Embracing External Risk: Nonconsensus and Right

What Maples is saying when he talks about investing in crazy ideas is that he embraces external risk, because this is where the opportunity for a huge upside lies. This is not to say that Maples believes in rolling the dice and seeing where they land. He is clear that, as he puts it, “We don’t believe a company is a lottery ticket.” He owes it to his limited partners looking for huge returns to be highly selective, and to that end every idea he backs has to fit two criteria: “nonconsensus and right,” a popular idea in elite VC circles.

The nonconsensus part is the one that refers to crazy ideas. “One of my favorite things to hear from an entrepreneur in a pitch is, ‘I’m not sure this is legal,’” he says. This is exactly what he heard from the founders of Lyft, Logan Green and John Zimmer, who were pretty sure their ride-sharing business was running afoul of current taxi regulations. Maples isn’t one to advocate shady, unethical start-ups, but rather those that challenge laws that, while originally designed to protect consumers, may no longer be in consumers’ best interest. This is similar to the discussion in the chapter on Enforcers of state-of-the-art reputation systems that can sometimes do a better and more efficient job of eliciting good behavior than government institutions. You might say Maples prefers to back what is righteous rather than what is legal. Why does he love pitches in that legal gray area? “Those could be good businesses to fund because a lot of times there are not a lot of competitors,” he explains. (Even though Uber has a competing ride-sharing service, UberX, Maples points out that Lyft started before Uber launched UberX.) Whether the laws eventually side with the entrepreneur’s venture or against it is a huge risk—the kind that many people are afraid to take—but that is precisely what makes the bet attractive; if it turns out to be right, the gain will be enormous and, because it is a nonconsensus venture, it won’t be shared by many others. Notice that it is also an external risk, and not an internal one: the entrepreneur has no incentive to undermine the VC’s goals by shirking, for example, because doing so would sabotage the entrepreneur. Maples knows how to embrace external risk while avoiding internal risk.

Mike Maples didn’t come up with the idea of investing in ventures that are nonconsensus and right, and he is certainly not the only venture capitalist to think this way. Marc Andreessen, perhaps the best-known VC working today, plots start-ups on a two-by-two matrix in which VCs should aim for the quadrant corresponding to nonconsensus and successful.28 It should go without saying that you cannot know for sure which ones will be successful, and even the best VCs are often wrong, but you do know which are nonconsensus. Andreessen and partner Ben Horowitz picked up much of their investment philosophy, probably including this idea, from investment advisor Andy Rachleff, a former partner at Benchmark Capital and founder of Wealthfront, a firm that uses technology to transform the investment advisory business.29 Rachleff, in turn, credits his “investment idol,” Howard Marks, with this framework.30 When the entrepreneur-turned-VC Peter Thiel asks, “What important truth do very few people agree with you on?” he is getting at the same sort of exceptionalism: the contrarian truth, something that is nonconsensus and right.

Understanding that the biggest returns will come from nonconsensus ideas is only a first step, though, because it is very hard to figure out the “right” part. Consider Twitter, which Maples invested in before founding Floodgate. It’s easy to look at a triumphant company and conclude, with the clarity of 20/20 hindsight, that the choice to invest in it was a no-brainer, but things are rarely that obvious at an early stage. For several years, Maples recalls, others made fun of his Twitter investment. “In the early days, people said, ‘How can you possibly have a company where the product only lets you say things in 140 characters? That’s the stupidest thing I’ve ever heard.’”

This is the problem with the advice to invest in ideas that everyone thinks are nuts: as Andreessen has pointed out, people thought that Einstein was crazy, and they also thought Charles Manson was crazy;31 only in retrospect do we know for certain which one was fit to be locked up. Crazy ideas are inherently more risky, leading as they do to more extreme outcomes: either spectacular successes or total failures. But who knows before the fact?

 
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