you name it. They have tons of celebrities writing newsletters. They do B2B. But anyways, that founder was from Morning Brew. So he was a CTO of Morning Brew. Tyler Dank. Yeah, Tyler Dank. He's amazing. Also pretty interesting just to double click on like, why did Morning Brew, a newsletter company, have a CTO? Well, that's how they scaled so quickly and sold. Like they applied a lot of automation techniques from day one at a time where people weren't applying tech to newsletters and media.

40:39So they were ahead of the curve, took that playbook and said, let's build it for everyone. Let's make this company called Beehive. Great idea. I mean, killer founder. If you guys know Tyler, he's amazing. If anyone meets him, they're like, this guy is just like the one of the, you know, he's like a tier one, one of one founder. Is that something that you ascertain very quickly? It's like they have this unconditional love for what they do as opposed to conditional. So it's just like in love or partnership or anything. They're missionaries, not missionaries. They're missionaries. Yeah, 100%. And I like the word unconditional because I think in today's world, you can build conditionally.

41:08And 99 % of pitches I get are, and especially when you're talking to early stage founders, it's like, I'm working at Bain. I'm going to try to raise$3,$4 million. If I can raise it, I know this guy Andreessen. If I can get that round done, I'll probably quit my job and start experimenting ideas. I'm like, what? You're taking no risk. There's nothing on the line. As opposed to the girl beer founder, Tyler, it's like it's, you know, from Beehive, it's happening with or without me. If you're not funding this, I'm taking out a credit card loan. Like that's the kind of level of this is meant to happen.

41:38I'm building this unconditionally, not when every single situation is perfect. You need that because if you're starting your company that way, there's going to be ups and downs, but you've already trained yourself to build unconditionally. As opposed to if you started in a really cushy way, when something inevitably doesn't work out your way, I see those founders who got it, who had it really easy off the bat struggle in the middle. And the middle is when it's boring. There's no hype. You're no longer the darling. No one cares about you. Like what is driving you to push forward? So you need this mercenary style focus.

42:07And you can read that very quickly, especially for me working for a celebrity. Actually, the best secret is people are trying to get something from you all the time, right? Like everyone is trying to get their only friends with you because they want access to the celebrity or they want money from you they're always pitching you they're always an alter your motive they're so cynical but they're they're very shrewd because they know i mean they're not dumb they know hey this guy's probably ripping me off but like it's okay it's worth it cost of doing business i'll take the 20 cut he's definitely ripping me off or this girl is definitely ripping me off but they know you know they're not idiots and so anyways taking all this back to like the narrative discount with beehives specifically they were building in the creator economy which year over year has exploded i mean we're doing a podcast right now like you we see the value of distribution and content that was my I guess unconditional love and speaking of beehive yeah she had a newsletter on beehive got to about a thousand subscribers and great platform have nothing negative to say but my heart wasn't in it and at this point in my career something that I've learned is all the value and anything you do has to do with compounding so if my heart wasn't in it what a downstream consequence of that I'm not going to do it for 10 years if I'm not doing for 10 years I should quit so I quit like two months into it wow there's this idea that you shouldn't quit that quitter you shouldn't be a quitter you should absolutely quit very quickly in order to make room for other things what's the other thing for me it's this podcast i do it five times a week i've now done this is roughly episode 370 i'm going to be doing this probably for the rest of my life until ai replaces me it's not even hard for me and i know that i could build this compound advantage in this specific thing because i love it i have what you call this unconditional love i love it and you could tell i mean that's a that's a high volume to do five days a week yeah it would be very difficult to push through that although as i know you're a second generation immigrant and first generation immigrant, we kind of thrive in these difficult and impossible things, this kind of grunt work.

43:51Sometimes, by the way, that could be a downfall. Sometimes, why are you grunting? Why are you grunting on the New Zealand letter? Oh, well, my heart isn't in it. Well, you're going to be losing to the people where the heart is in it. They're going to be running circles on them, just like I run circles around people that just today decided to do a podcast. A hundred percent. And that's how I really felt when I started my fund. I felt like I had very strong opinions in a way that others didn't and that I could outwork anyone. And at least in my fund one, I was really trying to prove my value to the founders.

44:15And it was just that like immigrant hustle where I felt so confident. And I was like, I will outwork you. Nobody else is going to be staying up this late. VC is supposed to be a cushy job and I'm going to make it really hard. It's so interesting because I thought about the downstream consequences of loving what you do in this intrinsic love for it. And they're oftentimes very tacit and very powerful. So right now in emerging managers, you see this extinction level event. So there's roughly 3 ,000 managers, by some accounts, 50 to 75 % of them are on their last fund, which begs the question, why aren't 25 to 50 % of the managers on their last fund?

44:50Now, some might just have good traction, might've gotten lucky on some investments, but a lot of them are going to keep on grinding, keep on hustling. Why? It may not even make financial sense. They may be a CMO at a top pre-IPO company, make money. They intrinsically love it. And the downstream consequences of that are actually quite powerful. They start to problem solve around what you need to do to stay in this business. There's so many examples of this. I had Eric Bond from Hustle Fund. He created this whole media network. They make millions of dollars because they're fun. They want to keep their fund size small.

45:19They want to have a great fund for LPs. They build these ancillary businesses. There's other investors that I know that are now partnering with people on secondaries that are offering co-invest to their LPs at discounted terms so that they stay around and fund their future funds. But the more love you have for something, the more your ego goes down, the more you go from victim mindset or passive into problem solving and active. And it becomes a self-fulfilling prophecy where the people that are, their heart is in it. They're missionaries, not mercenaries. They're able to figure out the things that need to happen in order for them to just keep doing what they're doing.

45:54That's a great point. That's a great point. Someone, Brian from Starface, do you know that company? It's the Pimple Patch Company. I had like the first time I had a call with him. He said this to me, I'll never forget it. And at the time, this was in relation to nothing to do with venture. I was producing like a short film. And he was like, it's always fun to do it your first time when you don't really know what you're getting into. But the real test of like entrepreneurship is, will you do it the second time when you know how hard it is, but you still choose to double down? I think like between me starting my fund one and going into fund two, when I didn't really have any results and like some of that high wears off.

46:26That is it is the love and it is the creativity that pushes you through. Right. Alex Ramirez, a two time podcast guest and a mentor of mine. I consume all of his content, which is contrarian for. I love it. space. He talks about this concept, choose your heart. Everything's hard. Grass is not green anywhere. So choose your heart. It's not about whether something's hard or easy. Everything has competition. Everything has friction, especially if it's profitable. But where do you want to slave away? Where do you want to have all the highs and lows? Make sure that's worth it. It goes back to this missionary drive.

46:58I love it. I love it. To close the loop on the kind of like narrative premium or narrative discount with Beehive, you know, talking about the creator economy, which we have, I have so many thoughts on that whole space. But the interesting thing there was when Beehive was starting, it was right at the end of 2021 and Clubhouse had just imploded. The creator economy, which was this like big thesis that many funds like co-opted quite quickly, you know, there were a couple other startups like Patreon raised a big round and there was, there were recaps in certain companies. And so there's this whole belief in Silicon Valley, all of a sudden that 18 months after the creator economy started, it was over, you know, like clubhouse died that was the peak of it it's over and i guess everyone's going to go back to coding i don't know what their thesis was but just completely fell out of favor like if you were doing a creator economy deal you were considered low iq and you were considered you know like you didn't get the memo you didn't get the memo like oh we don't look at those deals anymore and so when beehive was raising that's how they started in that environment and you know like the first few rounds were people who didn't believe that who actually it was a lot of creators actually um i I think Scott Galloway participated.

48:05So there were all these participants that didn't come from the traditional VC world that all actually made their investing career off of Beehive, including myself. Like that first investment ended up really appreciating. It was like a pretty fast 10x for an emerging manager where I was pounding the table around this thesis and talking about how the next gen of consumers is like on Robinhood. And they're all trying to be influencers. And everyone thought that was low IQ. But then if you look at how that translates to real life, I mean, decisions are driven off of distribution now. Even people really, you know, look over influencers, but influencers are driving like trillions of dollars of consumer spending, not billions, trillions.

48:43OK, it's like totally gnarly. But and creative economy revenue year over year is growing. Like it was like 100 percent year over year market, but not 100 percent year over year. If you track that with VC funding, it's been declining ever since 2021. one. And so, you know, I think there's that's a great example of narrative discount. Whenever you're investing in a company in a sector that's fallen out of favor, it's similar to what we talked about with, you know, loving what you do and being unconditional in your pursuit, where when you fall out of favor, you're just not able to raise as much money.

49:13So you're not going to get the$10 million seed round, you're going to get a one or$2 million seed round. And so the irony of that, and it's great for actually early state investors is you better be capital efficient because you don't have leeway to mess up. And as soon as you run out of that money and you go back to market, you better have results because your category is out of favor. So you're not getting any handouts. You're not getting the narrative premium. In fact, you're held to an even higher standard. So as a result, the founders that start that way, at least in our portfolio, have wildly outperformed on revenue because they have no other option.

49:42They have the right DNA from the start. Yeah, they have the right DNA from the start. They are capital constrained off the bat. And typically when something's out of favor, that is the right time you should be building. So they have a ton of demand. So they end up building a great business. these narratives and these memes are so powerful they're so intrinsically linked in how silicon valley is run that they're invisible they're almost assumed two most famous ones the two most joked about companies in the dot-com boom were web van and pets.com web van became instacart not literally but the reincarnation of web van was instacart obviously fabulous vessel great pets.com chewy multi-billion dollar company so if you just keep on if you just focus exclusively on memes, narratives, and all these things, and doing what you know you're supposed to do and not doing what you know you're not supposed to do, it could lead to whatever the opposite of first principles thinking is, this mimetic type of copying.

50:34You're approaching your 10th year as a VC next year, 150 investments. If you could go back and give yourself one piece of advice before you made your very first investment, what would that be? To trust your gut more. It's an obvious piece of advice. Even at that time or trust your gut today? No, to trust my gut at that time. One of my biggest misses was Whatnot. And the reason, and I passed on that in multiple rounds. And I actually looked yesterday at the app store, like the top apps on the app store, just to see what was going on. And of course, it's all the AI labs. It's like Dunkin' Donuts, Monopoly.

51:04Like it's so funny. But then Whatnot was creeping up on that list. And it was a live shopping app. I didn't invest in that because I asked other VCs. I was junior in my career. I was like, hey, Asia is always ahead of the curve on, you know, like consumer in general. um they they have in many different ways right they had the super app they were ahead on kind of like messaging all these different things so Asia's always behaviorally advanced on digital culture let's say that and they're in Asia live shopping is a big thing this is like a reincarnation of QVC for modern era it totally makes sense and everyone was like no that's not going to work here it's been tried before um there were a bunch of zombie companies that didn't work and I really was out kind of was like, okay, they must know more than me.

51:49And the people who had sent me that deal was a, yeah, anyways, long story short, I relied too much on other people's opinions, thinking when I was young that they knew so much because they had done all this research. Not understanding the reality, which is that research was like regurgitated slop pretty much. And I was the recipient of it. And so I made an investment decision off of other people's opinions. And I think that is what I would coach anyone to do. If you don't have a strong opinion, don't participate like wait to form an opinion or don't participate well my thanks so much for jumping on looking forward to doing this again soon yes thank you for having me this has been awesome