Dice. Magnets. Venture Capital. (Part 2)

Link to Part 1, this post is Part 2 of 2.

When I go to Vegas, people are always surprised to hear that I am not a gambler, or maybe it’s just my wife is surprised because as she says, “Your entire job is gambling on startups.” And I’ve never really been able to refute that. From the outside world that may seem true, but just as dice migrate towards a truth and magnets attract, I know in my bones that the winners in venture keep winning, even though it starts with the roll of the dice, and there is something that Venture Capital has that a game of chance does not.

“VC has an expected value of greater than one. Dice have an expected value of one. Gambling has an expected value of less than one.

Historically, the stock market has increased at about 12% compounded. Banks lend at about 5% historically. Real estate, when efficient returns about 10%. VC has a historic rate closer to 18% compounded, but with less history. Investing money in general returns more. Gambling returns less (except the casinos make more). A dice roll returns what you put in to it.” - Tim Draper

As a follow up to my previous newsletter, my Dad answered with the above, and he is obviously correct. This encapsulates everything based on historical outcomes. It also gives evidence to the fact that yes, gambling is a worse investment than Venture Capital.

However, what I’m trying to discuss isn’t about the results, I think everyone reading can agree that venture capital historically is a far better asset than roulette (Except for the house). The curious question I’m contemplating is WHY? Why is Venture Capital not a game of chance, or how is it different than dice rolling.

I believe that the difference lies in the nature of compounding value. People can create compounding value, and dice are dice. People who are insanely good at math, attract others who are insanely good at math. People who can explain something with clarity and vision can pass the message on from one person to the next with ease creating virality… and dice are dice.

As an early stage investor, the goal is clear, invest in a startup early for a low valuation and do what you can to help that company progress and grow into a world dominating beast.

The things that separate the winners from the losers is a simple case of compounding characteristics:

  • A founder with a great understanding of the market.

  • A great leader.

  • A founder who can distill complex concepts into very simple ideas.

  • A founder who has failed or succeeded in building a startup before.

The more compounding characteristics you have the better odds of success. Its like trying to roll four 6s with 8 dice rather than 4.

Dice have no compounding value. When you roll dice, the odds of success are always the same on a 6 sided die. For every die you add to the roll, the difficulty of getting the same number increases by a factor of X^n.

With startups it’s the opposite because these characteristics are compounding and create more value the more you have. It would look like the opposite chart, but the startup chart would be over a 10 year period, and rolling dice is over a 1 minute period.

“But, Adam, you mentioned magnets in the last post, and I’ve been thinking about dark magic for days since then, and you haven’t brought up how magnets tie into this?”

When an entrepreneur is asymmetrically capable in one of these characteristics, they become a magnet inexplicably for others like them. Have you ever heard the saying “If you want to go fast, go alone, if you want to go far, go together.” These characteristics and others operate as a sounding beacon to summon talent to one area. At the end of the day, the most important part of building a startup is attracting the best talent, and that is where being a magnet comes in handy!

It’s like how Professor Xavier’s school for mutants (I just lost half of you) brought all mutants to one location. Their school operated as a beacon for a specific gene. Same type of thing happens with a strong background in a market, a founder who can speak with clarity, and a founder who has experience. These characteristics attract similar capabilities, which lead to the odds exponentially improving the potential outcomes of the startup.