Why Venture Capital is a Probabilistic Game

1. SPSpeaker0:00

   If you're talking about public equities or any public market, there's so much information out there. Yes, maybe you can have some advantage, but it's very hard. If you're instead operating in a private market that is at least relatively to the public markets, much more illiquid, you can have more advantages. So you've shifted your career to doing mostly early-stage private market investing. Is that a big reason for that?

2. AMAndrew Marks0:28

   Well, so what I'd say is, first of all, I think you'd be hard-pressed to say that venture is super inefficient. It's not a market where everyone can transact, and it's actually hard to get in the place where you can, um, in- invest in, in, you know, seemingly great companies, but the competition to invest in those things is very fierce. So I wouldn't say that I came to the realization that venture was this super inefficient market. I wanted to capitalize on that insight or whatever. And by the way, and leaving aside the fact that I love hunting for founders, I love working with founders. I love so much that goes into the whole business of venture investing. But if you'd wanna just talk about the proposition, the reason why I went into it is, um, nu- number one, you know, it sort of suits my skill set more to, um, make kinda long-term qualitative judgments about the future. And I think venture, you know, so much of, um, what you're doing is you're finding huge gaps between what you're paying today and what this could be worth if it's right. So you have to really imagine in ten years, if this is successful, well, what could that business look like? And much more so than the sort of analysis that goes into being a public markets investor, you know, that really suits my skill set much more. And then the other thing is, it's a much more probabilistic endeavor. I mean, what you're doing is you're trying to find extremely high expected value investments, where the average occurrence is that you're gonna lose your money, but make enough of those bets, and so it works out to be a great return. And then, by the way, you know, try to help the companies in whatever way you can and, and, you know, follow them closely so you can, you know, add more capital to the ones that are doing well and whatever. And so that whole endeavor really suited my makeup much more.

3. SPSpeaker2:28

   Oh, man. We, we were chatting before we started recording. I, I, I went back through my notes from business school, from Howard, your book, uh, The Most Important Thing Illuminated, and every other page on there is like, risk equals permanent capital loss. Do everything you can to avoid permanent capital loss. And venture is not that.

4. AMAndrew Marks2:45

   It's not that, and I also don't think that I would be particularly great at that. I mean, if you told me I had to have an, you know, a portfolio of, of ten companies where, uh, not only would they... the portfolio return be twenty percent, but they'd all be roughly twenty percent, or they'd go somewhere between ten and thirty or something like that. I mean, I just don't know if that would be as suited with my skill set.

5. SPSpeaker3:10

   And in 1978, when I left the, the equity area, it was really because of the [clears throat] terrible performance of the Nifty Fifty, which, uh, I, as director of research, was associated with. So they said to me, "What do you wanna do next?" And I said: I'll do anything except spend the rest of my life choosing between Merck and Lilly.

6. SPSpeaker3:28

   [chuckles]

7. SPSpeaker3:29

   'Cause you can take the best drug analyst in the world and sit him down on the first day of every year and ask him, which is gonna perform better, Merck or Lilly? And my guess is he'll get it right half the time. But the good news is, my boss said, "I want you to go into the bond department." Uh, and it played to my quantitative skills and to my conservative personality. And if they would have said: I want you to start, uh, a venture capital fund and be ready to invest in Amazon when it starts, I would have been a disaster, because I'm not an optimist, I'm not a futurist, and, and financially, I'm something of a chicken. So the point is, so far, Andrew and I have gravitated things that are right for us, and that's a hell of a lot easier than doing something which is wrong for you and trying to put a square peg in a round hole.

8. AMAndrew Marks4:17

   One of the things that really interests me is applying some of the more traditional investing lenses or, you know, Buffett investing lenses or whatever to, to, to venture is really interesting because I think, you know, you have to think about, well, what can this be worth if it works, and what's the potential probability that it works? And in order to do that, in my opinion, I think it's very helpful to be able to visualize what, what the business could look like. And if the company IPOs in ten years, what's that person gonna be looking at when they're thinking about investing in the company? So you have to sort of visualize, well, well, what could the financials of this busi- business look like down the road, even though it's totally nascent? And what could the moats in that business look like, and how much capital might it take to get there? And what's the likelihood of competition? And, you know, what could they evolve into after they establish themselves in that market? And et cetera, et cetera, et cetera. And I, I think it's really interesting, and, and to me, I, I find it to be, yeah, really, really thought-provoking.

9. SPSpeaker5:14

   Remember what I said, that Andrew said, readily available quantitative information about the present is not gonna give you the key to the castle. He said a couple of minutes ago, however, that he's good at making qualitative judgments about the future. And so if everybody has all the company data about today, then the means to massage it, how do you get a knowledge advantage? And the answer is, you have to either somehow do a better job of massaging the current data, which is challenging, or you have to be better at making qualitative judgments, or you have to be better at figuring out what the future holds. So he's had to evolve from the old value people who, you know, Buffett talks about buying dollars for fifty cents, which is not such a terrible idea, but to doing more like he does, dealing with these challenging aspects of qualitative and future.

10. AMAndrew Marks6:13

    Yeah. I mean, I think you just have to find the type of thing that, that suits you, and I like being an optimist, and I like thinking about, well, what could this be if it works? And there are other people that like saying: Well, this company clearly sucks, but it doesn't suck as much as everyone thinks, or people think this business is gonna die, but I think it's only gonna be maimed or something. [laughing]

11. SPSpeaker6:32

    It will die slowly over more, more years.

12. AMAndrew Marks6:34

    You know, that's an incredibly valuable skill to have, and you can make incredible returns doing that. It's just not in my nature.

13. SPSpeaker6:41

    Well, Oaktree's... I think the thing we're known best for is investing in distressed debt. And when we started that in '88, my partner Bruce Karsh and I had this idea. It was actually Bruce's idea, but he joined me, and I'd been in the high yield bond business for ten years at that point. People would say: Well, that's crazy. You're gonna buy the debt of companies that are bankrupt? They're not gonna repay the debt. And the answer is, they're not gonna, A, they're not gonna repay it in full, but they're gonna pay part. That may be enough, or if the creditors are unpaid, they get the company. That may have value. But that was good for me. It was great for Bruce Karsh. It wasn't the right thing for Andrew, so fortunately, we gravitated in the right direction.

14. SPSpeaker7:25

    [singing] Who got the truth? Hmm. Is it you? Is it you? Is it you? Sit me down, say it straight. Another story on the way. Who got the truth? Who got the truth now? Hmm.

Episode duration: 7:44