In a recent post, we laid out how investing in individuals is paradoxical: on the one hand, all investments are investments in individuals, but actually investing in individuals doesn’t make much moral, legal, or business sense. So the lesson was that investing in individuals was both inevitable and impractical.
In this post, we take a step towards resolving the paradox by reversing the polarity. First, we explain why no investment is really an investment in an individual, and then we explain exactly what kind of individuals to invest in when you inevitably do.
Nobody ever Really Invests in Individuals
First principle: every investment is, in essence, a bet. Don’t tell the SEC, but it’s true. Depending on some uncertain outcome, investors/gamblers win or lose money.
Second principle: the outcome is always social, never “natural”. To see why, consider the most basic bet — flipping a coin. The probability distribution of the outcomes is simple and self-evident. There are two possible outcomes, and each has a 50% chance. But that fact alone is meaningless. It entails precisely nothing. You can flip a coin all day long in solitude, and all you’ll lose or gain is the wasted day.
The coin itself doesn’t imply the bet; the bet can only exist if there is someone else on the other side, a counterparty betting against you. The interesting outcome is not whether the coin comes up heads or tails, but what the two gamblers decide to do when the coin comes up heads or tails. Flipping a coin is a physical process, but making a bet/investment is a social process.
Another way of thinking about it is that nobody invests in the absolute value of a thing. There is no such thing as “absolute value”. An investment is a bet on what other people will assess the value of a thing to be. That’s why GameStop’s stock can rise, like, 20x and Robert Downey Jr. can raise money for growth-oriented startups or magic beans with the same ease. It’s a bet on others’ perception; the object they happen to be perceiving is incidental. Market value is contingent on the market, which is other people. The only thing we can ever bet on is each other.
It gets deeper. A bet is a kind of game, and games come with rules. Rules need to be communicated, and they only have meaning in a certain community that knows and observes them. For example, the Kula ring is a trade syndicate among Trobriand Islanders in which certain valuable necklaces are circulated clockwise from island to island, while certain valuable bracelets are circulated counterclockwise from island to island. They know what they’re doing, what the point is, and how to do it right. But their activity is probably as impenetrable to a Silicon Valley VC as the post-money valuation of vested common stock options would be to Trobrianders. Investing is a bet, a bet is a game, games have rules, rules pertain to cultures, and cultures are mass — not individualized — phenomena.
Every investment — from cash in a sock under the mattress to the most arcane reverse merger — depends on a whole cultural foundation sustained by thousands, millions, billions of people who understand the game and collectively agree to respect the rules that make it intelligible.
Another sense in which nobody ever really invests in individuals is just brute quantity. There might be an app that would improve one user’s life to the very limits of their imagination, and that user might trade everything to get it (sound like we’re back at Faust? Well observed. Life is imitating art). Even if that app could be built by a genius developer in an afternoon for $500 and yield the one user’s lifetime earnings in return (10,000x!!!), venture capital doesn’t care. That’s not how you play the game.
Venture capital is about growth. Everything else is a distraction. Regardless of the one-off return, a single-user product doesn’t have a growth curve; it has two states of not-yet-purchased (zero) and purchased (100% of TAM achieved, monopoly secured). Growth requires the user base, the revenue, the valuation — something! — to increase over time. That’s what it means to scale-up.
It’s also the second reason why nobody ever invests in individuals: scalability implies the existence of multitudes, and we’re investing in the multitudes.
To recap: even though every investment is an investment in individuals, nobody ever really invests in individuals. Every investment depends upon a whole culture propping up the intelligibility of the whole game, and we need hordes to play the game according to our rules.
The Individuals We’re Looking to Invest in Anyway
Let’s go back to the coin flip. The rules that make the bet intelligible have the form of a super simple algorithm: if heads, then gambler A pays X to gambler B; if tails, gambler B pays X to gambler A. There’s the conditional statement, the transfer, and the future state upon which the transfer depends.
Investing venture capital is, at base, not very different. LPs invest in our funds based on anticipated future states of their value, we invest in companies we expect to grow and gain value. When the expected future states obtain, everybody gets paid.
The transfers and the conditional statements are the easy parts. They’re well understood, and they can be realized with proven tools like contracts and banks. The trick is the future state. The future state must be uncertain, which is what gives the bet, the investment, meaning. If the future outcome were certain, the course of action in the present would be obvious to everyone, and there would be no counterparty to the bet and nothing to gain.
Consequently, that’s the kind of individual we VCs invest in: the ones who claim to be able to shift the probabilities of future outcomes in our favor.
The predictions we hear, however, tend to be bizarre. It’s not that they contain lots of aliens or talking animals (though they may); it’s that they’re describing a world nobody has ever seen and most can barely imagine. Anything else would boil down to building a better mousetrap — at best. It would lack the requisite deviance. Predicting a world in which media would be stored “in a central processing location and have them accessible by phone or cable TV, directly patchable into the user’s home-taping appliances, with the option of direct digital-to-digital transfer” was bizarre in 1989. But it was right (Zappa — who else?), and those who bet on it are doing quite well.
What’s the word for a person who can predict future events with nearly divine insight? Exactly: a prophet. However, it’s not enough to see the future. A successful prophet also needs the charisma and sheer will to convince others that a prophecy will come to pass. A successful prophet must be willing to make the prophecy a reality themselves, if necessary. The boldness to claim that they climbed the mountain and spoke to the burning bush is not enough for the prophets of startup growth. They must also come back down and convince multitudes of others that the bush spoke back.
So even though investment is about multitudes and the rules they observe and maintain, we still need individuals to dream up a future that deviates drastically from the world we know and who can convince others that their prophecies are certainties, when in fact the uncertainty is what gives the activity meaning.
Yes, this slightly convoluted post comes to the conclusion that VCs chase prophets. I hope the pun-chline was worth it.