Risk And Reward

I’ve been thinking about the timeless phrase, “risk and reward.” Entrepreneurs and investors both need risk in order to reap a reward. Of course, founders and early employees often take very different risks than investors do. There are always examples to break the rules, too — successful, repeat founders who become LPs in funds and/or invest on the side (even on a side fund), or investors who branch out on their own to start their own franchises. Whatever the blend, I still contend the following should be true: In any endeavor, the protagonist(s) of the story should take the first risk.

In a decade since the Global Financial Crisis, the availability of cash for startups in the Bay Area has increased to never-before-seen levels. A decade after Airbnb and Uber were founded, into the first decade of seeing Facebook and Amazon shoot past $500B market caps, society-at-large now knows how great the stakes are. Entrepreneurship, to me, still requires a special alchemy — a founder overcoming adversity, an investor concentrating a portfolio on something his or her peers (and LPs) do not yet understand.

The following is my opinion. I believe risk-taking matters a lot. As an investor managing a fund, I would not expect the LPs in my fund to have taken the first risk in our relationship — that burden rests with me. Similarly, when I invest in a new company, even if I am the first investor, I do not want to feel as if I’m taking the first risk. I’ve begun to think about this after hearing many pitches for new companies when the risk to be taken by the entrepreneurs is only contingent upon getting funded. I understand that the environment for funding has changed and made this possible, but for me, deep down inside, it messes up the special alchemy I look for when making an investment.

Risk-seeking behavior (measured) and the proven ability to overcome or at least fight through risks feels like a super-critical element to me. It’s often an element that I can’t get over. Perhaps some of it is misplaced survivorship bias — I have slowly fought and clawed my way to managing around $50M across a few funds, so it’s hard for me sometimes to just jump on board a fast-moving round that’s pre-product where the founding team hasn’t left their current jobs yet. Lucky for them, plenty of other people are there to invest in them.

All this said, the concept of “taking risk” in one’s life could mean something different for everyone. Perhaps founders should proactively identify and articulate the risks they’ve faced when seeking to convince investors or new recruits to jump onboard. (Of course, there will always be the very technically-sophisticated folks who will always attract funding, and usually the risk they take is the opportunity-cost of forgone salary and their time.) Nevertheless, the ability to seek risk and destroy is critical to the alchemy I’m talking about. Just think of Travis’ many failures pre-Uber, living in his mom’s basement at age 26; or think of Airbnb, going into credit card debt selling politically-themed cereal to stay alive. These are extreme examples, but founders will often face risky points in their business endeavor — Should we pivot to a new business model? Should we take a flat round or sell the company?

As an investor, I want to see prior evidence of risk-taking in founders I back because I know there will be new risks that they encounter in the life of the company. I want to know more about the founder’s thought-process in these situations — will they take the big risk that’s needed? I should be clear here that there are many ways to demonstrate the ability to take risk — the most common is financial risk, leaving that job or dipping into savings, etc; there’s family risk, as some folks need to support other family members or even live in different places; there are health risks, too — where people overcome incredible odds to fight on another day. The point here is not to glorify the risks or seek them out recklessly, but rather to acknowledge that, as a founder, risk management is a necessary skill and, as an investor, I need to feel comfortable that the folks I back will not shy away from risk, but rather have exhibited traits which lead me to believe they could thrive in it.

I’ve danced around the issue here in this post a bit. The truth is that this is a complex topic and I don’t want to offend someone who at least carefully reads this. There are lots of folks who view starting a company today akin to getting into college — and there may be lots of truth to that. But the blunt reality is that, in today’s environment — especially in the early-stage Bay Area market — the concept of risk has been nearly stripped away and vaporized. We often talk about how the reduction of risk is good, with more being able to participate — I get that argument. But we also need to consider the underbelly here, that if risk is scraped away, and if risk is correlated with reward, will there be enough reward to go around?

I don’t know the answer, but I feel confident we will find out in the next year or so. There are lots of companies priming to go public. There will be some belt-tightening on investing. The Bay Area remains the center of experienced “web-scale” management teams and networks, yet today is a brutal recruiting environment for new teams. At the end of the day, I cannot control these macro conditions, nor do I care — my job remains simple — to remember the risks I took, and seek out others who I hopefully can identify have taken similar risks themselves.