Supported by Greenhaven Road Capital, finding value off the beaten path.
“There are a lot of ways to make money in this world,” said Brent Beshore, “but you ultimately get one life.” Venture capital is a small slice of the investment pie and VC is over-represented in the media but Jerry Neumann is a venture capitalist and one we can learn from.
Neumann likes to invest early. “I try to be the first money in and be very involved for the first couple of years. One of the ways I can be involved is helping raise the next round of capital.”
And got a fortunate start. “I started in 1997 and made a ton of money even though I didn’t know what I was doing.”
Circle round to 2019 and Neumann’s landscape of experience is worth driving through and these notes are from his 2017 podcast with Patrick O’Shaughnessy, his 2015 talk at Percolate, and his 2014 podcast with Nick Moran.
“In the past, venture capitalists would win because they would see the deals nobody else would see.”
“People have been saying deal flow is no longer a competitive advantage and that’s not entirely true but it certainly is becoming true.”
One area this advantage remains is in niches. Paul Graham noted this years ago, “our m.o. is to create new deal flow by encouraging hackers who would have gotten jobs to start their own startups instead.” Brent Beshore has done the same for ‘boring businesses’.
Inbound requests initiate because of bequests. It’s ain’t all about the Benjamins, baby. People want a something else. Expertise, experience, and connections can decrease the price and increase returns. Neumann said, “If you look at the best performing seed-stage venture funds you will find they started investing where the market price indicated a discounted price.”
Rishi Ganti said markets set prices and, “In order to get real alpha you have to avoid a price mechanism and to avoid a price mechanism you have to avoid a market.”
Neumann faces this challenge too. “So how do you win, how can you make money if the dumbest guy in the room is the one setting the price?”
When missing out is more important than getting in, a default answer of ‘No’ is often the best course of action.
“I can’t possibly evaluate ten pitches a day. I do respond to all of them and 80% are an immediate ‘No’. My default is ‘No’…for the 20% I read the pitch deck for, 80% of those are ‘No’.”
Neumann said he might entertain a pitch a week and always sleeps on a pitch. “If I made snap decisions I’d always say yes.” Meb Faber noted this about early-stage investing too, “At my core, I’m an optimist so everything sounds like a yes to me. Where in that world you need to start at no and get to a yes.”
How does Neumann invest if he mostly says ‘No’, wants to be early, and has only okay deal flow? Using his experience and the Technological Revolutions and Financial Capital theory he looks for things that kinda-sorta-mostly fit the market now but will fit wonderfully later.
Neumann said, “If people already know what they want then you’re in an existing market and selling against solutions they already have.” That’s tough. It’s like being a Jimmy Buffett wannabe in Key West.
This is why Susan Tynan got out of transportation and into displays. “When I got to Taxi Magic I thought, ‘So many smart people are competing in the category and I’ve got this category I’m so eager to make better and nobody is thinking about it.”
But it’s not enough to be different, you also have to be different and be right. Howard Marks noted, “You must learn to see thing others don’t, see things differently or do a better job of analyzing them – ideally all three.”
It’s not just having the faith and taking the step but the bridge has to be there.
This is I think where Carlotta Perez’s theory enters. The financial, cultural, and economic backdrop matters a lot. Neumann said that metallurgy, steam power, and the LLC “together meant you could build a railroad.” And, “Until the US government came in and invested a ton of money building the interstate highway system you didn’t have the society changing aspects of the automobile.”
The automobile waterfall is clear in the stories of Ray Kroc and Rich Snyder. But there’s a Facebook and iPhone example too said Brian McCullough, “I think the reason mobile didn’t take off for so many years was that there wasn’t anything for normal people to do with it. The iPhone comes out in 2007 and six months later Facebook opens registration to everybody.”
“A technological revolution starts,” explained Neumann, “when you have a bunch of innovations that come together to form a technological system.” No one articulated burgers and milkshake franchises. No one demanded Facebook. “Steve Jobs couldn’t do customer development. You can’t do customer development with markets that don’t exist.”
Circa 2018 this is/was platform businesses. GPS devices with cameras and payments are perfect for solving the transaction cost problem, and everything boils down to transaction costs said Michael Munger.
eBay happened because people had home computers, internet connections, and Beanie Babies.
Apple and Facebook coevolved, wrote McCullough, thanks “Maybe you had to have Facebook to go mainstream for the iPhone to go mainstream and vice-versa.”
But these co-evolutions are hard to pin down. Ben Horowitz said that no one ever predicts the killer app. Avi Goldfarb said the same thing about AI, we just don’t know what it’s going to do well.
What we know is that it takes different things coming together like metallurgy, steam, and the LLC! Independently they’re good, together they change the world.
But what happens once the world changes? “The goal for production capital is to fund innovations customers want.”
This is a drum we beat again and again, because (maybe) we’re in what Perez calls the “deployment age.”
Talk to your customers. Talk to your customers. Talk to your customers.
When Peter Rahal started selling homemade (RX)bars at Crossfit no one there knew they wanted a paleo friendly bar. But once they did he started collecting feedback, tweaking and trying again. “You should learn (the Lean Startup methodology) because these tools are meant for the deployment age,” said Neumann.
Ideally, a founder wants to be somewhere the competition is not. They need to be somewhere their competition isn’t, do something their competition can’t, or know something their competition doesn’t – ideally all three.
You can also invert the question. If I were in a big company, what would prevent me from competing? “In a big company, you can’t walk into your bosses office and say, ‘I don’t know what the expected value is, I don’t know how big the market is going to be.’ Nobody in their right mind would do that.”
“It’s the same thing Porter says in Five Forces if a supplier has more power than you they can abstract more of the value.” “So how do you do something where they’re not going to copy? You either have complementary assets where you have some control or you have something that’s hard to replicate.”
But everything good gets copied. Alpha erodes. Albert Wenger noted, “lots of people caught up with us and started talking about network effects, and then we started talking about finding network effects in less obvious places.” Annie Duke said poker’s been like this. And it’s why investors like Pat Dorsey look for moats.
We started noting there are many ways to make money, but also some consistencies around strategy, decision making, and markets that apply beyond venture capital. There’s also an attitude of ambition, curiosity, and wonder at the world.
In his book, A Curious Mind, Brian Grazer wrote that there are two parts to curiosity; asking the question and following up with the answer. Neumann does that too.
“What you find out when you start teaching is if you don’t understand something you can’t explain it to someone else. You read a book and you’re like, ‘I get it’ but then go and explain it to someone else and then it’s ‘I don’t get this at all.'”
Thanks for reading.