Building the future vs. chasing financial returns
“Someone’s sitting in the shade today because someone planted a tree a long time ago.”
(Warren Buffet)
When I used to work as analyst in private equity I always tried bringing investment deals to the table.
There was an investment partner that gave me the same feedback every time — “show me how can we make 2x on this” (i.e. doubling the investment at exit).
I would than go and try to do various calculations to ‘prove’ that I can make 2x on that investment — by showing earning growth, multiple expansion, increase in growth rates or other financial metrics.
Trying to show 2x was a pretty financial exercise- I needed to find arguments that support a spreadsheet that shows this company generating economic activity above a certain threshold.
Every assumption I'd put in would than be argued and analyzed to see if it’s strong enough to stick (“How do you know that gross margin will improve?” “who did you talk with to verify?” )
As years gone by, I found that a much better question for me to think about new investments was:
‘Why is what they are building is important for the future?’
Obviously this question doesn’t replace some basic economics that you need to consider, but I find myself that using this approach, which is a more positive and less financial by its nature, much more helpful for me to think about things bottoms up.
Today I believe that a much more logical way of investing is starting from why something is important and walk my way backwards.
Usually most people think on investing as the byproduct of investments— making money. You put $1 in and you get $X out after a while (if you did good). But making money is just a byproduct of generating something that is meaningful to society and has economic surplus.
You will get rewarded by creating a net positive to society and ‘money’ and ‘returns’ are just proxy for that value. Capital allocation is just a way of distributing different resources in society to build things. If those things that are being built are important than you will get rewarded for allocating right.
Being rewarded has more to do with understanding ‘what should be built’ than ‘how can you make money’.
I also like CEOs and leaders that has this same mindset — some CEOs focuses mostly on product and customer experience, and know that revenues will be naturally created when they do this right. Building great products with great distribution and great customer support will create value (obviously economics are very important too). While some CEOs mostly focus on financial metrics and tables.
I prefer the first kind, as they understand that you should focus on value and the financials are just a byproduct of that. I find that the great leaders are always ‘first principle thinkers’ and start from why is what the thing being built is important.
Asking ‘what should be built’ is even more important in crypto, as the exit model and economic nature of a lot of things you see are unclear. You don’t have a very good framework of exit/valuation models, or even a business model in some cases. Sometimes you just see things that you know are an important piece in the crypto puzzle, and you only have a general hunch of economics. You start with understanding this and walk backwards into trying to figure out the rest of the puzzle.
So for summary:
- Focus on why something should be built and why it is important
- Make sure economics make sense
- Congratulations! You are a first principals thinker
- This is far better than try to compress everything into financial metrics and adopting a too financial mindset (which will make you very strict over time)
- Adopt first principals thinking and don’t try to think by analogy (“this is 2x because something else is 1.5x and this is much better..”)
And the next time someone asks you to show them 2x, explain to them why is the thing being built is of high importance first. After they understand that show them all of the financial metrics in the world.
Idan
