329. Resisting “financial gravity”: How purpose-driven companies endure

0:00For McKinsey & Company, I'm Sean Brown and welcome to Inside the Strategy Room. Two questions are at the heart of today's conversation between Ryan Davies and Eric Ries. The first is what makes a great company endure and create value over the long term? And the second is as organizations grow, take on outside capital, or even enter the public markets, how can leaders best protect the purpose and principles that made them so successful in the first place? Ryan is a senior partner based in our Washington, D.C. office who leads our capital markets practice globally. And Eric is the author of the New York Times bestseller, Incorruptible, which examines how companies can resist what he calls financial gravity, a term that describes the pressures that can pull organizations away from their mission as they grow.

0:55Eric is also the author of The Lean Startup and the founder of the Long-Term Stock Exchange. In their conversation, Ryan and Eric explore how governance can help companies stay true to their purpose, why trust can be one of an organization's most valuable assets, and what leaders of both young and established companies can do to build their businesses for the long term. They also discuss what these ideas could mean for investors, capital markets, and the institutions that underpin our economy. We hope you enjoy the conversation. And now, here's Ryan. Thanks so much, Eric, for making the time to be with us today.

1:34Oh, it's my pleasure. Glad you like the book. Yeah, you're both coming off of and going into, as I understand it, several months of book tour. So what surprised you the most from your first couple months of bringing this out into the world? Yeah. Oh, it's been really fun. You know, the biggest surprise to me, I knew that this book would resonate with founders and investors and board members. Of course, that's really who it's for. I've been surprised by the breadth of the audience that has come to the book. And I wrote in the book that this is a pervasive problem, but I didn't really see how aware people are of it.

2:09We just don't have a word for it. So that's been really interesting is we do an exercise now in audiences and I'll say, everybody, tell me about a favorite company, favorite brand, favorite product of yours, you know, where you were a customer or an employee or investor, you know, something you have a relationship with, you cared a lot. Tell me about a time when they took on a private equity investment or they went public or they got acquired by a public company. Anyone have a story like that for me? And I think this is different from past generations. Like people now are far more aware of those kinds of life cycle events in the companies they interact with.

2:40So everyone's got a story like that. Everyone raises their hand I say, great. Now someone, anyone in the room, can you tell me a story of a company or a brand like that where after the vast infusion of capital resources they were able to get, the product got a lot better and every hand goes down. And in fact, everyone has the opposite story. They'd like to tell me about the betrayals. In almost every category, people have been sending me their horror stories. And I include a bunch of these horror stories in the book, so it's not like I wasn't prepared for it, but the stakes are a lot higher than I thought.

3:13I think that's quite sad. So that depth of feeling, that sense of outrage, it just seems to be everywhere I go, I'm hearing about it. Yeah. Well, I think it's, as you say, it's important to be aware of that. It's certainly our view as McKinsey that capitalism and for-profit companies can be tremendous forces for good when they're set up in the right way and doing things in service of their customers and the financial success can be very compatible with making a positive difference in the world. But the sentiments you express are very real and out there. And I think important for everyone to be aware of.

3:49I'll get over the course of our discussion to your broader journey and the journey of the book, but maybe to bring people into the book, one of the concepts you talk a lot about is financial gravity. You tell us a little bit what you mean by that and how you observed it as you got deeper into the research and what the implications are. Sure. Yeah. So let's pick up where you just started, which is the McKinsey view that business can be a force for good. I think that's the aspiration that draws a lot of people into business. Actually, I think that is a very natural idea. Why do people become entrepreneurs?

4:20Why do people want to do their work in the context of a for-profit company? A lot of people do that because they think the products that they make genuinely make their customers' lives better. the value creating engine of a well-run for-profit company is an awe-inspiring thing to behold. I've gotten to see it up close many times. But I think the thing that I've realized doing all these years working with companies, helping so many people start companies, hundreds, thousands, I don't even know what the count is at this point. You don't get that positive world-changing effect automatically. It's not guaranteed.

4:54And I think this is where we run into trouble. When we ask people to defend capitalism, this is how they do it. I call it the moral bedrock of the arguments that defend our for-profit system. When you're digging, digging, digging down through the sedimentary layers of arguments people have used over the hundreds of years, the foundational one is that value creation leaves both parties better off in a transaction. That when we make products more efficient or higher quality, when companies compete for their customers' favor, this creates socially beneficial effects for the company and for the customer, the employee, everyone alike.

5:27So that is the reason we get into this. And yet having been around this activity for a really long time, I felt like quite often I was up against a force I couldn't name. It was like we would spend, I spent so many years helping some really big companies transform their management systems only to see all that progress basically erased at the stroke of a pen in the boardroom. by a boardroom betrayal or under pressure from an activist investor. It just started to feel like there's a layer beyond management that at first I thought was about the capital markets, about investors and the power that they wield.

6:03And of course, that's part of it. But having built a stock exchange and having been in this world now quite a while, I started to talk to investors and activists and board members and all these grand poobahs. They felt the same way. They weren't really in control either. I call it in the book, the force that no one controls, but everyone obeys. And it's interesting. It produces really homogenous outcomes. That's how you know it's a force. Because if it was random, companies as they got bigger, companies as they went public, companies as they interacted with investors, think about the diversity of investors, investment theses, and investment goals that are out there.

6:39That pressure would produce random outcomes. Some companies would be better, some would be worse, some would be beautiful, some would be ugly. but our modern big companies are so generic. They're so similar. And it occurred to me after a while of fighting this phenomenon that it really is a force, like a physical force that acts on organizations. And I call it financial gravity because I want people to use their visceral understanding of physical gravity as an analogy. This is a force that is always pulling companies down towards mediocrity or worse. And as a result, it transmits a very specific set of values which emanate from our financial system.

7:22And the key to it, the stories about financial gravity, and we can tell some of these stories if you want, they're depressing. They're stories about a founder being betrayed, about a company losing its way, mission drift, a lot of these kind of stories where something really bad happens. And oftentimes, the bad thing that happens is the collapse of the company's for-profit engine. So not only does it betray its promises to customers, but then it also goes bankrupt. So they're quite sad stories. And yet to me, the key to understanding financial gravity is to realize that it has predictable laws and therefore we can harness it, use it as a force to our own ends, meaning we can build companies that can resist that downward pressure.

8:00And again, we have to reconceive governance as closer to an engineering discipline. I call it in the book, the art of organizational soul craft, that we have choices about how organizations are structured. We have choices about how the board is constituted. We have choices about the relationships they'll have with their investors. And those choices, it turns out in the academic literature, have more solutions than most business leaders have ever been exposed to. And some of those solutions are quite old. They're generations old, centuries old even, and we have pretty good data that they work. And yet they defy our modern so-called best practices about how we're supposed to lead in structural organizations.

8:38So this disconnect between the kind of formal systems we have that say, this is the best way to do things. This is what we all agree is how our economy should be run. Ignorant of this force, this force of financial gravity, I think is producing these malign outcomes. So we have to kind of reach back into the literature to rediscover some of these techniques that I think have become unpopular or even completely unknown in order to build organizations that truly have the strength to operate in the face of this force. One of the things I really appreciated about the book was how you identify financial gravity as a force.

9:14You identify that financial gravity is not predestined to produce positive outcomes, by the way, financially or more broadly with externalities. But you go well beyond that to actually put forward some quite specific tools in the toolbox, if you will, on how to address it and harness it to produce more positive outcomes. And obviously, we won't be able to survey them exhaustively, but could you maybe summarize a bit what are some of those that you feel like are most compelling and really real world test it as well? Yeah. Yeah. In the book, I lay out what I call the new governance. So today, I mean, honestly, most board meetings are really boring.

9:53I've been on quite a few boards, okay? I think we could do a lot better as an industry. The way we're teaching board governance, the way we're teaching people what is the purpose of a corporation, there's not that much to it. It's pretty much compliance and like a little, like a smattering of shareholder primacy. You know, make money for your shareholders. Don't break the law while doing it. That's pretty much it. Occasionally we'll discuss strategy like our product in a kind of perfunctory way. I think we do a lot better than that. So I think governance really should be about three additional things beyond just compliance.

10:25First, purpose. Second, coherence. Third, integrity. And I use those dimensions to lay out a blueprint. The majority of this book is a set of very specific prescriptions that are backed by evidence and successful case studies that show that being a mission-driven, long-term oriented company, you will outperform financially as well as in these other dimensions that we care about. And therefore, we have to study the techniques that are designed to make that happen. So let's start with the question of purpose. Today, we live in the era of what's called shareholder primacy. As everyone knows, this is taught to people today as if it was a law of nature or an ancient pillar of capitalism rather than what it really is, which is a relatively new idea.

11:07I always tell people, walk through your neighborhood park, you will see trees older than shareholder primacy. This is an idea that does not deserve some reflexive deference for its time-tested success. In fact, I think it's mostly been very problematic since it was adopted mostly starting in the 1980s. And what's interesting about shareholder primacy is I meet so many leaders. I say, why does your company exist? What's it for? And they'd be like, my company is a vital, beautiful organism designed to create high quality products. Or they'll tell me, I want to take care of my employees. That's what I care about the most.

11:38Or I care about design or beauty or quality or the environment or whatever. They have something they care about a lot. and that's the reason their company exists. That's in their mission statement. If I read their mission statement, it sounds great, but we've lost the sense of mission in our governance conversations. So in the purpose dimension, what we have to do is find structures that allow us to make fiduciary commitments to people other than just shareholders. Nothing wrong with making commitments to shareholders. Making money for shareholders is perfectly fine. As I argue over and over again in the book, the data overwhelmingly shows that having a long-term orientation highly correlated with investor returns.

12:16And in fact, here's one of my favorite little factoids in the book. Since 2008, companies that have been rated by a governance rating agency to have good governance versus bad governance, the companies that have bad governance have outperformed for shareholders, the companies rated to have good governance. Okay, so I don't want to hear that our modern best practices are good for shareholders. The evidence shows quite the opposite. So in order to make fiduciary commitments, the company simply has to answer this one simple question. Who would you rather die than betray? If you look at the loss of trust in institutions that is happening worldwide, this is really the question that customers and employees and everybody is asking.

12:55Would you betray me for a dollar or not? And I think the answer, if you really want to activate these superpowers, if you really want to be trusted, the answer has to be no, I will not. And we have to write those commitments down. Now, a really easy way to do it is in the United States, this is called becoming a public benefit corporation or PPC. This is by far the easiest thing to do in the whole book. You could do it at any stage of a company's life. All it does is write into your corporate charter something else beyond any lawful act or activity. You're able to say, our company exists to pursue this public good.

13:28And if anyone ever tries to enforce, for example, the Revlon doctrine on you in the future, forcing you to sell the company to the highest bidder, even if it's antithetical to your mission, this gives you the ability to say no. So that's just to give you an example of something we could do in the purpose dimension. Second dimension is coherence. To what degree are all of the resources that a company commands, human, financial, and otherwise, directed towards this purpose or mission? Most modern companies are totally incoherent. If I interview, I've been a consultant, so you know this, you interview people in every department of the company, ask them, what is the purpose of this company?

14:02What do we really stand for? What are our principles? You'll hear a hundred different answers. And in the book, I have a lot of stories of the leadership failures that have led to the breaking of the coherence of companies and recommend specific leadership practices to help create that alignment. Maybe something that would be of interest on this podcast is this idea of what I call the culture bank. One of the things I learned from really high, strong culture companies, they have this concept that they call it different things. I call it the culture bank because whenever a company does the right thing, it sacrifices some short-term advantage for one of its long-term principles.

14:44This creates a new asset. A brand new asset is instantly created right there in that moment called trustworthiness, the most underrated and most valuable asset in the world today. And so I call it a culture bank because we have to see this as an asset that we deposit it somewhere and companies have to learn to track and measure this asset and then to defend it. One of the key ideas in the book is that the more successful an organization becomes, the more valuable it becomes as a target. This should be intuitive and yet so many leaders have a mega blind spot about this. And the trustworthiness asset I think helps us visualize why this is so.

15:24Most really mission-driven companies, long-term companies, companies who a really well-functioning value creation engine are stockpiling this amazing asset. They're becoming trusted by everybody. And they're just leaving this asset like lying on the floor. It's not in a vault. There's no locks on the doors. There's no wind. It's just lying around. And then people are shocked, terribly shocked that someone would try to steal it from you. What'd you expect? So the idea is to see this as an asset that we protect and we deposit. The other key thing about it is we realize that I said when we make a sacrifice, give up something in the short term for in defense of our long term principles, that's a deposit.

16:00The reverse is a withdrawal. And so most companies are drawing down this account without even realizing it. So the book, a lot of the book is about how to build up this asset and to preserve. And the third dimension is the most difficult one. I call it integrity. And when people hear the word integrity, they think I mean something more like fairness or keeping a promise. And I do mean that sense for most organizations. You need this dimension in order to make and keep promises that people can believe. That's a really important dimension of trustworthiness. But I also mean it in the sense of structural integrity.

16:33Companies are huge. Even startups have all these moving parts. They are a complicated structure. Their structure is weak. Then the thing collapses in the face of gravity. Imagine, Ryan, that you had a bridge that collapsed and you called me in as an engineer to please evaluate the bridge. And I come over and you show me the wreckage and the parts lying on the ground of this valley where the bridge was. Can you picture it? And I say to you, ah, yes, I see what happened here. You say, why did my bridge collapse? And I say, gravity. If not for gravity, the bridge would still be up. You're going to be annoyed.

17:07You're going to be like, Derek, that's, I mean, and I'll be like, what? It's true. It is true. But that's not helpful. Why is it not helpful? This is so much business advice today is of this form. Gravity, yes. And, you know, it's like culture. Yes, very important. Oh, thank you. Thank you, O wise sage. But why did this particular one collapse when the one next door didn't? And why did it collapse today, not yesterday? Okay, fine, fine. You want me to go analyze the wreckage? Okay, let's go look. Oh, look, all the metal bolts are rusted and corroded beyond belief. That's why your bridge collapsed.

17:42Would you say, oh, well, I guess can't make bridges anymore. Too bad. Corruption is inevitable. No. you would say, well, gosh, what can we do instead? What can we do better? Ah, why don't we build with stainless steel next time? And so the question of integrity is the question of for organizations, what is our equivalent of stainless steel? What are the construction techniques and materials that provide organizational strength rather than weakness? I kind of think this is like a new dimension to evaluate an organization on, not just is it successful or unsuccessful, big or small, strong or weak.

18:16Strong means somebody tries to bully you from the outside, someone tries to take you over, trying to force you off mission, you have the ability to resist. But similarly, on the inside, if someone tries to create an autoimmune disorder for you, create a tumor inside by tempting you to betray your promises for a quick profit, you have the strength, you have the immune response to say, no, that's not how we do things around here. So in this dimension are things like, I think there should be something I call the director's oath, the equivalent of a Hippocratic oath, but for board directors, they should have to be bound to certain standards of conduct.

18:48We know that oaths work. So that's one thing I recommend. But I also think this is the place we should be looking at alternative structures for how companies are organized. And I give a whole bunch of examples in the book, Purpose Trust, Employee Ownership Trust, what's called the Industrial Foundation Structure, like the Nova Nordisk Structure, where a nonprofit foundation owns the for-profit subsidiary. Most of these structures, most leaders have never heard of or never encountered in their business or legal education, or if they have, they've encountered it like as a curiosity. And here's one of my favorite stats in the whole book.

19:18Companies with the industrial foundation structure, these companies are five times more likely to live to year 50 compared to conventionally structured companies. They outperform in almost every financial metric you can imagine, even though according to our modern theories of finance, they should be at a massive competitive disadvantage. So when I say integrity, this is what I'm talking about, looking to these techniques to figure out which of them might be appropriate for our organization to help us remain strong, even in the face of an ever-increasing financial gravity emanating from our financial system.

19:51Yeah. As I was reading through the book, the thought went through my mind of just how common the positive examples are as well. Could you bring to life a couple of success stories and what the journey to being a success story with that structure, with that enduring governance look like? Oh, man, there's so many to choose from. You know, I mentioned Nova Nordisk, which has a really awesome origin story, like literally a Nobel laureate and his wife figured this out 100 years ago and wrote it down, like wrote it down that one day this structure would be necessary. I tell in the book a story about a time when that structure created more than 500 billion dollars of shareholder value.

20:29So this is not some hypothetical. But definitely the story that resonates the most with people as I've been on the road is the deep cut origin story of Costco. Costco is widely seen by everybody as the kind of exception to every business rule. And in fact, I was at an economics lecture and the guy was going on this rant basically, where he's just like, only family run companies can be trusted to keep a multi-generational promise. And he's listing off all these family run companies, get a litany of them. At the end of his lecture, He's like, oh, and also Costco for some reason. So he's just like, anyway, moving on, moving on.

21:04So most people don't know how this magic trick is accomplished. In fact, I used to think, people used to ask me, how come Costco has been able to endure now for 40 years, keeping these promises in the face of hostile pressure? I used to tell people, well, they're a$400 billion public company. They're too big for Wall Street to mess with, I guess. And if I tell that story with anyone who's in the know, that's a laugh line. people are like, oh, sweet child, nothing. There is nothing on this earth too big for Wall Street to mess with. Are you kidding me? $400 billion? Oh, boo-hoo. Yeah, no way. And in fact, every couple of years since they founded Wall Street has found fault with something that Costco has done and quite frequently mounts an activist campaign to try to force it away from its own ethos.

21:47So to understand how this came to be and why Costco has the strength to resist those incursions, You have to go back to the 1950s to learn the legend of a guy named Saul Price. Saul is a legend in retail circles. Anyone in the retail business widely considers him to be the father of modern American retail. To give you a sense of how influential he was, when Sam Walton was thinking about starting a retail company, he named his company Walmart as an intentional tribute to Saul's company, FedMart. So for people of a certain age, FedMart is a company they still remember. It was really a breakthrough concept, the original membership, big warehouse store.

22:26He started in San Diego, my hometown in the 1950s. Saul was a lawyer before he became an entrepreneur. And so he perceived his duty as a business person as being what he called a fiduciary to the customer. I said before that this is a critical first step in building a mission-driven company. Who would you rather die than betray? Saul understood that as a retailer, the customer is my client. So I have to do right by them. If he could find another local competitor that had the same products he sold at a lower price, he would post it up in his own stores saying, hey, don't buy this product from me.

23:01You can get it cheaper down the street. He would rather go out of business than cheat his customers out of money that he thought was rightfully theirs. And there's a hundred funny Saul stories like this. There's the time when he convinced one of his suppliers to let him sell one of their products at a discount. He would take 50 cents off. The supplier would take 50 cents off. the product would be a dollar less to customers, but they'd make it up in volume. They didn't make it up in volume. And he gave the 50 cents back to the supplier. His own category buyer was like, Saul, we don't have to do that.

23:30He's like, I don't do things because I have to do them. I do them because they're right. I never talked to anybody about this story. They're like, that's the kind of person I want to be. That's the kind of business I want to shop at. And of course, customers loved FedMart. They would drive miles out of their way to shop there. And the company He thrived. Saul became a wealthy man. He took the company public as his investors were thoroughly satisfied with the exceptional returns he made for them. Just kidding. Of course they weren't. Come on. What do you think happened? Everyone knows how this story ended.

23:58I don't have to tell you. Everyone listening knows his investors were never satisfied. They always wanted more. So he was always fighting with them because they thought he was violating the best practices. They would say to him, why do you charge less than you could get away with charging? Why do you pay your employees more than you have to pay them. Again, he would say, I don't pay my employees well because I have to. That is the secret to our success. So this fight went on for more than 20 years, Saul versus his investors. And eventually in 1975, Saul comes to work one day and he can't get into his office because they've changed the locks on the door and he doesn't work at FedMark anymore.

24:37The investors finally got their way. They got rid to Saul. And what happened next? Well, it's kind of a parallel sliding doors kind of story now. On the one hand, the reason why FedMart is a distant memory is because the investors got exactly what they wanted and they got it good and hard. They were able to convert FedMart to conventional retail best practices. And by 1982, within just seven years, they had driven it into bankruptcy. Saul, on the other hand, was so betrayed and so upset by this occurrence. Remember, this happened late in life. He had been a lawyer before an entrepreneur, so he could have easily retired at this point, but no.

25:13Saul took two weeks off and then he leased the office upstairs from FedMart and started over again because he understood that this trustworthiness was created by an engine. It wasn't about him, his personality, his charisma. It wasn't about his suppliers. He understood that the artifacts that he had built, he could leave them behind and start over and it would work. Now, he created a company called The Price Club, which when I was a kid, that's where my family shopped, always at The Price Club. I didn't even know, by the way, that Price was a guy's name. I just thought it was the Low Price Club.

25:45Like, that's where you go. No, no, named after a price. And that company is also not that well-known today because of something else that happened. This is now where people will start to recognize the story once again, because one of the people who quit FedMart in protest the day that Saul was fired had worked his way up from stock boy to executive because Saul really believed in promoting and hiring from within. His name was Jim Senegal. And some years later, he became an entrepreneur. He started a big box warehouse company and he and Saul would eventually merge their two companies into one combined entity that they called Price Costco.

26:22But today we just call Costco. See, I told you this is a story that will give you the deep cut origin of Costco. Now, the reason I've liked this story so much and reason why I think it's so illustrative for this principle is why has Costco endured when FedMart was destroyed? FedMart's investors want to FedMart to comply with their demands for best practices. Like I said, Wall Street comes after Costco every couple of years. One of my favorite quotes in the whole book is from a Wall Street analyst who complains, Costco takes money that rightfully belongs to shareholders and instead invests it in improving the customer experience.

26:59that's supposed to be a criticism by the way i just love that so whenever this would happen jim senegal would go meet with investors at the insistence of his cfo and he would say we don't care we don't care say you can write whatever you want about us you make the stock jump up and down and do all your whatever short us and do this and that we don't care we don't care now why did he have the courage to say we don't care was it because he's so brave no it's because costco was protected by what I call a governance fortress, a series of governance practices that we talked about, you know, purpose, coherence, integrity.

27:33Costco has all three, a mechanism by which outside pressures are insulated. Companies insulated from those pressures. This mechanism is the reason why the company has endured not just for 40 years, but also through four generations of leadership. It's a really compelling story, Right. And it's hard to argue with the value creation performance of Costco either. At the end of the day, I think I looked and it's, you know, 400 billion market cap or something like that now. It's doing pretty well. Yeah. Many of our listeners, I would imagine, work for large, mature public companies who don't currently have in place some of the best practices you recommend.

28:13And it's one thing to be founding a company and, you know, you read Eric's book and you do the right things early, not too late and so on. But it's something else to say, you know, hey, look, I could imagine people thinking, hey, Eric, I'm already in this mature, is there anything we can do, I can do at this stage and where we are? Yeah. I personally do not think these techniques are stage specific. Now, it turns out that it's easier to convince people to try at the early stage because they feel like they have less to lose. And people who are in established positions of power are frankly more cowardly because they're worried about losing their status, losing their position, right?

28:50Like nobody ever got fired for buying IBM. Remember that old slogan? Like that's, if you, if you comply with the so-called best practices, you know, that could be a career advancer for so many people. I tell a bunch of stories in the book of boards that betrayed the company, betrayed the mission, destroyed the company. And you ask, where's that board today? They're all off on other boards because they were agents of shareholder will, and that gets you promoted, that gets you on other boards. So I get it that people feel like, gosh, it seems frightening to go against the grain. But on the flip side, where are my bold contrarians at?

29:24Where are my mission-oriented, results-oriented peeps at? Where are the investors who are looking to reward those executives and boards that actually are oriented around performance? I have a lot of stories in the book of bad activists, but I think activism can be really good too. I met an activist the other day who, when he took over a company, he insisted that every board member in order to be on the board, because the board had been like a real old boys club before. He's like, no, now if you want to be on this board, you have to have more than half your net worth tied up in the stock of the company whose board you sit on.

29:55We need people who have skin in the game, who are oriented around the mission of this company. And so I think there are investors who, if you differentiate yourself, there are managers, there are places in this world where if you differentiate yourself as truly results oriented, truly mission oriented, you might be surprised what's happened. I mentioned Viva Systems there. I think last I I checked, like a$60 billion public company. They converted to a PBC after going public. They were already a public company and they were able to do it. It just takes the courage to do it. In a lot of cases, it all takes a shareholder vote or even just a board vote.

30:27And then a number of the techniques in the book are pure leadership techniques. So things like the culture bank, I have a bunch of HR and internal policies that I advocate for in the book that I call the two-way review. Those don't require anyone's permission. Those can be done company-wide, but they could also be done in your department. that could be done for your team. I think one of the biggest lessons of the book is that each of us have more power than we think in this economy. Part of the negative thing about our economy, the way it is today, it produces in most people a sense of loss of agency.

31:00We feel like this big, bad system is the way that it is. It's too late to change it. Who am I? What power do I have? I'm just an executive. I'm just an employee. But no matter who you are, if you're listening to this podcast, for God's sake, okay, I guarantee you there are thousands of people in this world, maybe even millions, who would look up to you and say, wow, what a privileged and powerful person you are. But just because you are feeling the lack of agency, you feel this lack of power, doesn't make it true. And in fact, in the book I talk in the later chapters about how many billions of dollars are spent every year trying to make you feel that the way things are is inevitable.

31:34That's the tell. If it really was inevitable, they wouldn't waste so much energy trying to convince you now, would they? They just sit back and watch. There are a lot of emotions and opinions out there around private equity and the private capital ecosystem. And it's enormous, right? It was probably 30 ,000 companies owned by private equity in the US alone. And private markets are actually growing relative to public markets in terms of funding. Is there anything about this that you feel specifically relevant or specifically tailoring required for it to resonate and land and make a difference in that ecosystem specifically?

32:11Gosh, we have an urgent need for new financial instruments. Urgent, okay? Like, first of all, the fact that private equity is booming and the private markets are growing and the public markets are shrinking, that's the tax that our governance best practices are imposing on our economy, okay? I have a whole chart in the book that just says best practices destroy shareholder value. And just look at the magnitudes. I won't get into it, but some of the research suggests some of these practices are costing, like all public companies, is a net total of like 5 % of their market cap. We're talking about trillions of dollars of lost opportunity.

32:41But the biggest loss is public market investors are being deprived of the opportunities to invest in growth because all the growth is now happening in the private markets in an unregulated way. So our grandparents would be like, what are you doing? We worked this out for you the hard way. Why are you neglecting those lessons? But that's not to say that private markets are bad or that there's no role for private equity. I think about how many companies have been transformed positively. Like to take over a company, to take the risk, Personally, to bear the risk of trying to reorganize, re-architect a company and bring it back to the public markets in a superior position to seek out efficiency and to make the mission stronger, positive.

33:17So here's the problem. I meet with a lot of mission-driven companies, a lot. And many of them are scared to death to take on investment at all. They understand intuitively that in the era of shareholder primacy, to take on investment at all is already to break the coherence of your company. and therefore investors are being deprived of the very best investment opportunities. The very best companies don't need to raise money. They don't need to go public. They're able to evade all the money that wants to be invested in them. I think that's a tragedy. So we can't be telling people, look, your only options are to betray your promises or to die in office.

33:54We gotta do better than that. I mean, I hate the word exit, but we have to create alternate ways for companies to maintain their capital structure, to maintain their longevity, alternate ways for investors to invest in companies. I think there's a lot that could be done here. And the first thing is simply to recognize that as an investment thesis, long-term corporate purpose outperforms. So we should have many, many more funds that are dedicated to those structures. I think there's a lot of companies where if you could give them, if you're willing to do the investment in the context of a purpose trust or an employee ownership trust, you'd be able to access companies that currently cannot exit at all.

34:29And you actually, by doing so, you make those companies more valuable. You're not just like buying low, selling high. You're creating value in the world. Because when customers increasingly talk to companies, they say, do I want to transact with you? Do I want to buy from you? It's not just the ones that are owned by private equity customers run for the hills because they anticipate the betrayal. Even now, companies that might be taken over by private equity, people are suspicious of. So by being able to push back and say, look, here's a company that is structurally organized to win, earn, and keep your trust, that is making the company more valuable.

35:06One last topic for us on my list, at least. You talk at the end of the book, you have a chapter on civic infrastructure. And there's this concept of civic infrastructure and standards. And I love you have an example of, we buy a banana at the grocery store, and you enumerate the many dozens of standards and civic infrastructure that go into making that transaction as seamless as it is. You tell us a little bit what you mean by civic infrastructure, how you came to that as a concept and why you're excited about it and think it's important. Yeah, the later parts of the book are really about expanding the aperture for leaders to see the scope of what can be done to solve the problems in the world.

35:46Part of the problem with our best practice is just how narrow they are. They have these blind spots. They're blind to positive externalities. They're blind to positive externalities, but they're also blind to solutions to problems that might require cross-sectoral hybrid forms of organization. So public-private partnership or hybrid forms that blend nonprofit and for-profit elements together. We are blind to this despite the fact that our life is invisibly governed by dozens and dozens of these organizations that touch everything that we do. They actually constrain what we are capable of doing.

36:17give a bunch of examples in the book, like who determines which products can be sold in a store, which stocks can be listed on an exchange. Like your options as a consumer are invisibly constrained by UL and by stock exchanges and by all of these different organizations. They are also buildable. Like when I first started to build long-term stock exchange, the biggest obstacle I had to overcome is people looked at me and just said, that's not the kind of thing you can do. As if we'd been handed down these institutions like on stone tablets. It's pretty wild. And I did a deep dive in the book into all of the different kinds of civic infrastructure there are in the world.

36:57And it's just so varied. These organizations wield immense power. My favorite little tidbit is there's a whole organization whose job it is to manage leap seconds, to decide officially that it's time to introduce leap seconds into the clock. There's a series of atomic clocks that keep a perfect time. And we have to keep your phone synchronized with these atomic clocks. That way we all agree on what time it is. And in these days, agreeing on the time needs to be down to the millisecond because we now engage all these computer protocols that are highly time sensitive and need to know exactly, exactly what time it is.

37:29They're organized to do this responsibly and so many other organizations to boot. As you mentioned, you buy a banana, it takes you three seconds. And between the credit cards and the banks and the shipping containers and the skew that got scanned on the barcode and the physio sanitary certificates that are like, it's incredible the currency that you paid for and all of the attendance standards. We're talking about the work of millions of people over generations that have come together to produce an experience so invisible, you don't even notice it. So if I was like, hey, you know what? I want to create a new kind of skew, a new kind of barcode a new most people will be like what you can't do that okay fine we already got one we already have a skew what's but think about all the problems in the world that require this level of public coordination climate obviously a really obvious one but think about ai safety when people talk about ai safety we're not talking about building the kinds of institutions that we talked about in the past like in the past when we had a safety problem we started the national Highway Safety Transit Association.

38:34We built, we're like, oh, people are dying in cars. We need to build institutions, civic infrastructure to prevent that from happening. I tell in the book the difference between driving errors where we do have this infrastructure and hospital medical errors where we don't. What's the difference? It's just very obvious that the difference is the era in which we became aware of the problem. We simply do not have that strength anymore to build these kinds of things. They've been kind of buried in the literature, generally don't even learn about them in business school or in law school. So we're kind of hiding from ourselves this really important kind of civic work that our grandparents engaged in routinely.

39:11So we've got to recover that ability and use it to solve some of these global scale problems. As I was thinking about it, we're in an extraordinary moment for entrepreneurship, right? I think if you look at rate of new company foundation and set it through the roof and - Oh my God, incredible. One of the thoughts I had is what would it take to catalyze the same level of enthusiasm of people to build great new civic infrastructure as to build great new companies? Yeah, yeah. So if you look at what's happening, we have an urgent, almost desperate need for more entrepreneurs. We're probably short by an order of magnitude would be my guess.

39:49And when people hear me say that, they're like, seems like we got a lot. You sure? And the problem is this, okay? If you look at the money that is flowing into the entrepreneurial sector, I mean, startup financing and investing is a very small slice of our economy, okay? Like, it's very small. And the reason and the size of it is determined by one thing and one thing only. It is by the investment formula that the largest pools of capital in the world use to allocate their savings. The so-called Yale model investment is the current dominant one, as you well know. and it has a little bucket. You have a trillion dollars, you have a hundred billion dollar endowment, whatever it is.

40:25You have this little slice you're supposed to put into illiquid alternatives. That includes a bunch of stuff, private equity, all kinds of things. But one of the things in there is supposed to be high, non-correlated, high alpha, right? You're looking for venture. It's like a little itty bitty slice. The problem is we have so much capital sitting around in these pools, so much. This itty bitty slice is a lot of money. And the problem is notice that the formula for how much money should be invested in startups does not have the number of good ideas as one of its terms. It is simply a proportion of the money that is to be invested.

41:00So as the world has switched over to this formula, and as these pools of capital have increased, but due to a bunch of other factors too, the amount of money that needs to be invested in solutions to problems is greater than the number of actually good ideas we have to fund. We just, we don't have enough entrepreneurs to take in all this money in any kind of intelligent way. when supply and demand are out of whack, what do we see? We see price inflation. We see a lot of nonsense. We just see too much money chasing too few opportunities leads to all these middlemen charging fees to be the last dollar in to venture rounds.

41:35It is being caused by this simple mismatch between the amount of economic activity that needs to be happening according to the vitals of our economy and the amount that is actually happening. Civic infrastructure is a major a casualty of this. Then we have the rise of all of these fee and extractive financial instruments that have come to dominate this ecosystem, which means a lot of the money that's supposed to be invested in innovation is being diverted into the pockets of the middlemen. That's rentier 101 going back hundreds of years we've had this problem. But a huge part of the problem is simply the limited aperture of what we consider to be valid targets for entrepreneurship.

42:13The biggest problem. I mentioned this when I was doing long-term stock exchange. So many people I talked to, both investors and other founders were like, that's just not the kind of thing you can do with a startup. It's just invalid. Who do you think you are? I called it the two moons problem. You tell people you want to build a new stock exchange. It's as if you said, I want to build a new moon. And he would give this look that's like, well, we already got one. But also, who do you think you are. That's like a celestial object. So by holding certain problems, certain areas of entrepreneurial activity, I mentioned positive externalities, I mentioned these hybrid and long-term problems.

42:51By holding those outside of what we consider to be the valid zone of entrepreneurship, we shrink the pool of people who might be drawn in and be willing to try. So I think we need a great expansion of the kinds of problems we can tackle as entrepreneurs and the kinds of people we allow to do that tackling in order to solve this mismatch. and also the social and moral benefits too. Yeah. But I'm just talking financially. Maybe in the spirit of YC's requests for startups, we need a request for civic infrastructure every list, every six months. I would love that. You know, you mentioned, we haven't talked about long-term stock exchange, but I think it's very relevant to the conversation.

43:29So maybe share with us a few words on that and the journey and where it is today and how you see it. Oh, goodness. This has been the hardest thing I've ever worked on in my life. and it's been in some ways a total nightmare. But I'll just, for those that don't know, LTSC, Long-Term Stock Exchange, is a national securities exchange. So it's in the same regulatory category as NIC or NASDAQ. It lists public companies, currently has three listed, and trades stocks just like they do. It has taken me many, many, many years to figure out how to do it, to figure out how to get it approved by the SEC, which it was a few years ago, how to convince companies to list on it.

44:05I'm incredibly grateful to the companies that have chosen to do so. And the whole idea is simply to bring long-term thinking back into our capital markets. When I was working on the lean startup, so this is 15 years ago, I remember I would give lectures at that time and I would tell people we should all try to be like Toyota. I had studied lean manufacturing, Toyota production system. Long-term thinking is the foundational philosophy of Toyota and so many other great companies, as you well know, thanks to a lot of McKinsey research. Long-term thinking is a foundation of most great companies and one of the unheralded engines of value creation in our economy.

44:40It's part of the reason why, if you look at the stock market over the last 25 years, all of the gains that have been created in the stock market accrue to a very small percentage of companies. Most companies are treading water or worse. That's why I think it's a mess. A few exemplary companies that have this long-term orientation are basically like Atlas carrying all the rest of the market. So when I would tell people, hey, we should create long-term companies like Toyota, they'd say, well, okay, but it sounds good, but everyone knows that the public markets are the most short-term environment on the planet.

45:10Why are you telling us to build long-term companies, but also telling us to build venture-backed companies and take them public? And I was like, I don't know. I mean, I assume there's a good reason. I never thought about it. I was not a capital markets person. I don't come from that world. And so I started digging into it. Hey, why is it this way? And it was pretty wild, actually, because people would say to me on the company side, I meet middle managers. I've spent a lot of time working with my own managers over the years, boards, leaders, senior managers, everybody. Why are you doing this insane thing?

45:38Why are you cutting your research projects to make the quarter and all this other nonsense? They'd always be like, well, that's what Wall Street wants. I don't know. That's what Wall Street wants. And I'm like, really? Your investors want you to lose money on purpose? And I'd go talk to investors. And I'd be like, is this really what you want? They'd be like, no, we're not the short-term ones. It was like, we're both going like this. In a building, we both set on fire saying it's somebody else's fault. And I had the epiphany, what I would now call the civic infrastructure insight. Hey, there's money to be made here if we could take the companies that are organized for long-term value creation and the investors who believe in that too and bring them together for mutual benefit.

46:15So that was the idea of long-term stock exchange is exchange whose listing standards require an adherence to a set of long-term principles. And we have the evidence to show that when companies adhere to those principles, they outperform, they attract more long-term investors, and they get themselves in this virtuous flywheel that I think more companies knew about it, we'd be able to get more companies to list. for all the years I've spent working on this, it is still early days because getting people to do something like lists or company on a new exchange, you know, is risky. It's perceived to be dangerous.

46:44It's perceived to be a big leap. So we got to work ever harder to educate the market, to get people to believe that it's something they can do. We're big believers in long-termism and how important it is. Thank you, Eric, for all of your ideas and your energy of bringing this out into the world. My pleasure. Sure. It's been great having you and good luck on the next leg of your book tour. Thank you very much. I really appreciate it. With many thanks to Eric and Ryan for sharing their insights with us today. And thank you for joining us. We hope you enjoyed the conversation and we welcome your feedback and ideas for future episodes.

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