Being right when everyone else is wrong.
As I was reflecting on the start of a new decade, one quote by Naval stuck with me the most: "Money in this business is made by being correct when everybody else disbelieves."
Or as I would translate it:
You get paid for being right when everyone else is wrong.
Overall, you are paid for value creation. When it comes to the startups, the value is measured by the delta between the status quo and what you create.
This means that:
Real opportunity exists by being right when everyone else is wrong.
You make money by capturing this opportunity.
Everyone else disbelieving is important because if you're right when everyone else is also right, then no opportunity would exist because that means everyone else is also pursuing that same idea.
Chasing alpha
In the investment world, alpha represents the excess return of an investment above the benchmark.
E.g. if S&P returns 7% and your portfolio as a fund manager returns 9%, you're better than the benchmark by 2%. If you also returned 7% as the fund manager... then you didn't add much value. Your client would be better off buying the S&P.
In startups, new products exist when you're able to build something better than the benchmark (status quo). That's when value is created.
A tool powerful enough to run a business in your pocket rather than old desktops (iPhone), getting from A to B with click of a button rather than waving down a taxi (Uber), find anything on the web rather than YellowPages (Google). The value they create is measured by how much these product are better than the status quo, the delta.
It's important to note that alpha only exists when others think you're wrong — they disbelieve your thesis.
E.g. say you believe corn is worth more than the market price because more corn related recipes are becoming popular, there's potential alpha here in your insight. It's an opportunity. However, if everyone else agrees with you that corn should be worth more, they would buy corn futures, driving the price up and thus closing the opportunity. This then "prices in" your insight and the opportunity to make money is gone.
Hopefully you bought some corn future before everyone else realized you were right and driving the prices up.
Conviction on judgement
The bigger the delta, the more value you create. However, being wrong is hard. When everyone else disbelieves, sometimes you start to question yourself. The ones who succeed are the ones who have conviction to continue... while end up being right despite the unpopular stance.
You being proved right is how you eventually get paid, however, if you don't have a position built to capture the opportunity, you won't get anything. So there's a balance between convincing everyone else that your thesis is the right one, however, also continuously building a moat such that you can defend yourself when everyone else eventually realizes you were right and tries to copy.
Along this journey, you'll also find smart people giving you compelling arguments on why you're wrong and stupid. This is why it's important to build a system to sharpen your clarity of thought in order to maintain your conviction.
Building up a position
You'll only get paid for the opportunity if you can build a position to capitalize on it.
E.g. if you were correct about corn prices being too low, if you don't purchase corn, you won't be able to capture any of the value from your insight. Similar to those people who claims "I spotted that trend a mile away!", but failed to capture it. They aren't rewarded with anything.
Why do people fail to capture opportunities? It's due to either a lack of conviction or the know-how on execution. So in our example, you might have thought corn prices would go up, but unsure if would be worth losing $1,000 to bet on. Or you didn't know how to buy corn futures.
E.g. back to the corn example, you can put in $1,000 if you have enough conviction that you are right. But how do you get paid more if you have really strong conviction? Leverage is a way of amplifying your payout (bet).
Typically, you seek financial leverage: get a loan, put your house on the line, max your credit cards, get an investor to join you.
However, if you want to further leverage, you can leverage your time and start planting corns and build a corn farm.
This is in essence what a startup does. A founder builds companies to further leverage their time in order to capture an opportunity they want to bet on.
Building a company is a leveraged way to capture an opportunity where no liquid market exists. If you believe that market with a true representation of your insights exists, you can simply invest your money there. How can you create a larger return? Leverage. Building a company is a founder's way to use their time as leverage.
To capitalize on your insight, you need to build a position.
Of course... easier said than done.
Conclusion
Startups is a space where you're paid to be right when others are wrong.
Need to be able to maintain conviction when everyone thinks you're stupid.
If you really believe, build up a position and apply leverage — ante up!
One of my personal goals for 2020 is to get better at spotting these deltas. Similar to any skill, I think to get better, you need practice and good feedback loop. So I plan to writing more, make a stance. As a close friend would say: "die on the hill."
A cheap way to build a position in my situation would be to publish my thoughts to a group of people I care about and putting my social capital on the line. Thus when I'm wrong... you can call me stupid and that's my feedback loop to getting better (hope I get better... fingers crossed).
Till next time,
Charlie