Harvard's Judgment Professor: The Curse of Optionality, and the One Habit That Builds Better Judgment

0:02My biggest mistakes have been waiting too long to fire people. Like, no question. And it's not just what you think. It's not just that that person is underperforming and you can replace that person with a higher performer. There's something much more sinister when a founder or leader accepts underperformance, which is that it massively negatively impacts the entire culture.

0:34That was Reza Satu, Harvard Business School senior lecturer and six-time founder, on the hardest lesson of his career. I'm Motley Fool analyst Rachel Warren. Last week in part one, Reza and I covered why judgment beats intellect in the age of AI, whether judgment can be taught, and his billion-dollar walkaway deal in student housing. This week in part two, we'll get into what it actually takes to raise capital without fooling yourself, why capital allocation is the sharpest test of a CEO's judgment, a curse of optionality, and the single habit that Reza wants every investor to build to train their own judgment muscle.

1:08We hope you enjoy. You are both a serial entrepreneur as well as, you know, founder, investor. What are some of the hardest lessons you've learned as a founder? so i will tell you and this is the it's not even close and it's a harsh thing to say but it's it's just my truth um which is my biggest mistakes have been waiting too long to fire people like no question and it's not just what you think it's not just that that person is underperforming and you could replace that person with a higher performer. There's something much more sinister when a founder or leader accepts underperformance, which is that it massively negatively impacts the entire culture, okay?

2:00Which is suddenly people are like, well, he's not holding everyone to the same standard or well, you know, so I'd say to you that, but of course firing someone is a hard thing to do, right? Like you don't want to do it, right? Like, I mean, every time I fire someone, And I remember the look in their eyes. I remember thinking about their family. I remember the part I would have played in it, that I misjudged the role or the hire or whatever it may be. So it's something that's very painful but is so necessary. And the cost of not doing it and waiting is far greater than I think most people calculate it to be.

2:40So certainly if I think about my greatest mistakes, it's been waiting too long at waiting for waiting for perfect information to make an obvious decision when it comes to firing like not wanting to deal with the difficulty of firing someone and and as i said it's not just the singular person's performance it's the cultural impact of that and so look this obviously falls under a broader bucket which is like human beings have an instinct to wait for too much information before they make a decision right i think when it comes to firing, I'd say my personal view is I've waited too long on those. And oftentimes I've waited too long to pull the trigger on people who on paper looked perfect, right?

3:24Like meaning they looked great on paper. And so you just were like, okay, they're going to figure this out. And, you know, oftentimes, look, my world is founding businesses, but I've hired lots of people from larger organizations. Not always, but often they've had a very hard time working in a more resource constrained environment. Interesting. Going back to this idea of storytelling, it's obviously vital for raising capital, but it can be a bit dangerous in some cases if leaders or company leaders starts believing their own hype. So how do you assess whether a leader possesses, say, the intellectual honesty to separate their grand vision from a current operational reality, whether that's the business, the industry, both?

4:09So let me take both sides of it. Let me sort of say, what does it take to raise capital? Okay. Like what are the traits that it takes and how do you as an investor make sure that you're not being hoodwinked by it? Okay. So, so let me, and I play both sides. I mean, I hope I haven't hoodwinked anyone, but I've seen both sides of it. Okay. So let's just say I have three words I use, and this is specifically for founders, but I think you can extrapolate it for others, as to when you're raising capital, what you need. So the first thing you need is authenticity. No one's going to give you their money if they don't trust you.

4:48Meaning you can't pretend to be someone else. You need to be authentic. Two is you need to have momentum. There needs to be things that are happening fast and people can see that there's action and you're getting customers or whatever it may be. The third one is perhaps the most important and the hardest, especially for a founder, is you need to convey a sense of inevitability. So authenticity, momentum, and inevitability. So what does inevitability mean? Inevitability is not arrogance. What inevitability means is that you believe in your heart that this business is going to fly. With or without whoever you are pitching.

5:28Okay? Meaning you have a mindset, which is not that you are begging for money, but a mindset that you are the prize and that you're giving your investor an opportunity to make money. Okay? And that effectively this is inevitable. Okay? Okay. But you can, now to your question, you can imagine why that could lead to, you know, someone pitching something that that framework can lead to nefarious behavior. Okay. So, so what I say, what I, what I'm always looking for. So I do think leaders should have those three traits. Meaning I do think if you're going to ask people for money, you better believe that it's going to happen.

6:08Okay. If you haven't convinced yourself, that's a problem. Okay. So what I'm looking for is a sense of humility within that inevitability framework. And also what I love seeing is founders, leaders addressing the inevitable negatives in their business, like the inevitable risks, and starting with that. Like I love it when a founder or leader, and you don't lose any inevitability when you do that, frankly, because every business has risks associated with it. And what you get as a founder is you get to actually articulate the narrative around that risk. So from my perspective, I am always looking for someone because when I get pitched and it's all sunshine and roses, I'm just like, this is ridiculous.

6:55OK, but if I'm getting pitched by someone who, yes, believes it's inevitable, but is also talking about all the competitive threats and the technological issues and how they're going to deal with it and what their plan is, knowing that it might change. That, to me, is a much more authentic proposition and for me feels much more believable because they know what the issues are. So just tell me what the issues are and let's figure out how you're going to solve them because there's no business without issues. So I think I don't want to make it as trite as lead with the bad news. I would just say that I do respect leaders who articulate in a very clear manner the inevitable risks that they're facing and take the opportunity to address them and have a real conversation about it.

7:42Yeah, I think it was Warren Buffett who once said that capital allocation is a CEO's most important job. When you look at a leadership team's or a leader's capital allocation history, what is a pattern that maybe tells you they're playing a long-term game rather than just managing short-term expectations? Yeah. So look, I think it's funny, right? Because capital allocation at the core is the sharp edge of judgment, meaning that is where judgment is most shown by a CEO, right? So meaning when we talk about how you evaluate it, what you just identified is how is it demonstrated from a CEO's perspective.

8:18There's no better way for a CEO, for you to evaluate a CEO's judgment than to see the capital allocation decisions they've made. OK, so I think you've hit on exactly the point as to how we evaluate, like what is the metric we should look at if we wanted to sort of evaluate judgment for a CEO? It's really these decisions around capital allocation. It's probably the most important decision. And so I think your point is exactly the right one, which is there has to be a time frame that is not about keeping my job for the next quarter or hitting short-term results, but much more about how to actually build a business that long-term is going to be a great compounder of capital for the CEO and for his or her investors.

9:03And so I think the way to look at it is, I mean, there's no better way to evaluate judgment than to look at previous judgments that they've made. So I think the way to look at it, Rachel, is to say, okay, I would ask the question, tell me what the three most consequential capital allocation decisions that you made that worked and the three that didn't work. And, you know, I think through that lens, you would quickly understand, are they thinking about capital allocation from a short-term perspective or a long-term perspective, right? Because if they're suddenly talking about a capital allocation decision that, you know, was measured in months rather than years, that tells you something.

9:38But I also think that the learnings that they can convey from the ones that didn't work out are also critically important. And so and I think the thing that you're hitting on, which I think is very important, is what let them let them answer it in a way where they're evaluating the time horizon. And so, you know, what I'd be looking for is what time horizon are they looking for to measure these decisions? In your own ventures, how have you balanced the tension between conserving cash and aggressively deploying capital into growth? Yeah. I mean, look, it's such a it's such a tension point. And, you know, I'll give you an example of a business where.

10:19OK, so we talked about the student housing business. So the student housing business was one where where when we had that offer for a billion one and we sold it for a billion seven, we actually made about three hundred million dollars of acquisitions in that year. OK, which ultimately was well worth it because we generated an additional 400 million dollars of equity value as a whole. OK, but we needed to deploy capital quickly in that year to get to that valuation. So that's an example of where we just we made the right call and we decided to do it. And there was a number of, you know, there were international students that were coming in.

10:57There was still a spread between student housing cap rates and multifamily that we thought was going to compress. there was a massive institutionalization of the student housing market with lots of pension funds Brookfield CPP Tomasic coming in so there were there were lots of tailwinds that we thought were going to be helpful to us over the next year or so okay let's take another story so a business that I had founded beforehand uh with my brother actually was a storage business actually and Kevin O 'Leary the three of us founded it um a storage business and um there look we did very well. I mean, we sold the business for$110 million in 2007.

11:34We started in 2003. But I would tell you, we made a massive mistake. Okay. We should have kept deploying capital. Like we had a brilliant idea, right? We were the first people to do sort of multi-story, urban, high household income focused storage. This was in Canada. No one was doing it. Everyone was doing sort of single story in the middle of nowhere. And we had this idea and we should have tripled down. Like we should, this should have been a billion dollar business, but we made an accurate decision, which was, we thought that we should have taken the money off the table as opposed to deploying more capital.

12:09So I think what I'd say, Rachel, when I got to student housing, I was like, I am not going to make that mistake again. Like I'm going to learn from that mistake and, and, and, and really think hard about this. But I think this is where there's no science. It's really a judgment call around all the various issues. So storage is an example of one where we made a judgment that I would say is flawed. I mean, we did fine. I think we made four or five times our money, but we could have made 20 or 30 times our money in that business. That should have been a billion dollar business. But we learned, and in student housing, I think we calibrated the risk appropriately.

12:42Now, like in anything in life, it could have gone the other way, but it was the right decision based on the factors of time.

12:53trading at schwab is now powered by ameritrade giving you even more specialized support than ever before like access to the trade desk our team of passionate traders ready to tackle anything from the most complex trading questions to a simple strategy gut check need assistance no problem get 24 7 professional answers and live help and access support by phone email and in platform chat. That's how Schwab is here for you to help you trade brilliantly. Learn more at schwab.com slash trading. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount plan, and monthly revenue to quota by region.

13:41In seconds, you'll see exactly what's behind your quota risk and fix it before it's missed. Question answered, action taken, crisis averted. When you have critical business questions that need answers, don't just file a ticket and wait weeks for an outdated report. Describe what you need and have Rippling AI build it instantly from your live people and business data. Whether it's a dashboard with detailed charts or automated workflows with the right triggers, conditions, and approvals. Ready to rule your business? Head to rippling.ai slash fool to get the only AI built to give you full visibility and take complex actions across your entire organization.

14:18That's r-i-p-p-l-i-n-g dot a-i slash f-o-o-l. Sign up for exclusive access today, rippling.ai slash fool. You know, there was an HBS case study session you did with Tim Ferriss where you focused on the curse of optionality. Yeah, yeah. And I wanted to ask you a bit about that. This idea that having too many paths forward can cause analysis paralysis. Oh, yeah. Talk to me about that. So, Rachel, so I, look, I talk a lot about this in my podcast, The Founder Mindset, where, you know, you invariably see the folks on my podcast, whether it's everyone from, you know, Reese Witherspoon to Mark Cuban to Michelle Zatlin.

14:56And what you see is ultimately the impact that they've been able to have, the impact that, you know, every human being wants to have has come about because they have committed to a certain path. OK, and they shut off a bunch of options. So I started thinking a lot about the curse of optionality because here at Harvard, you have these students who collect gold stars for a living. Like literally, you know, they've gone to, you know, Stanford undergrad. They worked at Goldman Sachs. They then go to KKR. then they come to HBS. Like literally every box is checked. Okay. And many of them, you meet them and you're like, wow, I can't believe you were born to the single mother in Birmingham, Alabama, and, or you were born in this family in India or wherever it is.

15:42And you managed to get to Harvard business school. The trajectory was so steep. It was so improbable. And then you come to a school like this and you do entirely probable things. You go take a job at McKinsey or you go take a job at Goldman. Like you take these jobs that are entirely available to our students. And of course, the reason that's happening is because they're just preserving options. Okay. They're preserving options. And so, because they're like, well, we'll commit to something in the future. And this just allows me to learn more, see different things. And at some point in my life, I will commit to the thing that I really want to do.

16:17I mean, it actually raises a much broader societal point, Rachel, and I'm actually writing a book about this, which is I think society, there is a massive existential risk to our society, which is that people view commitment as a sacrifice and not as a superpower. Okay. So what you, what you're seeing is that forms of commitment are declining dramatically across all, across all, all of our lives, right? So there's a decline in marriage. There's a decline in people having kids. There's a decline in home ownership. There's declined people going to church. Whatever the thing is that people used to commit to is declining and it's been replaced by options.

16:54Most acutely, you swipe left, you swipe right. There's lots of options at all times. My argument to you is that at the end of your life, and there have been lots of studies. In fact, Harvard did a study, unfortunately, it's just of men, but they had 800 men. It's the longest longitudinal study of happiness over the past 60 years. They tracked 400 men who graduated from Harvard in the 1930s, 40s, 60 years ago. No, I guess it would be the 60s. And 400 men who were in the inner city. Okay. They're now, 550 of them are still alive in their 80s. And they said, to what do you attribute your contentment?

17:30And by a long shot, the thing that came up was, did I have long-term enduring relationships? Now, the thing about long-term endearing relationships is they all go through crises, okay? And it takes commitment. And so commitment is sort of this superpower, I believe. And it's the same thing with this curse of optionality, which is around, you know, founding, which is I think everyone should be a founder. Like everyone should have a founder mindset in the age of AI. Like I really believe that. Like I think of everyone, because it's judgment that we're trying to build. And where judgment matters most is when you're actually stepping into the arena, of commit cutting off other options and seeing what you're truly capable of when you commit and so i i think optionality look every option has value but what's being massively underpriced in this world is what commitment does which is you know and what i say about commitment ritual is it's not just the obvious thing which is you learn what you're capable of when you truly commit to something to a path there's a second order thing that happens and i call it magic okay and the magic happens when people commit to you precisely because you've committed.

18:36So I can't tell you how many times I've experienced this, where the first investor shows up, the first customer shows up, my first employee shows up precisely because they see the commitment from you. And so it's a magical thing, right? And so what I try to teach at the core is how do you commit to a thing in the face of massive options because I think it's through that commitment that you will have the impact that you most want to have. Something that I've seen you do on your podcast, The Founder Mindset, is asking company founders and leaders to revisit the moments of doubt that terrify them.

19:16So I've got to turn that around and ask you, in your journey building six companies, what is the most terrifying decision that you had to execute before you knew it would work? Yeah. Okay. So, so my wife has a joke where she says, raise it. If things are too calm, you blow things up. Like I actually like it's, I think it's, I'm like, it's a pathology or something, but I will say to you that I actually want a really uncomfortable, uncertain life. Like, like I actually crave uncertainty and risk. Okay. Not because I want to jump off a cliff, but because I'm not arrogant enough to believe that I can have the impact I want to have without taking risk.

19:57The equivalent of having real impact and not taking risk is investing in a bunch of T-bills and getting S &P 500 returns. It doesn't happen. OK, so so I want to just start with the proposition that I think a life of certainty and a life without risk. Is in many ways quite inconsequential, OK, meaning meaning I think we need to reframe how we think about risk and uncertainty and adversity. It is a good thing, not a bad thing, OK, it is where learning really lies because that's where judgment is built. So I just want to start with that framework, which is I don't view the crises or the adversity as, I mean, in the moment, maybe they feel bad, but I know they're part of the learning and the journey to be able to generate the resources that I want to have, the confidence, the credibility, etc., to have the impact that I want.

20:55OK, so so I start with a mindset, which is this is going to happen. OK, it's good. Like there will be adversity. There will be crisis. And the question is, is can I stay committed? You know, how can I respond in these moments? OK, but but look, there's no question there are moments where there is complete terror. OK. And so and I don't know if terror is the right word, but what I'd say is like I as a founder, this idea that you're ever certain about anything is just not true. Okay. Like meaning these decisions are like 51, 49, 60, 40. They're not 99 one. Okay. And so, but what you realize is you have a right to recover.

21:35And even in, in sort of failure, there's real, but okay. I'll, you know, the hardest decision I made was a business that I started that ultimately failed. And, um, you know, I had been investing personally in a bunch of hedge funds. So, you know, I was an investor in Persian square, loan pine, some very fancy hedge funds. And I met a fellow who was an academic who basically was talking about how the best way to evaluate hedge funds, and it sort of married up with my own instinct. So we created a company called Stelation. We very quickly raised a few hundred million dollars to invest in the world's best hedge fund managers.

22:11And I made a very difficult decision during the crisis to give back the capital to my investors before we had any meaningful redemptions. And I did that because I was very concerned about the stability of our partnership, right? And I was worried about our scale, whether we could get... Now, it turned out to be the right decision, okay? And I think my investors appreciated it. But you can imagine, from my perspective, it was an incredibly difficult decision because it was a public failure, okay? Now, what I'll tell you about failure is it turns out... Look, I'll tell you one last thing on failure, which not only do I think we as a human being sort of overestimate how bad failure is.

22:51But I'd also say the market values people who actually exercise judgment and fail. So quickly, one of my colleagues here at Harvard did a study where they looked at 5 million data points. And they only looked at two types of people, people who went and did traditional paths and people who founded and failed. Okay? So people who went to McKinsey, Goldman, Google, Amazon, whatever, others who founded and failed. Forget about founded and succeeded. And then they grouped them in terms of similar prior historical educational and professional experience. And what they found was the failed founders reentered the workforce with two and a half years of seniority above the traditional folks.

23:34Wow. So think what that tells you. What that tells you is the market values their judgment even though it was flawed. They valued the fact that they were in the arena making decisions, feeling the consequences of it, calibrating risk, however flawed, such that they came back into the traditional world with two and a half years of security. And it makes sense to me because even if you're getting it wrong, you're building judgment. You're seeing what it's wrong. So I think these are important moments and certainly important educational objectives.

24:29you take the lead. This is the most advanced Range Rover Sport yet, a master class in uncompromised performance and unbridled agility. Inside, the innovation is seamless. You'll find an elegant 13.1-inch touchscreen that puts total control of the vehicle's systems right at your fingertips, but it's the refinement that sets it apart. Sculpted 22-way heated seating with built-in massage function ensures every journey is defined by peerless comfort. Whether it's through unique interior finishes or custom wheel options, the ways to personalize your Range Rover sport are nearly unlimited. Command attention and experience ultimate luxury in motion.

25:06Exclusive offers are available now. Explore further at RangeRover.com. When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen and helps reach people with the right skills, certifications and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a$75 sponsored job credit at indeed.com slash podcast. That's indeed.com slash podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed sponsored jobs.

25:41You know, something that you've written and talked about is that what looks inevitable in hindsight usually look completely irrational in real time. because maybe the market signal hadn't formed. So I wonder, how can one tell the difference between, say, a management team making a brilliant, irrational but correct bet versus one that might be drifting off course? So it's interesting because, of course, I see it from the framework of a founder, right? Like I almost inevitably, when you think about a founder, right, effectively what a founder is doing is they're imagining a world that doesn't exist today, okay?

26:15And they're trying to convince you of that world. And almost everyone can't see it. And it's logical that they can't see it because at least if everyone could see it, the opportunity wouldn't be there. Right. So the fact that they can't see it is why the opportunity is so large. But it often takes one person, first investor, first customer, first employee, to, I say, behave almost irrationally. Right. Like to actually be the first person to come and join. And so the question is, why do they do that? How do you differentiate between a founder or CEO who's sort of a snake oil salesperson versus someone who actually can't see something that you can't see?