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Black Swan Seed Rounds
- cwal37 12y agoI don't think black swan is an appropriate title. This investing is more like when a small group of people split a large powerball jackpot; statistically unlikely, but not really fitting the definition of a black swan (at least as proposed by Taleb). His rules: 1. The disproportionate role of high-profile, hard-to-predict, and rare events that are beyond the realm of normal expectations in history, science, finance, and technology. 2. The non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities). 3. The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs. http://en.wikipedia.org/wiki/Black_swan_theory http://en.wikipedia.org/wiki/Black_swan_theory On a related note, Antifragile is a fun read. Taleb is extremely sure of himself, and extremely passionate. His books and ideas (culminating in Antifragile) can be pretty seductive in the moment.
- graeme 12y agoI think there's a difference from a Powerball jackpot. There, the upper limit is defined. Whereas there's no upper limits on Sam's investments. They're perhaps not black swans in the sense that Sam is aware they may increase in value, but other than that they seem to match the criteria in a way that Powerball doesn't. Taleb has spoken specifically about how black swans are not lottery tickets because of this calculability.
- cwal37 12y agoThe limit doesn't matter so much as striking it in the first place. Realistically, all of the mentioned investments are within the realm of reasonable thought. The presumption of a black swan is that it is completely outside the ability for one to rationally assess a system then predict it with decent success. 5/40 would be a phenomenally high success rate. Lottery is totally not black swan, which is exactly what I was trying to say. Despite having prior knowledge of the company's situation (unlike a completely random lottery), it seems to me that these investments are closer to the lottery than black swan. You don't place bets on a specific black swan, but you could place a different, outside bet on a disrupting event (kind of the idea of antifragile, benefiting from disorder). I think under Taleb's comments in Antifragile, living life as an artist as opposed to someone who is inherently reliant on the stability of say, an office job, is placing that bet every day.
- pdenya 12y agoI also misunderstood this It's more like when a small group of people split a large powerball jackpot as [A Black Swan is] more like when a small group of people split a large powerball jackpot
- cwal37 12y agoAhh, I see the confusion now, sorry. Thanks, edited for clarity.
- stillsut 12y agoWhy is it even unusual for multiple people to split a large powerball? By definition: a large powerball means there's more tickets and thus more possible matches for the random draw. Another minor point: there's gotta be dozens of people playing the Lost numbers, the Miami heat starting lineup, etc... every time, so there are natural clusters of group splitting jackpots for lotto winners .
- cwal37 12y agoI just said group because presumably he wasn't the only investor in those companies, so a group of people stand to profit. If he was the only investor I would have said individual. It's also meant to highlight the fact that multiple people are in on this, whereas an actual black swan event is something that tends to be much more difficult to predict or be a part of. I would be amazed if someone could go 5/40 in predicting black swan events under their original definition.
- sokoloff 12y agoI think the "group" here splitting the Powerball implied a group of people collectively owning/splitting a single winning ticket (such as an office, team, or family pooling money to buy a block of tickets) rather than more than one winning ticket splitting the jackpot. Much like a group of investors investing in early stage companies.
- graeme 12y agoThe point is that is that you can precisely calculate the (negative) expectation value of investing in lottery tickets. Or even the expectation value of lottery tickets. But you can't calculate the expectation value of startup investments. One outlier skews the whole sample, and there is no limit on how high. Taleb explicitly placed startup investments as those that are antifragile.
- JoshTriplett 12y ago> I think there's a difference from a Powerball jackpot. There, the upper limit is defined. Whereas there's no upper limits on Sam's investments. Statistically, you can still define a finite expectation value for an unbounded probability distribution, just as you can compute a finite value for an infinite sum.
- graeme 12y agoHow does that work?
- JoshTriplett 12y agoIn the general case, you'd take whatever formulas you have for return rate and corresponding probability (e.g. exponentially lower chances of exponentially higher returns), and feed that into a definite integral from -infinity to infinity (0 to infinity in the case of a model like investment return rate where you theoretically can't lose more than you put in). Consider, for instance, that the area under a standard normal curve (like any probability distribution) is 1, yet that curve extends infinitely in both directions, and there's a non-zero chance of it producing an arbitrarily large value. If you have a continuous analytic model, you can integrate that analytically (or for the various standard models, just look up the answer based on the parameterization). If you have a discrete analytic model (a step function), you can construct an infinite series. If you have a model based on discrete statistical samples and extrapolations thereof, you can use a combination of numeric integration/summing and model-based bounds. So, even though the total possible return on a business venture is potentially unbounded, you can still establish a finite expectation value for it.
- prostoalex 12y ago> Whereas there's no upper limits on Sam's investments. There's no public company with a valuation above $1 trillion, so there's an implied upper limit in practical terms.
- lifeisstillgood 12y agoI like this. My favourite rubric in this area is "there are no Black Swans only Xmas Turkeys." I think that is similar to your view - that all the evidence we need to deduce an out come is available in front of us if we have the right model (human farmers are charitable to turkeys is a bad model, 23rd of December will not result in another free meal is a better model) I am surprised that investing, especially with Mr Altmans connections and experience, is still a 1/8 crap shoot and that's with no IPOs / exits. It indicates that the model we hold for what the world will look like in 5,10,20 years is far far from complete.
- cwal37 12y agoI think that 1/8 sounds amazing actually, let's look at some totally theoretical and extremely simple numbers (basically all we can work with in this case without doing some significant legwork to try and sniff out the actual investments). To keep it simple let's invest $100 in each of those 40 companies. He defines success as companies that have grown at least 100x over. We know 5 companies have hit that mark and know basically nothing about the other 35 that we'll just consider failures (even though they might only be 10x or 50x[a success in other areas for sure]). Failed$ = ($100x)35 x is the multiplier on that money across all 35 companies. Perhaps he lost it all and it's 0, maybe it's slightly above 1, who knows. Regardless, in this totally mad eup case the total potential loss (ignoring potential to be invested elsewhere) is $3,500 or 87.5% of initial outlay. The remainder using the simple information and interpretation available to us looks like this: Success$ = ($100* 100) * 5 = $50,000 That is 12.5x the initial outlay of $4,000. Making 12.5x your outlay in presumably only a handful of years is massive. Obviously growth doesn't mean exactly 100X, but I just wanted to show that a handful of hits (and I think 5/40 is bigger than a handful) can easily pay for everything else and more. Reread the article, this is only 2-3.5 years of duration. That seems insanely quick for these kinds of results.
- jmtame 12y agoI don't follow your logic here. What rules do seed stage startups break when it comes to Black Swan theory?
- spinlock 12y agoIt simply doesn't apply. A black swan is a rare event that is almost certain to happen (or at least one of them will) that will destroy vast amounts of wealth. Because they are so rare and it's so hard to predict which one will actually happen, people don't prepare for them so they do an incredible amount of damage to the financial system. The idea is orthogonal to seed round investing.
- jmtame 12y agoIt simply doesn't apply. A black swan is a rare event that is almost certain to happen (or at least one of them will) that will destroy vast amounts of wealth. Black swan events are unpredictable and have enormous impact. Whether they're positive or negative is irrelevant. I'm reading the comments on this page and it seems many people are confused about the term. If you're interested in the connection to business and startups, check out this book: http://www.amazon.com/The-Black-Swan-Improbable-Robustness/dp/081297381X http://www.amazon.com/The-Black-Swan-Improbable-Robustness/d... In the very first sentence of the book description, it defines a black swan event: "A black swan is an event, positive or negative, that is deemed improbable yet causes massive consequences." It's used quite a bit to describe startup success. Paul Graham wrote about this in one of his essays as well. I think the term fits perfectly for this blog post.
- spinlock 12y agoIt's true. I think so many of us assume black swans are negative because we first heard the term to describe the subprime mortgage mess.
- mehwoot 12y agoThe non-computability of the probability of the consequential rare events using scientific methods (owing to the very nature of small probabilities). Success rate is computed and regularly measured by VCs. Otherwise rule of thumbs like 7/2/1 (On average 7 startups will just fail outright, 2 might make your money back, 1 will make you a profit) wouldn't exist.
- Alex3917 12y agoTaleb's book is basically anti-science, in the sense that he's making a (good) case about the dubiousness of the epistemology underlying the scientific method. In the colloquial sense though a black swan has just come to mean an event that most people didn't expect.
- mseebach 12y agoI've only read Fooled by Randomness and The Black Swan, but those at least aren't anti-science at all. The argument is that in physics as our ability to measure the world goes up, so does our ability to accurately predict it to an extremely high degree of precision, and we've relied on this fact to build an expectation that the same is true of all sciences, and this is simply wrong, especially because it looks like any fault in prediction is just a flaw in measurements. As soon as we humans making our imperfect decisions enter the equation, a treacherous but inherent element of pure unpredictability appears and unless we temper our faith in our ability to predict the world through models, we stay prone to being surprised by black swans.
- zmitri 12y agoWhat's an approximate range of $ raised/valuation that makes for a Black Swan seed round in your opinion? It's hard for me to understand what the implications are of this besides "don't believe the hype" without having some relative sense of that.
- tormeh 12y agoA recent blog post [0] from the Economist stated that buying random stocks on the stock market actually performs better than valuation-weighted investment and conscious investment. I wonder if the optimal strategy is to just invest randomly? [0]: http://www.economist.com/blogs/freeexchange/2014/06/financial-knowledge-and-investment-performance http://www.economist.com/blogs/freeexchange/2014/06/financia...
- chimeracoder 12y agoThat's really an argument for buying index funds, since the costs and fees of buying and selling random stocks would eat away any profits very quickly. (Even just buying and holding truly random stocks is still less likely to be a better investment strategy than index funds after taxes and fees are taken into account, let alone the volatility).
- applecore 12y agoThat strategy only makes sense for markets that are close to "informationally efficient", e.g., the public stock market.
- tormeh 12y agoI don't get it. The strategy involves throwing darts at randomly sorted stock listings. It uses absolutely no information other than the fact that the company is public. It actually implies that information is harmful. It's vulnerable to people setting up lot's of companies to win the investment lottery, so everyone can't do it, but otherwise I don't get what you mean.
- snowwrestler 12y ago"Make your own decisions" is good advice, but I think the main question is whether there exists any reliable means of distinguishing the good contrarian vs. bad contrarian investments--or whether it's just luck. The title seems to imply that the answer might be just luck.
- silverlake 12y agoSo investing at the seed stage is random. I'm surprised that VCs don't help new companies more in the early stage to mitigate some of the common failure patterns, for example the list PG had in 2006. Perhaps couples counseling for YC founders? Every little bit reduces investor risk even a little. http://www.paulgraham.com/startupmistakes.html http://www.paulgraham.com/startupmistakes.html
- prostoalex 12y ago"Engineered random". Sam still gets a better deal flow than most of angel investors are out there, so even "meh" companies with high risk have passed some initial filter. Any angel investor without the name or brand recognition gets much worse deal flow plus the companies subject to negative selection bias, as they've been rejected by sama, SV Angel, YC, etc.
- deleted 12y ago[deleted]
- sama 12y agoto be clear: i don't think seed investing is random. far from it. i just think it's really important to think independently and take the time to really get to know founders and understand businesses instead of just following other investors.
- deleted 12y ago[deleted]
- holoplus 12y agoThis is intuitive - Startups that follow all fail - Investing in startups should be the same Curious if there are patterns in why the hot ones Fail ?
- S4M 12y agoDon't forget that any startup has by definition a low probability of success - maybe the best ones have something like 20% (a ballpark) - so I don't think there's a definite pattern to predict successful startups.
- edanm 12y agoCurious thought- you mention the (unsurprising) thought that people who are good at fundraising aren't necessarily good at running a company. But, all other things being equal, I'd expect someone who's good at "winning" at the game called "raising money" to be the type of person who is better at winning at other games, e.g. running a good company. In other words, while being good at raising money doesn't necessarily mean they're good at running a company, I'd still take them over the "average person". You seem to imply the opposite in your post - is that really right? Maybe people who are good at fundraising have spent too much time/energy on that vs. getting good at building a company? That sounds specious to me.
- nostrademons 12y agoIf the skillsets needed to found a company are largely independent and time spent learning them is a limiting factor - both of which are true in my startup experience - then time spent learning the fundraising skillset cuts into time spent learning customer development, or the particulars of your market, or engineering, or hiring, or management. You'd expect skill at fundraising to be anti-correlated with some other important skill, then, because you don't have time to get good at some other skill you need. I've never seen a startup where the founders knew everything they needed to at company formation. Usually it's one giant, steep learning curve.
- tmuir 12y agoIsn't basing the multiplier on valuations at the latest investment round disingenuous? After all, its just a number the owners and investors hope someone will eventually pay for the company. It's the asking price set by people hoping for large returns.
- rgbrgb 12y agoWell it's a number that some people (the investors in that round) DID pay for a chunk of the company. If those investors have any sway on the board then it's well below the asking price for the entire company.
- tmuir 12y agoA valuation based on an investment round is the valuation of the complete company, not just the amount invested. So if I invest $1M for 10% of a company, that "values" the company at $10M.
- bthomas 12y agoThere's no evidence here that successful seed companies are more likely to look like bad ideas than unsuccessful seed companies. If 4/5 black swans look like bad ideas when they start, but 4000/5000 of this year's startups also look like bad ideas, then there's no effect to explain. The only lesson is that seed investing is just throwing darts.
- foobarqux 12y agoAnd being wealthy and well connected.
- recalibrator 12y agoTeespring and Zenefits I've never even heard of until today. Are they rolling in the bank and disrupting their respective industries? And Stripe, there was huge pent-up demand for a PayPal alternative before they came on the scene. How could anyone say that was a "black swan" bet? It doesn't make sense.
- bellerocky 12y agoWhen Stripe came out it did not compete with Paypal, it competed with companies like Braintree. Stripe was never just a traditional payment gateway. It created an API for payments and a dashboard for managing invoices and recurring customers. Pent-up demand for a PayPal alternative are from sellers who have a customer facing PayPal payment mechanism. Customers know they're paying with Paypal and customers usually have a PayPal account they use to pay you with. PayPal can hold on to customer funds like a bank. With Stripe, a customer doesn't know you're using Stripe and if they had a Stripe account they wouldn't be able to see all the purchases they made at various sites that used Stripe, they're just not the same thing. PayPal now owns Braintree, so they now do compete with Stripe.
- recalibrator 12y agoI recall Stripe was being positioned as a PayPal alternative to collecting international funds, but that wasn't the point. My point is there is no black swan here. Far from it. It makes no sense in this context.
- bellerocky 12y agoThe argument that Stripe was a black swan comes because getting into established industries with significant regulation used to be considered dead on arrival, now it's hip.
- recalibrator 12y agoThat's the heroic narrative used by investors like Sam, but I don't believe it.
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- imjk 12y agoSam, could you (or any other Angel investor) talk frankly about the money your put in and what your exact returns have been. How much have you had to reinvest in later rounds too. I can't find any really experienced angel to talk frankly about this with me.
- sama 12y agoin 5 years, when the numbers should be real, i will shared all my aggregate data. the normal warning i give people: seed investing has always been hard, and likely to continue to get harder. valuations are up on average maybe 3x since i started, and it's not clear the companies are 3x more valuable.
- ChuckMcM 12y ago> valuations are up on average maybe 3x since i started, > and it's not clear the companies are 3x more valuable. This is something I've been thinking about as well. Are companies creating less value? Or is the value being going elsewhere? In a constrained supply there might be an argument that things that wouldn't have been funded before, now are, and those represent less value creating ideas. But it seems YC is always oversubscribed, would that keep the quality high? Is the vision of the investors getting cloudy, or more specifically are there still companies that are 3x as valuable but they are being funded elsewhere? Or is just the capital availability pushing down the yield price on seed rounds? I don't have any answers, but its interesting to think about.
- lifeisstillgood 12y agoSurely value going elsewhere is a Good Thing. There are few places for value created by investment to go if not back to Capital, and especially if you cannot see it going in balance sheets, and that's usually to wider society. Investment in trains/railroads in the 19C seems a good example. Perhaps the first eyrie canal almost single handed my built the wealth of the USA - having all that return to the Mayor of NY might not be the best idea. I think we can all we the potential value of many of the start ups on the scene - and I think it is a positive that it is hard for them to capture all that value.
- razvanr 12y agoI suspect there's also an inverse correlation between the amount of money raised at an early stage and founder focus going forward. It's easy to interpret a large seed round as early success and become side-tracked or overestimate what your company's impact really is at that stage. Which can impact focus and lead to disaster.
- ameister14 12y agoWhile there might be a point where an effect like this would take place, I think you'd have to raise an extremely substantial seed round for that. I don't think it would be a truly inverse correlation, at least not a normally distributed one. It would probably be one sided as well, because getting no funding shouldn't increase focus.
- EGreg 12y agoDoes Sam Altman continue to do angel investing or now that he's running YC he's stopped as part of their policy?
- panabee 12y agohe lists four: teespring, zenefits, stripe, and optimizely. anyone know the fifth?
- chatmasta 12y agoA few more reasons raising a quiet/controversial seed round might be a good signal: 1. Publicly raising a large seed round creates a lot of hype when the product might not be ready yet, or even before there's any product/market fit. As a founder, that creates a lot of pressure to satisfy the hype, and also might cause you to attempt building a product that satisfies the opinions of the blogosphere, rather than your customers. In contrast, when you raise a quiet round, you can build your product and achieve product/market fit without worrying about the outside world, instead focusing purely on your customers. 2. If no investors are questioning the model, you should be alarmed. Almost by definition, no company seeking a seed round has proven revenue model. Knowing this risk, you should expect some fraction of investors to be questioning it. If none are, then it's likely a signal that they've been swayed by smooth-talking founders who are very good at raising investment, but, as you mention, not necessarily fit or ready to build the business they're hyping. So if we assume quiet seed rounds help with success, this leads to some questions about YC, which is essentially a loud seed round. Namely: should you announce your YC acceptance before you have product/market fit? Should you go through YC in stealth mode until ready to capitalize on hype? It seems your observations can tell us a lot about the value, or anti-value, of product hype. The lesson seems to be, in the words of Denzel Washington/American Gangster, "the loudest person in the room is probably the weakest."
- wunderlust 12y agoThis essay might be remotely insightful if Sam explained why great companies "often look like bad ideas at the beginning" and "look really risky at the seed stage".
- hharrisbrown 12y agoIn the case of competitive seed rounds (like mentioned Optimizely), would be interesting to hear why someone like Sam's money was accepted over others -- any thoughts?