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Howard Marks & Andrew Marks: Something of Value

Howard Marks & Andrew Marks: Something of Value

Tue, 30 Aug 2022 00:00

We sit down with legendary investor Howard Marks of Oaktree Capital and his son Andrew who, while less-well-known, is also an incredibly accomplished investor in a very different arena: early-stage VC. The purpose of the conversation was to discuss their joint work together on Howard’s all-time most popular memo, “Something of Value”, which made the then-shocking argument that Value and Growth investing are not diametric opposites but rather two sides of the same investing coin. We of course dive deep into that, and also cover plenty of fun Oaktree and investing history, as well as Andrew’s favorite topic: selling (or not selling, as the case may be). This is not one to miss!

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All right, I think we figured it out. Andrew, I think you have a bright future in technology. I appreciate it. Especially Windows technology. Yeah, you should invest in some tech startups. Yeah. Who got the truth? Is it you, is it you, is it you? Who got the truth now? Is it you, is it you, is it you? Sit me down, say it straight. Another story on the way. Who got the truth? Welcome to this special episode of acquired. The podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm the co-founder and managing director of Seattle-based Pioneer Square Labs and our venture fund PSL Ventures. And I'm David Rosenthal and I am an angel investor based in San Francisco. And we are your hosts. Today we have two guests with very different investment styles. A value investor and a growth-oriented tech investor. Head to head, but not just any investors. We are joined today by the legendary value investor Howard Marx, the co-founder of Oak Tree Capital Management, and his son Andrew Marx, the co-founder of TQ Ventures. Oak Tree, for those who don't know, is one of the leading investment management firms in the world, specializing in alternative investments with $159 billion in assets under management as of the end of June 2022. Probably far fewer of you know Andrew and his firm TQ Ventures. But what they've accomplished so far is pretty equally impressive in a very different field. So as we'll talk about, TQ is an early stage venture firm that Andrew and his partners started about five years ago. They have a billion dollars under management now, including I think a $500 million dollar third fund that they just closed just a couple months ago. I can say I do know that their returns so far have been top desial across all venture funds raised during that time period in all of those ventures. We can't just say that they're going to be a big deal. But we're going to have to go through those ventures. We got to know Andrew over the years as a acquired community member and listener and then I've gotten to know him in the context of kindergarten ventures, my angel list fund that I managed with, not manning, and a little over a year ago, Andrew and Howard co-authored one of Howard's famous memos together in a departure for Howard where they were debating their COVID together as a family, as father and son, value investing versus growth investing, tech investing, and what was going on in the markets, and they turned it into a memo, and it ended up becoming, we'll talk about it on the episode, Howard's most popular memo ever, which is incredible in a career spanning many, many decades as one of the most popular authors of investment memos. Oh, Howard's memos and books are among the most coveted in the entire investing landscape. Even Warren Buffett is quoted and saying, when I see memos from Howard Marks in my mail, they're the first thing I open and read, I always learn something. Well, if you want to discuss these topics with us after you listen, you should come join the acquired community at slash slack. Our new merch store is available at slash store. You can listen to the LP show by searching acquired LP show podcast player of your choice, or get new episodes two weeks early at slash LP. Now, we are very excited to welcome back to acquired our presenting sponsor, Vanta, the leader in automated security and compliance. We are enormous fans of Vanta and now investors and their approach to the whole compliance process, Sock2HIPAA GDPR and more, and we've got CEO and co-founder, Christina Cassiobo, back with us today. All right, Christina, we talked last time about the story of the tremendous round that Vanta raised in the end of April, even as the world was falling apart around you. But now that you've raised that round, how are you operating the company now in this environment that has changed quite a bit here in 2022? And what advice do you have for other founders who are in the same boat? Yeah, so you think at a high level, a lot of actually what's said on Twitter and the invoice that's given out is really good. It's take the last round you've raised, which presumably it's your last or at least you're not going to raise for maybe two to three years and operate the business accordingly. Also going to assume a bunch of your metrics are going to degrade. So whether it's you're going to spend more or require customers or the retention is going to dip. I think that's all really good. A few things we've done just super tactically. I tend to find tactical advice actually helpful to take the platitudes down to what we're actually doing. So we have an operating plan for two and a half years that we are revisiting on a weekly basis and then we'll make updates on a monthly basis. And it filters into hiring and filters into marketing budget. And it's just designed so that we again have the runway we expect despite whatever changes might happen. We can just look at the plan, look at the actual results, dip them, be like, okay, can we speed up hiring? Should we slow down hiring anywhere? What should we do based on what just happened and having those touch points? And also just a set of people responsible for looking at the data and making the decision every month? It's super helpful. So another thing we do is we have napkin math for a bunch of different roles. And that's how we figure out whether or not we can control the hire in this environment. It varies per role. But for account executives, it's very much a pipeline and an attainment number. So our current salespeople attaining at a level such that we want to bring on new folks. We also do a bunch of sales capacity modeling, sort of in the salesforce school of thought, that our CRO Stevie brought in of, we have this many AEs with this quota and this attainment, what do we think revenue can be? From that then we'll back out a customer number and then back out a number of CSMs, and implementation managers. It's pretty much fourth grade math, but much more helpful than the like, oh, do people feel overloaded? Does anyone make feel like they want to go recruit? Because I think in that world you get, in some cases, too little recruiting in some cases, too much. Fascinating. So it's doing a lot of focusing on head count related to revenue and trying to tie that as closely to predictable revenue as possible based on all the data you have on your existing head count. Exactly. The go-to-market side event I think especially as an SMB focus business today, you can operate in this predictable, almost machine-like way on the go-to-market side. I think for the engineering and product and design side, that's a little different in there. We're actually just hiring as much as we can and it's great in this environment versus last year's honestly, but very much predictable revenue on the go-to-market side. That is great. Our thanks to Vanta, the leader in automated security and compliance software. If you are looking to join Vanta's 3,000 plus customers and get certified for your compliance in weeks instead of months, you can click the link in the show notes or go to slash acquired for that sweet 10% discount. Now onto our interview with Howard and Andrew Marx and remember, this show is not investment advice. Dave and I may have investments in the companies we discuss and this show is for informational and entertainment purposes only. Well, it's such a treat to have you both here. So the memo you wrote together, something of value, Howard, I believe this is the most popular memo that you've written across your entire illustrious career, is that correct? That's right, David. Previously, that was held by a monorod. I think it was in January of 14 or 15, called Lock, in which I talked about how lucky I've been and that I'm a big believer in lock and it's great to be on the right side of it. And I listed about a dozen ways that I think I've been lucky and people like that because it showed the personal side as did something of value. Well, you write in the memo about how this came to be of the two of you collaborating over the pandemic, but maybe here to recap on the podcast. How did this amazing thing happen of a father, son, writing this incredible piece of work together? Well, Nancy and I came to California on March the 6th of 2020. Oak Tree was scheduled to have a conference for its clients on the 11th. Although we canceled the conference, we did record it at the conference venue for live streaming. And so we were in LA, which of course is Oak Tree's headquarters. Andrew and his family came out on the 13th and moved in with us. And we stayed that way for I think until June. So we were incarcerated together and first of all, we have fun talking about what we do and kidding each other. And we have a lot of differences. We're not the same person. Andrew's business is different from mine and his general mindset is different. What he learned 40 years after I learned what I learned, initially, hopefully still learning both of us. So there were a lot of instances of differences and that made for a very spirited period and I hope a spirited memo. And how many memos had you written before this first one that you co-wrote together? I've never actually counted them, but I think it's about 160. Just trying to frame for listeners, Howard Marx's memo is a thing in the investment community. And it's crazy to see one come out with both your names on it. I mean, I remember first seeing that and thinking, oh, this is going to be cool. And I'm curious if you had, even before we get into the content and the debate that you had in creating the tension with it, did you yourself have any reservation of, oh, my gosh, am I changing the nature of what the memo is by co-authoring it with Andrew? No, because, first of all, he didn't get near the keyboard. But we communicate really well. The ideas that he expressed, many of the ideas came from him as counterpoint to mine. And when he expressed them, it was clear that we'd have a really good talk. Yeah, and I think what's also interesting is that I have been an investing nerd since I was really little, but only evolved into investing more in what you would call growth companies or what would generally be called growth companies. I started off being a value investor, first parroting my dad as all little kids do. And then I got, fortunately, into the Buffett letters really young and so turned into a huge Buffett nerd and all the things that come with that. And so my sort of trajectory was across the value end of the spectrum to the sort of growth end of the spectrum. And I had to make that journey myself and understand how the two relate and why I thought spending time in one area was better than spending time in another area or whatever. And so I was able to talk to my dad in his language. And so I wouldn't say it was, it definitely wasn't a debate. It was just more of a discussion of the discussion of how things have evolved and trying to examine it a little bit. And Andrew, do you recall in your journey over the course of your life, the first time where you saw what you felt was a really attractive investment opportunity in what people would consider growth investing or high growth investing or tech investing that felt counter to some principles that you had internalized from your dad from reading the Buffett letters from your style of investing earlier in life. You know, I can't remember a specific one. But I think the sort of evolution happened a little bit gradually. So a value investor, you would sort of look at what the current cash flows of the business are and kind of valuing it on that and not making much assumption for growth. And then there's a cohort of growth companies that were in exactly tech companies in the way that tech companies looked today. But you know, you could look at things like where rolling out stores is a big thing. Starbucks or the auto parts companies or Walmart or Costco, all that type of stuff. And then also things where really attractive acquisitions and synergies were attractive or were a huge part of the story. You know, John Malone's, cable roll ups and things like that. And what's interesting is you sort of learn that instead of looking at cash flows, there's this concept of the business instead of looking at cash flows, there's this concept of sort of maintenance cash flow. And then you could think about where to reinvest that. And if you can reinvest that at really high rates, really attractive rates, that's a better thing to do than just sort of hoarding the cash or whatever. And by the way, and Buffett talks about this when he talks about the concept of owner earnings and things like that. And then it's not too far to then say, well, those same sorts of investments, you can make them out of the cash flow statement. But you can also make them out of the income statement. Things like high return sales or talented engineering teams and R&D and things like that. So I think I just got exposure incrementally to different sorts of things that traverse that spectrum and that sort of where I found what made sense to me. I have to ask both because it's fresh out our minds given recent acquired activity, but also you write about it in the memo. I can think of no better example company of that than Amazon. What is the two of your journey that you've been with Amazon? Did you discuss that? Was that part of this thinking about value and growth perhaps not being two different things? I think it's also really interesting because a typical value investor you sort of look just at the fundamentals of the business. And you look at the economics of the business. And Buffett is very famous for saying that you want a business that an idiot can run. Because eventually someone will. Yeah, exactly. And so he sort of talks about the primacy of business model over management. But I think Amazon is a great example of the opposite because you could have never dreamed that if you owned Amazon when the story was about growing as a retailer, you could have never dreamed of AWS. That shows what happens when you bet on an amazing founder who can leverage their business to create value in really compelling other ways. And so I think it's a great business case study but it's also a case study of putting faith in a management team and recognizing the optionality that comes with that. How did Amazon ever intersect with your investing career? No, I'm a recovered equity investor. I was in the equity research department of Citibank from 69 to 78. And then I left. And in the credit field where I spent the last 44 years, we historically have not had contact with what you would call a tech company. Although they had some distressed debt at one point in time after the tech bubble. But again, remember, we put very heavy emphasis on predictability. And I think that for the most part, Oak Tree does what Warren and Charlie do. They put it on the too hard pile. I think by the way, one other thing that I would add about Amazon that may be too wonky but also may be interesting. I think it's also an example of one of the things we sort of talk about in the memo, which is it's hard to just take a sort of knee jerk, 30,000 foot view, and you really have to sort of dive in and understand things. So what people said for the longest time was that Amazon was losing money and could never be profitable. A charity run for the benefit of the American consumer. Exactly. And that came from looking a lot at the income statement and recognizing that they were losing money, partially because they were continuing the lower price to achieve scale. But I think what's interesting is they actually had a very favorable cash conversion cycle. So the business was much more sound from a free cash flow perspective. Much earlier than it was from an income state perspective. Michael Mobison wrote the research note that was not as popular as Amazon.bomb and Amazon.toast. But he called it And that's what it was. Yeah. And so I think it's just another sign of the fact that you probably shouldn't come to conclusion about something without really trying to understand it for yourself. Well, this captures two of our earliest points of discussion. Number one, that the companies we're talking about are more complex. Then the simple profit earners of the, let's say, deep value era. And so you can't, as Andrews says, have a knee jerk reaction to some superficial knowledge. You have to really get deep. And then the other concept was this idea of optional profitability. The value investor wants to maximize cashflow and profits, EPS. But the growth investor sees losses, sometimes, as the right thing in the interest of the future. So that's in a very, very important divergence. But also very often not. And so you can't just be in one camp and you can't say, well, I shouldn't care ever about losses. Or I should just take for granted that all reinvestments and growth are good. But you also can't take the point of view that none of them are good. Right. Wasn't Mark Twain who said all generalizations are flawed, including this one? And by the way, when I say the value investor does this and the growth investor does that, probably the biggest single theme of the memo was that that dichotomy should not be so hardwired. Yeah. Which is so great. You make the point in the memo, which we talked about a lot in our Berkshire series, Ben Graham made the lion's share of his money on Gecko, which was not a value investment. Right. Well, I think one of the great enemies of profitability is rigidity, because I'm lucky when I switch to managing money by switching to the bond department at Citibank and there couldn't be a bigger backwater at the time. They said, could you figure out what high yield bonds means and start a fund? And I found this area where everybody said, oh, no, no, we don't do that. Everybody. Most investment organizations had a rule against buying bonds that are rated below A or below triple B. And I'm buying single B bonds. And everybody says, no, we don't do that. Well, guess what? When you go to an auction and you sit down, take your seat, and you see there are no other bidders that's usually a good thing. So the point is open-mindedness was really the most important single theme of the memo, I think, along with continuing to evolve your thinking as you get older. Can you take us back a little bit to that moment when you were starting to do high yield investing and nobody else was every day? I assume Milken wasn't active at this point in time. No, Milken was. No, Mike had been interested in low-rated bonds. I think all along, he got out of Wharton. Same year, I got out of Chicago, 69. And I think that he immediately found, among other things, he wasn't dedicated to an area, but I think he found low-rated debt. And there's a famous book called Hickman, which talks about bonds experience from 1900 to 19, I think, 43. And supposedly, Mike found that book, and he read in it that the lower a bond's rating was, the higher its actual rate of return was, not its promised yield, but its realized total return. Because yes, there had been some defaults in bankruptcies, and let's remember that that period included the great depression. But nevertheless, the excess yield you got as an inducement was more than sufficient to offset the credit losses. And that was like an aha moment for him. And at that point in time, it was impossible to issue a low-rated bond. They were called non-investment grades, Beckledov grades, it's just a good issue. So the big banks weren't doing it. Right. And the big investment banks, which in those days was separate, the big underwriters. And let's remember that in Moody's Manual, it defined a B-rated bond as follows. Fails to possess the characteristics of a desirable investment. And when I teach classes about this, I say to them, let's go down to the street, I have a car there, I don't need anymore, and you have money and you need a car. But hopefully, before you say whether you'll take it or not, hopefully you're going to ask me one question. What is that question? I'm debating whether the question is what's the value of the car, what's the price of the car? But I want to know both. But the value you can't ask me because I'm a seller. Right. Okay. I want to know what the price is. But you can ask me the price. Hopefully, before you say I'll take it or I won't take it, you know the price. But in 1978, Moody said these bonds are not proper for investment regardless of price. How can that be? Well, the other thing that you say sometimes is how can life insurance companies make money knowing that every single person is going to die? That was one of my real epiphanies. Around 81 or two, one of the first financial cable shows interviewed me. And the reporter said to me, how can you invite these bonds? You know some of them are going to default. And this is one of those times when you know you just get the answer. It pops into your mind. I never thought of it before. And I said, the most conservative companies in America are the life insurance companies. How can they ensure people's lives when they know they're all going to die? And the answer is, number one, it's risk they're aware of. It doesn't come as a shock when somebody dies. You know, nobody breaks into the board meeting and say, hey, one of the people died. Number two, it's risky can analyze. And so they sent a doctor to your house to see if you're in good enough shape to get a policy. Number three, it's risk you can diversify. So nobody ensures just skydivers or just people who live on the San Andreas fault or just smokers. But they diversify their book. Number four, it's risk their wealth paid to take. So they look at me. They say this guy's going to die at 90. And they price the policy on the assumption I'm going to die at 75. There's the emergency emergency safety. Exactly. And I said, this is exactly what we do in high yield bonds. So we started doing it and we made money steadily and safely, investing in the worst public companies in America. Now, remember my background. I joined the investment business September of 69. I'd had a summer job in 68. So I got a look at it. But in 69, I went to work permanently at city banks, investment research part. And the bank was what was called the nifty 50 investor. The nifty 50 were considered to be the best and fastest growing companies in America. Companies that were so good that a, nothing bad could overhappen. And b, there was no price too high. This was the polar opposite of the not appropriate for investment. Exactly. For the nifty 50, it was no price too high. And for the high yield bonds, there was no price low enough. And of course, both stances are wrong. And if you bought the nifty 50, the day I got to work. And if you held it tenaciously for five years, you lost almost all your money in the best companies in America. For the main reason that they had been priced too high. The normal PE ratio for the S&P is 16 post-war. These things a lot of them were selling between 60 and 90. Guys, I don't know any companies like that today. Yeah. Was it the case that they were not the best companies in America? Or was it the case that they were the best companies in America, but they were just priced too high to make sense as investments? Some of each. They were all priced too high. But some in addition, it was illusory. Let's go down the list. The granddaddy was IBM. The saying was, you can't be fired for buying IBM. Did IBM go bankrupt? Maybe I don't remember. Close. Xerox was number two. They completely lost their market to imports. They had to find a new business model. The consumer companies and the tobacco companies were part of that too. For the most part, they did better. But I'll tell you one consumer company that didn't do well. And that's simplicity patterns. That was in the 50. You see a lot of people selling their own clothes today. If so, you travel in different circles from me. But that was considered a company that could never be heard. Maybe Sears was in there. I forget. But the concept of disruption was never considered. The moats were considered in violet. The thinking was really simple. Nobody thought about the fact that if Xerox priced their copies at 30 cents a piece, somebody from abroad could produce it. And that presented a price umbrella that somebody else could get underneath. So in those days, the Wall Street Journal used to run a box on the first page whenever something would crap out, showing the losses in a certain category. And we had lots of companies where you lost more than 90% from the high to the low. To go back to your question, I think if you're an investor, you have to have a couple of different skills. One is you have to think about the future potential of the company. And that's sort of what my dad was talking about about moats and disruption and things like that. And the second thing is you have to think about, well, what's that worth? What is that selling for? And if you come back to the fundamental ideas of the memo, one of them is that all investments in equities are worth the discounted value of their future cash flows from here to eternity. And for some companies, those cash flows are more in the here and now. And for some companies, those cash flows are very far away. But they all go into the formula. And by the way, if you think about the nature of a DCF formula, every company requires judgments about the future. It can be a seemingly stalwart company that has immense consistency and whatever. But those can be disrupted. Well, I think the greatest example, one of the industries that all the value people thought were impregnable, great moats was the newspapers. Because you had your newspaper, you didn't have to worry about competition from the newspaper in the town next door. You were entrenched. It only cost 15 cents, so nobody would stop buying it in tough times. And if you wanted to advertise, you wanted to advertise in the paper with the most circulation. And the local movies had to be in the local paper, the local one ads, the local car ads. And the great thing was that if the consumer bought it today, guess what? They had to buy it again tomorrow. Because it had one day shelf life. What could be a better business? And 20 years later, most of the companies that had an industry are fighting for their lives. If I could just make an observation, you sound like a crazy person when you assert that end mass very quickly consumer behavior is going to change. If you would have told me when I was reading the paper, and this was the most important thing in America, well, newspaper values are mostly going to go to zero because all of the consumer attention is going to be shifting to consuming everything on their computers and an interconnected web of servers that doesn't really exist yet. So therefore, the newspapers won't have value. You'd be like, what? Or if you came to me 10 years ago and said Facebook bought Instagram and they're demonstrating their ability to constantly keep all the consumer attention. But eventually, actually, this Chinese company is going to start and it's going to be short form. Yeah, Facebook won't figure it out this time. And so all the consumer attention is going to shift. And I'd just be like, you're wrong. I just don't believe you. Yeah, that's of course true. But I think the other thing that's really interesting to note, and there are these very widely circulated charts of the speeding up of technological adoption. And so it was very possible for companies to be much more durable back then than it is today, in my opinion. I mean, if you transport yourself back to 1950 and you think about, well, how many businesses are there where I think I can say with high conviction that they'll be the same in 10 years as they are today? I think that number would probably be much, much higher than you could say today. Without understanding what management is doing to further entrench their modes or fend off competition or continuously evolve or whatever, it's very, very hard to say. Well, with no minding of the ship, this business will just stay consistent. The very few businesses that idiots can run these days. But I'll tell you two second what Andrew's saying. If you go back to my youth in the 50s, or when I was a young man in the 60s and 70s, you just didn't have the feeling that the world was changing. My thought model for the world at that time, looking back at it, is kind of a consistent backdrop like on a stage, and the actors do their thing in front of the backdrop, but the backdrop doesn't change. And so there are cycles, ups and downs, excesses and corrections and all these things, but the world didn't change much. And comic book was a dime for my whole youth. But today, everything changes every minute. So here's a question then. Should companies be worth less? Because if the future is more uncertain and it's more likely that things get disrupted, and modes are less permanent than they've ever been, shouldn't we consider less future years of cash flows? Well, like everything, it's a double-edged short. I mean, on the one hand, you just made the point that without mining the ship, companies are much more potentially disruptable. But on the other hand, that means if you have competitive advantages and you continue to mine those advantages and you use them to enter adjacent markets or launch new products or going after other markets geographically or whatever, there's much more value creation to be had. And I think the ability to leverage your advantages and build more for the companies that are really doing so is probably never been higher. And by the way, with the internet, you can address global markets. We just talked about newspapers where you couldn't address the town next door. One of my favorite writings on investing, it's not actually about investing, but it's the Sky Brian Arthur. And he wrote something called Increasing Returns in the New World of Business. And that was in the mid-90s. And he made the observation that with the new world with the new distribution models of things like the internet and whatever, the best companies could continue to get bigger and bigger, whereas you were sort of capped out more in the old world. And so you would have diminishing returns to scale over time. And by the way, that couldn't have been more right. You look at markets over the subsequent couple of decades and you have companies like Apple and Amazon and Google and Microsoft that just continue to get bigger and bigger. And I think a lot of that comes from the fact that they're just continue to dominate more and more of various markets. This is one of my favorite pieces of trivia of all time about that paper. Brian Arthur was friends with Kormack McCarthy. The author wrote all the pretty horses and no country for all men. And Kormack helped shape the pros in that piece. Oh, very interesting. One of the reasons why it's very successful. Well, yeah. I guess for an economist, it was extremely well written. Before I lose the opportunity, I just want to add one thing to Andrew's list of criteria for success in this continued expansion mode. And that is companies that are able to avoid the negative effects of success. You have to stay lean, ins flexible, and unbiorecratic, and future looking. Andrew, you're pointing out this really interesting thing where you have two opposing forces that have budding heads. One is now we have globally addressable markets. So, Tams are bigger there for market caps can be bigger. And at the same time, you have competition happens faster than ever because paradigms change faster than ever. And so therefore, the future is less certain than it's ever been despite the fact that the opportunity for any given business is the largest it's ever been. Yeah. And by the way, I wouldn't just say global markets. I would say strategically adjacent markets as well. Again, look at the big companies and how they continue to step out and do more and more in things that are tangential to their existing businesses. I mean, Amazon's a great example of that. They started in books, then they went to media and then continued on and on and on. And eventually they leveraged their scale into cloud computing and whatever. And that ended databases and all sorts of stuff. Yep. Yeah, exactly. Ben, Andrew mentioned that he had never heard your voice at real speed because he listens to podcast accelerated. I think the way to think about it is take Darwinism and turn up the knob a few clicks. It's what it is. It's winners and losers may be more dramatic than ever and happening faster than ever. And then this all I think dovetails into one other point that we made from the memo that I think is really important, which is that markets evolve and games evolve. I was an obsessive poker player. I've always been an obsessive games player generally and my dad and I we sit around and we'll play back Ammon forever and whatever. And I got it obsessed with poker right when the poker boom happened, which was Chris Moneymaker won the World Series of Poker. And they started online poker. Moneymaker and Farha. Yeah, well done. That's the very impressive poker trivia. So when online poker first launched and everyone got into the poker boom, because no one knew how to play and it was so new, if you just sat around, you played aces and kings and nothing else, you could win money. And it was very easy. And then over time people figured that out and they sort of figured out the next level of the game and whatever. And the winning strategy turned into the very exploitable strategy and that evolution has happened a lot more times to the point that I'm probably terrible at poker now. But anyway, I think the same thing has happened in markets. And so back in the times when Buffett was starting, information about companies and the ability to transact in companies. And actually even finding out about companies was extremely hard. I mean, you had to go to the library and to take out the Moody's manual. He was driving around by a stock certificates from farmers. Yeah, I don't know if you've ever looked at a Moody's manual, but there's not that much there. And so if you were interested in something you had to mail away for the annual report and so on and so forth. And then you had to call your broker and they had to figure out how to buy in a liquid stock. And because there were so much friction to getting information and transacting, it was much more possible for value to be hidden in plain sight. And I wasn't there, but I know this because Buffett says that this is exactly what he did. You could look at something and just plainly see that the company just continued to march ahead and just plainly understand that it was undervalued relative to those prospects. If you had conservative assumptions about the future continuing. And nowadays information is totally ubiquitous. Anyone can buy a stock. There's tons and tons and tons of smart people investing in the stock market, but there are also algorithms and machine learning and all this type of stuff. And so it's very hard to believe that you can just have some sort of knee jerk surface level understanding of something and just look at financials and have some very elementary view on something and have it be some sort of insight that's profitable. Well, the phrase I took away from that and it's in the memo is readily available quantitative information about the present. And Andrew pointed out the evolution of markets and I was taught at Chicago in the mid-60s the efficient market hypothesis that everything is price-right because everybody's working so hard to find the bargains and the overpricings. And of course that's a framework and it was not true that everything was price-right. But certainly over time things are priced more right. It's become more true. Right, inefficiencies which I prefer to say mistakes things the markets misprices, where do they come from? They come from ignorance and prejudice. So moody's had a prejudice against the single-B bond. It had a prejudice in favor of the nifty-50 as did most investors. And I was lucky to find some things that either others didn't know about or didn't understand. But human knowledge is cumulative. And lately it's been rushing forward at an incredible pace. So it's hard to imagine that there's a piece of information that I can get off the internet that's going to make me any money for the simple reason that everybody else can get it off the internet. This is a zero-sum game for a fixed amount of profit. And it'll go to the people who do better at the expense of the people who do worse. So you have to have an advantage, a knowledge advantage, a skill advantage if you're going to be one of the people who ends up on the positive side of that equation. And so to bring this back to what we were talking about earlier it's very dangerous to just make qualitative judgments about a company that seemingly everyone has. Oh, this is a great company, whatever it will just continue winning without also saying, well, to what extent is this reflected in the price? And so that's the whole point of investing, whether it's value investing or growth investing, and that's sort of the point we make in the memo. I mean, you have to be able to make judgments about the future prospects of the company and then you have to be able to say, well, to what extent is this already reflected in the price? If you're talking about public equities or any public market, that dynamic is so strong that we were just talking about. 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 market it's much more a liquid. 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? 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 invest in 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 the super inefficient market. I wanted to capitalize on that insider, whatever. By the way, 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 want to just talk about the proposition, the reason why I went into it is, number one, it sort of suits my skill set more to make long-term qualitative judgments about the future. And I think venture so much of 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 10 years, if this is successful, well, what could that business look like? And much more so than this sort of analysis that goes into being a public markets investor, 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 going to lose your money, but make enough of those bets. And so it works out to be a great return. And then by the way, try to help the companies in whatever way you can and follow them closely so you can add more capital to the ones that are doing well and whatever. And so that whole endeavor really suited my makeup much more. Oh, bit. We were chatting before we started recording it. I went back through my notes from Business School from Howard your book. The most important thing eliminated. 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. 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 a portfolio of 10 years ago, I would have a portfolio of 10 companies where not only would the portfolio return be 20%, but they'd all be roughly 20% or they'd go somewhere between 10 and 30 or something like that. I mean, I just don't know if that would be as suited with my skill set. And in 1978, when I left the equity area, it was really because of the terrible performance of the 5050, which I as director of research was associated with. So they said to me, what do you want to do next? And I said, I'll do anything except spend the rest of my life choosing between Merck and Lily. 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 going to perform better Merck or Lily. And I guess as you'll get it right after time. But the good news is my boss said, I want you going to the bond department. And it played to my quantitative skills and to my conservative personality. And if they would have said, I want you to start 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 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 pig in a round hole. One of the things that really interests me is applying some of the more traditional investing lenses or Buffett investing lenses or whatever to ventures really interesting because I think 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 the business could look like. And if the company IPO's in 10 years, what's that person going to be looking at when they're thinking about investing in the company? So you have to sort of visualize, well, what could the financials of this business look like down the road, even though it's totally nascent? And what could the modes in that business look like? And how much capital might it take to get there? And what's the likelihood of competition? And what could they evolve into after they establish themselves in that market? And et cetera, et cetera. And I think it's really interesting. And to me, I find it to be, yeah, really, really thought-provoking. Remember what I said that Andrew said readily available quantitative information about the present is not going to 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, and 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 50 cents, which is not such a terrible idea. But to doing more like he does dealing with these challenging aspects of qualitative and future. Yeah. I mean, I think you just have to find the type of thing 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 is clearly sucks, but it doesn't suck as much as everyone thinks. Or people think this business is going to die, but I think it's only going to be maimed or something. Well, die slowly over more years. 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. Well, Oak trees, I think the thing we're known best for, is investing in the stress debt. And when we started that in 88, my partner, Bruce Garshan, I had this idea. It was actually Bruce's idea, but he joined me, and I'd been in the high-obahn business for 10 years at that point. People would say, well, that's crazy. You're going to buy the debt of companies that are bankrupt? They're not going to repay the debt. And the answer is, hey, we're not going to repay it in full, but they're going to 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 Garshan. It wasn't the right thing for Andrew. So fortunately, we gravitated in the right direction. For our next sponsor, it is a very appropriate one for this episode. Our good friends at Tiny, who share a lot of the same investment philosophies as what we were talking about here with Andrew and Howard. Actually, with both of them. Yes. And they've got something new to share with us. And we talked about this a little bit on our special with Anthony Gonzalez. As long time listeners know, Tiny is the Berkshire Hathaway of the Internet and has built and acquired a collection of truly wonderful internet businesses, most of which they fully own. Their story, which many of you know, is incredible. Andrew Wilkinson started the design agency Medalab and Victoria BC. They became one of the premier design firms in the world building UIs for Slack, Coinbase, Tinder, Headspace, Patreon, you name it. With that Medalab success, Andrew and his partners Chris and Jeremy started to think about investing. They became completely obsessed with Warren, Charlie, and the Berkshire model. And of course, that led them to realize, wait a minute. We know there are a whole bunch of companies out there just like Medalab that are wonderful internet businesses doing five million or more in recurring revenue at first. And recurring revenue at 30 to 40% operating margins. But it just doesn't make sense for venture capital because there aren't M&A buyers for them out there or they can't get to the scale required for an IPO. What would Warren and Charlie do here? They just go and buy these businesses and own them forever. And that is exactly what Tiny has gone out and done for the past 15 years with incredible success. You can think about companies like dribble, pixel union, creative market, 80-20 girl boss, arrow press, which I use all the time. All of these are now tiny businesses run by their own independent managers just like Brooks running, for example, within Berkshire and producing incredible cash flow for tiny and their managers. So David, what is new? Well, so it turns out that over the long bull market run of the past decade, a lot of wonderful internet businesses like these that should have been tiny type companies mistakenly took venture capital instead of the company. And now they can't get to an exit. So for anyone who's a founder or a VC in this situation, you know this sucks. I've been there personally many times, bad. You've probably been there personally. Yep, the company no longer has the potential for an exit that would make it meaningful to a VC's portfolio. And yet you're on the board. It's taking all this time. There's a misalignment of incentives. And at the same time, it's not like this is a bad business. It's a legitimately good small business on the internet and it doesn't deserve to be just shut down. So tiny has realized that they can fix this situation for everybody. Sell the company to them. The venture firms get their money back that they can then recycle and invest in the same fund into new portfolio companies and founders get to take control of the company back. Tiny has done this with several businesses so far this year. These are venture backed companies doing over 5 million in revenue at 30 to 40% operating margins or the potential for that to quickly be the case. And tiny came in acquired the business. The VCs got their money back and more importantly their time back and management and tiny got to run the business as it should be wonderfully and profitably with totally aligned incentives. Honestly, this is a total win for everybody. This function needs to exist in the ecosystem and I'm so glad tiny is now doing it. And more so in the last six months than ever before. I mean, there's so many companies where now this makes sense when there was just available capital everywhere. There was other options to kind of keep going and see now this makes a lot of sense for a lot more companies. So if you're running a business like that or you're a VC board member and I know there are a lot of you out there. You owe it to yourself and to your portfolio to shoot a note over to high at Just tell them Ben and David sent you. I honestly really wish that this existed back when I was an actual professional. What a boat VC and I was taking board seats. This is a no brainer. I'm so glad tiny is doing it. Thanks, tiny. We wanted to ask both of you about the firm building aspect of the investment business. One thing I've certainly learned in my career is that being a great investor is a very challenging proposition and an activity that can easily be one's life work. Building a great investment firm is a very different challenge. It's very rare that people can be great at both of those. And it's also not a second challenge to take on lightly. How did you two think of this? Well, having spent my first 17 years at Citibank, which is management intensive bureaucracy, I was pretty good at those things. I was not a guy who started in a garage, you know. And so processes and deliberateness were right up my alley. But on the other hand, we started Oak Tree at a time when the quest for alternative investments was extremely strong. The demand I think outstripped the supply. Most people kind of gave up on getting the returns they need from stocks and bonds. So we had a big tailwind. And what Bruce and I did for the most part is create a culture. We didn't ever have a macro managing, micromanaging mentality. We were too busy. It was not our day job to run the company. We did that as a sideline and it wasn't management intensive. So we weren't great on the profit margins, but they kind of took care of themselves. And we were happy about compensation. You know, we kind of respond to the last person walking the door. But the right culture at the right time with, I think, some exceptional people was enough to make the company a success, even though it was largely an unguided missile in terms of management. How did you think about splitting up the responsibilities of the core competency of the business investing versus the necessary lifeblood of the business of finding capital to manage? And recruiting and everything. Well, the great advantage we had is that the people who started Oak Tree, there were five of us, three others in addition to Bruce and me, had worked together on average for nine years at the time we did it. So we weren't dealing with strangers and trying to figure out an MO. All we had to do was what we had been doing at T.C.W. before Oak Tree. And for the most part, that meant I was out raising the money and visiting with the clients and representing us to the greater community and clients and prospects and Bruce and the others were back managing money. And David, you mentioned my book, the most important thing. That actually evolved from a memo of that title that I wrote around Oak 2. And that had a section on how to run a company, which I spared the readers of the book, because it had nothing to do with investing. But I said in there that the key among partners is to have shared values and complementary skills. And we absolutely shared values where all family men and conservative people and somewhat risk averse and so forth. Andrew points out we probably could have used one founder in the mix who wasn't quite as risk averse, but we did okay. But we had complementary skills. And I could do things in the outside community that Bruce maybe couldn't do, although he's better at it than he thinks, but had no interest in doing. And he could do things in terms of managing money that I couldn't do. But the great news is we each accepted the truth of what I just said. And so that produces a lot of respect, mutual respect. And that's why we've had such a great partnership for 35 years. And then for us, I mean, wow, I'm incredibly proud of and impressed by what my dad and his partners have built our approach is sort of totally opposite just because it suits us. That sounds like a theme between five days. Yeah, I mean, it's not for the sake of being opposite, but my partner Schuster and I who we both since we started have run the investment program and the sourcing and investment decisions and it helps that we've been long time extremely close friends and we talk all the time and we just feel like we have to really pinch ourselves that we get to do this every day that we just love love the investing. And to us, what motivates all of us is having absolutely world class returns over a long period of time. You seem to share that competitive streak with your dad, even though you have different ideals and many other ways. You know what then if you're not competitive, you shouldn't be in the investment business. Yeah, but I would say it's not competitive with others. It's competition with ourselves. I mean, we just want to be the best that we possibly can be. So everything we do at our firm is in service of that. And it's not because other approaches aren't also extremely valid or work for other people. It's just that this is what motivates us. And so we have no ambition to broaden our firm in terms of strategies or turn our firm into some big asset manager. And if our jobs turned from investing into management, we'd be extremely unhappy and that trade office and worth it. So everything we do is in service of trying to do what we love and maximize our time doing that and have the best returns that we possibly can. And so do the things that we think enable that which in our opinion in this business is really all about your reputation with founders and having as broad of a network of as many incredibly talented potential founders as you can. And then being able to do whatever we can to build the best relationships we can with them. And I think that comes from helping them. But I think that also comes from being great partners and also friends. That's how we build the firm and it's very different. You point out that the nature of oak tree and tqs investment businesses is very different. And that's the core competencies are very different to Andrew. Andrew, you don't rate public facing memos. You don't go on too many podcasts. Thank you for joining us here. But it's probably just not as important as it was a oak tree. Look, there are other people in venture who do that stuff extremely well. Other people in venture go on podcasts. I think those podcasts are great. And I think people who do it probably do it because they enjoy it. But also because it really helps them. I mean, builds great brands with founders and increases their network and adds a lot of credibility and all that type of stuff. I think at some point you just sort of do what suits you. And we have certain things that suit us and other people have things that suit them. And it's not really a strategic question about if going on podcasts help us or hurt us or being public facing or whatever. It's just you sort of do what you think is right for you. Which is funny. That's the echo of how it's something I've heard you say in the past, which is that you just have to make sure that your investment strategy suits your demeanor as an investor, which is almost saying the same thing. I mean, David and I talk about this a lot in the podcasting business. We say, should we change the content to match what the demand seems to be? Or should we just say, you know what, let's find a way to do what's natural to us because that's what we're going to have the most fun doing. That's where we're going to have competitive advantage. And that's where we're going to have durability. And I think that same concept applies in all three of those things just discussed. When I'm asked for career advice when I speak to students nowadays, I say something very, very much in line with what you just said, Ben. I say, look for something that plays to your strengths and avoids your weaknesses and that you'll enjoy doing. And it sounds like that's what you've done. And turn it around. We are so lucky to have the ability to do something we enjoy. And take that out of the equation. What are you left with? We only have one life. We should make the most of it we can. I think anybody who has a choice and does something he doesn't enjoy just to make more money is making a world class mistake. I think learning and evolution are really important. Learning at our firm is really important to us. And it's just important to who we are as people and continuing to try and expand our competencies and rub our nose and the many mistakes we make and all that type of stuff. And so I think you have to find something that suits you, but you also can't get to hung up in your comfort zone and just say, well, this doesn't fit in my comfort zone. So I'm just going to totally ignore that. And you guys talked about this on your Berkshire episode. I mean, one critique you could make of Buffett is he just totally ignored technology and technology not only became much more pervasive. But I also think that he's an incredibly smart guy and he understands lots of different elements of business. And when he talked about technology, I think he was referring to science projects, you know, where your technical advantage is what will allow your business to succeed over time. But there are lots and lots of technology companies where what they do is not so incredibly cutting edge and really what powers their business is notes that are very similar to other sorts of things. You also had Hamilton, Helmer on here and a lot of those sort of notes traverse both technology and on technology businesses. So I have no doubt that Buffett could have totally nailed it, but it was just not in his comfort zone. You know, this points out a dichotomy in investing or maybe a conundrum of which there are so many because what we just talked about was it's important to stick to your last and do what you're good at and fits with you. But it's also essential to be open minded and willing to change. I'm getting whiplash. Yeah, but look to be a good investor, you have to be confident because you have to back things that are iffy and stay with them if they go bad and if you're in the public securities market, you have to maybe buy more of them when they decline. But not so confident that you're big headed and keep throwing bad money after good, you have to concentrate your holdings enough so that the few good ideas you get in your lifetime really make a big difference. But you have to diversify to protect against the unforeseen. So this is really the nub of it. It's such a fascinating field because in my opinion, the things we're talking about can't be reduced to an algorithm. And this is where our humanity pays off because Andrew talks about making better qualitative judgments about the future. I like to believe that computers will not be doing that well for some time so that we'll still have some scope for success. Or if they do, then it will cease to become a competitive advantage. Right. Well, but we need to have some competitive advantages left, you know. But I think it comes from qualitative in future. I always say that I don't think that a computer can sit down with five business plans and figure out which one is Amazon in advance or meet five CEOs and know which one of Steve Jobs. And not many people can do it either. That's the important thing. But the few who can can really help their clients. And if the person who finds Amazon can also find Google and find Facebook and to the point where you can conclude, OK, it's skill not lock, then you really have something. So here's a philosophical question. If there is a very credible trope to be made on either side of an argument and you can always make both of them and then be stuck in the middle. Ultimately, everything always comes down to judgment. So where does judgment come from? Well, that's a great question. I was having lunch with Charlie Munger back in 2011 when most important thing was about to come out because he worked downtown right next to me in the building next door. And when I got up to go, he said, just remember, none of this is meant to be easy. Anybody thinks it's easy is stupid. And so I wrote a memo. I think it was September 15 if I'm not mistaken. And I talked about that. I called it. It's not easy. A friend of mine wrote a book on investing in the UK. And the title is simple, but not easy. The things we're supposed to do are simple to describe. It's just not easy to do them a better than other people and be consistently and see over time. It all comes down to judgment. Now that's not your question, Ben. Your questions, where does it come from? And you remember that the first chapter of the most important thing talks about second level thinking thinking at a higher level than others differently, but also better. That is to say more correct. It's easy to diverge from the thinking of the consensus, not always easy to diverge correctly. But that's what a superior investor has to do. You might call it second level thinking very in perception, knowledge advantage inside context, judgment, but it's an intangible. People say to me, can you teach somebody to be a second level thinker? And I said, I don't know. It's kind of like asking the best well coach to coach height. All his efforts will make his players any taller. Some people get it. Some don't. I mean, I would say it comes from probably comes from a lot of different places, but some ideas would be some combination of sort of deep knowledge and understanding of what you're doing and the real framework for what matters and what doesn't and why. I would say rationality, which is the ability to think logically and not emotionally, which sort of dovetails with knowing yourself and being able to know where your biases will infect the decision making process. I think there's intellectual humility that comes with it knowing that there's a good chance that you can be wrong even if all those things are true and also knowing what you don't know. So knowing where you can opine and where you have to learn and where you should seek others and things like that. And I imagine this is less so for you, but certainly at Oak Tree, you recruited a lot of people over a thousand employees, right? So you had to make judgment about other people's judgment. How did you do that? You know, back when I was an analyst in the early 70s, I followed Xerox. And one of the portfolio managers said to me, who's the best Wall Street analyst on Xerox? Sell side. And I said, well, the one who agrees with me most is so and so. Isn't that our definition of who's the smartest? No, but the truth is we look for smart people. We look for what Nancy, my wife calls smart eyes, exceptional people who get things maybe a little better than others who understand what's important and what's not who can go beyond the readily available quantitative information. And look, it's very simple like with oil. The cure for low oil prices is low oil prices. Some people get that intuitively. Some people don't understand it. You have to get the people who get it intuitively. But I think also very importantly, we look for team players. We look for people who can work and exchange ideas and can do well with ideas from their peers, from their lessons, from their superiors, managers, subordinates, you know, and throw it all together. We don't want the lone wolf. We don't want the you eat what you kill kind of person. And we don't pay people on the basis of their one years quantitative performance as an individual and we don't want people to work that way. I definitely can attest to having nearly as much experience and recruiting. We've vetted a whole three people to our team now. But I do think that the vast majority of the venture investment decision making is about understanding founders and having a sense for founders. I mean, again, after talking about all this business analysis stuff, we firmly believe that the vast vast majority of the investment consideration is backing the right people. And so what you're doing, I think every day, every week is evaluating people. And so you have to do that in the same way. And so I think first of all, when you hear a venture pitch, so many of them that we all here are like, you know, the person gets on and it's like, here's where I went to school, here's where I worked and then I worked here and now I'm doing this and let me tell you what I'm doing. And I sort of say, no, no, let's stop. I want to spend a lot of time understanding you. And I think the real way to sus out judgment is by going through the person's story and background and understanding why they made decisions, because you can sort of fake your way through prospective things. And when I and I'm sure you guys were recruiting at a school, you know, there was the vault guide for finance interviews and you can memorize every single answer about how you would do this and how you would do that and whatever. And CS there was a book called programming interviews exposed written by 3x Microsoft guys and it was truly the way to whiz through any of these. Yeah, but you can't fake what you've done. And so if you really dive into what people have done and why and if they've made decisions based on their own judgment and if they've learned and evolved and if they've made decisions based on first principles and we're willing to go against the herd and we're willing to do things because they're passionate and if their idea comes from specific knowledge of the real problem and a real deep understanding. I think you can evaluate judgment very well based on that. And so I think that translates into hiring too. You know, really understanding what people have done in the past and why. And then I think you can also test for specific skills in the hiring process. I mean, I think you want to understand why you want to hire someone and then I think you can test against those things in real ways. It's funny. I'm the founders thing. I was having a conversation with my dad about a potential angel investment recently and he was like, I know people always say the founders the most important but what's your view of what that actually means. And I sort of just barfed out this answer. Howard sounds like your earlier story just came to you and I was like, are they a weirdo and in particular, are they a weirdo at something where they're forced and or deviations from the mean at that thing. And it could kind of be anything. But if this person can't be in the middle of the distribution at everything or else the startup will never be successful. Yeah, well, I think what's interesting also is that there are so many ways to succeed by being amazingly good at the conventional thing by being the best at going through the map or following the map or whatever. And sort of hacking whatever the process is that everyone's done before you, but with startups, there's not much from that. I mean, there might be some general principles. But in any given area, you're doing what you're doing for the first time or if someone else is doing it, you're trying to do it differently and better and whatever. So you have to be able to think for yourself and you have to have real conviction in yourself. And I think to your point, the people who are more unconventional are people who are willing to do things based on what they think is right for them and their own views versus just being the best at what's conventional. You know, my last memo came out a couple of weeks ago was called I beg to differ. And it was all about the need to be different. And it's exactly what you're saying the path to exceptionality cannot come through doing what everybody else does. And the advantage of the things we do, especially Andrew does that we've been discussing is the fact that there is no clear roadmap. There's no simple algorithm, which will produce a consistently correct outcome. But we are dealing with challenging concepts here and the person who sees differently and better is the one who's going to win. And David Swenson, who ran the endowment at Yale, used to talk about the need to do things that are uncomfortably idiosyncratic. You have to be idiosyncratic to split tax and to win. And for many people, it'll be uncomfortable because they'll be out of step with so-called common sense, but you got to do it anyway. One way that I sort of into it for myself about this point about why founders are everything sort of the question I guess your dad asked is think of the best startup idea you could possibly imagine. I don't know. Someone gave you Google's pay drink algorithm. It's literally what I was thinking of too. And then imagine someone from your life that's mediocre or maybe better than mediocre or an A- or a B-plus. Or even talented at conventional things. Yeah, what are the odds that that person would have built Google? Zero. Zero, right? And that's because number one, it's hard to build a company, even if you have a great idea and execute on all the things you have to execute. But number two, if you're doing something well, other smart people are going to be like, hey, there's a lot of value to capture here. I'm going to go compete. So not only are you going to have to build your company, but you're going to have to outcompete everyone else. And I just think it takes exceptional people who can exhibit exceptional judgment, who can attract and retain other exceptional people. And all the things that go into being a great founder to build those sorts of things. For our next sponsor, it's Brex. And last episode we introduced you to the new Brex corporate cards and spend management that have zero receipt chasing, but with 100% compliance in over 100 countries. Okay, so here's why I'm calling it the new Brex. As many of you know, Brex launched in 2017 is that super simple to use corporate card. They later added a cash management account that was interest bearing venture debt and financial modeling tools. But here we are in 2022. And Brex has expanded into the next frontier of spend management software. So what is that? Well, if you've submitted an expense report in your life, you're familiar with the long and tedious process of submitting for approval, justifying it, categorizing each expense, etc. I got to wait for bed to approve my expenses all the time. It's terrible. You're probably also very much aware that the legacy tools are not fantastic and there can be something much, much better. Well, Brex realized it could fix a lot of this since it's also your corporate card. There's really nice ways to improve the UX by sharing data across both of those systems. Since they're now tackling bigger companies and not just startups, they realize they could go a step further. So if you've spent time at startups and big companies, you know that as companies grow, they take on more people, processes and systems. And unfortunately, with that comes more overhead and more bureaucracy. Plus today, all of those employees are likely to be living and working all around the world adding an even bigger challenge. So Brex has built spend management software that enables big companies to do everything necessary to support lots of people globally and drive 100% compliance at scale. But even better, it also enables them to preserve the trust and ease of use of the systems that keep startups moving fast. So how it works is super novel instead of reacting to expenses after they happen Brex customers are empowered to direct spend from the start by creating a budget for each purpose or vendor beforehand. Brex is totally changing the paradigm and flipping it on its head for each budget managers can set an amount and expense policy and assign employees this pre approved spending. The system is built to ensure that employees stay 100% in budget, totally compliant automatically frictionlessly. And of course, there's only one card for all expenses. So no need to juggle like 10 virtual cards for different purposes, budgets will categorize all spending to the right place automatically on the back end. And by making all this proactive versus reactive, Brex saves everyone the time and headache of expense reports in policy spending is greenlit automatically and only the outliers are the ones that actually require manager approval. Brex even flags suspicious transactions using machine learning and AI driven anomaly detection. So so great it was beyond time for this. So as we mentioned on the last episode, Brex also automatically gathers itemized IRS compliant receipts via exclusive merchant connections without employees needing to keep the receipts and track them themselves. That is zero receipt chasing now for your whole team employees will actually close out their expenses on time because it's easy and in many cases automated I joked about been approving my expense reports were fortunate we don't really have to deal with this that acquired because it's better than me. But my wife she tells me all the time like her direct reports don't do their expenses and it like holds up closing out the books she literally complains to me at the dinner table on a monthly basis about this and Brex solves all of this. Yes for non corporate card transactions. These are just a few of the ways that Brex helps big companies proactively manage spend in a way that drives accountability and reduces headaches all over the company. If you want to learn more, you can visit slash acquired. Thank you Brex. Well, I know we've drifted away from firm building a little bit, but I want to take us back there and kind of round that out by talking about the concept of an exit. We talk about it all the time with startups is become taboo to put what's the exit strategy in the deck. But you know everyone wants to understand how can I get liquidity on this investment at some point. Oak tree had I don't know if you would categorize it as a acquisition or a merger or potentially a majority interest investment. But how are I wondered if you'd be willing to share with us how you thought about that and what it means for you going forward. Well, it was really a dream transaction for us. Brookfield approached us and said that credit was the obvious mission in their list of alternative investment categories that they were providing and they could build it but it might take 10 years and they might end up with less than we had. So they wanted to invest in oak tree at that time this was 2018 we were half owned by the public and half owned by the founders current and former employees. So they proposed to offer a fair price to take out the public that's half and to buy a fifth of our half. So they started with just over 60 percent but we had criteria for a transaction that we would contemplate we've had them for 20 years and they were never fulfilled before and Brookfield hit them all which is that oak tree would continue to exist would continue to be an independent entity that we would run it. That Brookfield wouldn't tell us what to do and that Brookfield wouldn't try to interpose itself between us and our clients they would be oak tree clients tended by oak tree. So it was really ideal for us and also as I said they bought 20 percent of my stake, Bruce's stake, etc. And the former employees will sell an eighth of a year until they're done starting this year it happened already the current employees have the option to sell an eighth but they don't have to. And Bruce and I and the other founders and senior managers had the option to sell a fifth the year but we don't have to. Right now we can keep it as long as we want or sell it when we want and you know you reach a certain age when it's a good thing to have an exit when did you start oak tree 95 so it's 27 years old. I've worked there half my career so let's see if you can do the math. So we have an exit at our option we still run the place they consult us they help us they provide resources I mean it just couldn't be better and above it talks about skipping to work in the morning and I skip inwardly. Well and other big topic I wanted to cover from the memo is just that this the perfect transition selling you each brought very different perspectives to the topic of selling that was our most lively interchange I would say. I'd love to hear from each of you what your thoughts were on selling before coming together and then how they changed. So as you probably know I wrote a memo in January of this year I think it was called selling out and I observed that a lot is written about when to buy securities it's a little bit about market timing but not much about when to sell securities and of course it's half the equation and yes my tendency coming from the conservative background that I came from was to what would you say take some money off the table take some of the profits. I had this terribly misguided feeling that if you sell half you can't be all wrong but of course I wasn't dealing with securities with the potential of what Andrew deals with but anyway for people whose parents were adults during the depression who were brought up with don't put all your eggs in one basket save for rainy day that kind of thing you take some profits you know if you're more optimistic bent the timing of your birth was more fortuitous you never heard that you're not going to be able to do that. You never heard those things and so maybe it's easier to hold for the long run you know I wrote a memo on liquidity about eight years ago and Andrew gave me a great quote for that memo the greatest quote and he said if you see a chart of a stock that's been up for 25 years and you say man I wish I own that stock. I think of all the days you would have had to talk yourself out of selling so in selling out I told the story of Amazon that I think it was 89 in 99 and then it felt a six in a one and let's say you were fortunate enough to buy it at six would you start selling a 12 well most people start selling as well but it's a double which is sell at 60 10 X 10 X what about 600 100 X you know and then it went up to 33. So this idea that as soon as there's a profit you should take some of it off the table seems like a huge mistake Charlie Munger says you only get four good ideas in your life and you got to get the most out of what I said in the memo selling out half facetiously but only half is that there are two reasons people sell things because they're up and because they're down. So you can sell some before the profit evaporates and I'll feel like a jerk if it goes down they say I better sell some before it goes down more and I'll feel like a jerk in other words and that has nothing to do with the business right or the thing you're selling and a huge amount of people's preoccupation in my opinion is with the voiding regret embarrassment in front of others regret themselves. So the thing is consistent with the general way that we talked about the value and sort of growth dichotomy which is that what matters and invest in is really deeply understanding what you own and why you are making the investment and what you're playing for. And when it comes down to making a decision about selling or not what matters is understanding those sorts of things and then also understanding your opportunity cost I mean your money has to go somewhere. And so you have to think about decisions relative to each other but the point of the memo was that first of all most people don't think about opportunity cost and most conversation about selling our sort of academic you know thinking about should you sell this investment in a vacuum or whatever but outside of that most people make selling decisions based on price action if it's upper if it's down or whatever and most people confuse price action with fundamentals. So this company has been up into the right for years and so it must be a compounder must be compounding value intrinsically. So I think you should make your selling decision based on why you made the investment and how things have evolved and what you could be playing for take a simple example let's say you can buy a dollar for 50 cents well that's obviously a good thing to do. But if it reprices to dollar you should probably sell it because there's no more in the investment however let's say there's a contract where you can get a dollar but then every year the value of what you can claim compounds by 20% and you can buy that contract for 50 cents well you can buy it for 50 cents let's say it goes to a dollar you double your money but you shouldn't sell it next year it'll compound value to a dollar 20. So if it goes up to a dollar 20 you're up 20% you still shouldn't sell it the next year it'll go to 144 let's say instead of 144 it goes to 160 you probably still shouldn't sell it even though it's quote unquote overvalued because the right to compound at almost 20% in perpetuity is extremely valuable and so on and so forth. So you shouldn't just let price action alone determine what you should do and then I think the other thing to note is number one things that can do that these sort of compounding certificates you know in the form of companies are extremely rare but extremely extremely valuable I mean if you just look at a DCF if you really have something that can compound cash flows for 25 years you're up 100x so if you can do that for 50 years you're up 10,000x so it's really really hard to price that in in the near term and so number one if you can really believe you found something like that something crazy has to happen for you to sell it I mean the price can of course as my dad said anything can be price too high but I mean really recognizing what you have is really important and also recognizing that we have a huge tendency to want to act and so sitting idle on something for decades and decades is really hard but then contrary those things are extremely rare so most things are not that and if something appears where the price appears to be compounding and you get comfortable that it is one of those things you better be sure that it is and you better know why you own it I just think it's a nuanced conversation that comes back to well why do you own what you own what are you playing for you know what's your confidence in the future and then if I sold this where could I put the money you know it all comes down to maybe we can think better about the selling decision if we rebrand it and we call it the decision to unbuy the thought process should be the opposite of the buying decision and not some chicken stuff about being afraid to lose but you know I think Andrew points out a very important thing that in the olden days you look at the classic value investments and I did some of this you get this chance to buy the dollars for 50 cents and that's a great thing but once it hits a dollar you got to sell it you got to find another dollar for 50 cents the concept of the buy it at all of 50 cents and then it goes on to be worth two and four and eight and 16 cigar vets don't go to eight bucks yeah right and remember I was a credit investor and the bond investor generally does not think in terms of getting more than a hundred cents on the dollar so when the upside is capped or non-existent then obviously taking profits maybe somewhat more responsible and by the way I mean ventures and interesting lens to look at this the truly generational companies the truly monstrous companies are extremely few and far between the but when you have them selling them early is just a colossal mistake disasters there incredibly prolific firms where their reputation is built on a handful of fantastic investments and I think if you probably looked at the PAs of the most famous venture investors of all time a huge majority of it is made up of continuing to hold a few things and I think that's a great story of this I won't out the firm it could be one of several firms but I know that one of the earliest venture investors in Facebook after the IPO they distributed out the shares and among the partnership most of the general partners relatively quickly liquidated their Facebook shares but the partner who led the investment was like I'm gonna let this ride and that was a very good decision well I want to start moving us to a close here I always find that people tended mostly consume in whatever medium they're currently consuming in and David and I have played around a lot with like show you right should do blog post you do newsletters people we know for 100% sure are listening to this podcast so when I'm pointing them to go check out your memo I would like to do so in the podcast form so where can listeners go read the memo that we have mentioned so many times or listen to it well the memo and all my memos since 1990 are available at oak tree capital dot com slash insights under the heading of chairman's memos and you can read them all one at a time in order and the only thing I can promise you as the price is right because they're all free when did you start writing the memos and 1990 that's a good story by the way you should tell that I'll tell that story and it bears a little bit on what we're talking about here but in 1990 I went to visit a client in the Midwest who told me that the pension fund he ran for 14 years was between the 27th percentile and the 47th percentile every year for 14 years so if you say to somebody well for 14 years it ranged each year between 27 47 what do you think they did for the whole period you would say well probably about 37 right and the answer is fourth that pension fund was in the fourth percentile of all pension funds for the 14 years why because some of the other people shoot themselves in the foot so that was a lesson in consistency and then right around the same time there was a deep value firm in New York and they invested very heavily in the banks that year and the banks did horribly so the president comes out and he says well obviously if you want to be in the top 5% of money managers you have to be willing to be in the bottom 5% and the dichotomy between the implications of those two stories really caused me to write the first memo the juxtaposition my clients don't hire me to be in the top 5% I don't care of them in the top 5% in any given year I'm absolutely unwilling to be in the bottom 5% and I think so are they so that thing about being willing to be in the bottom 5% sounds to me like a post justification but anyway that's not how I choose to operate and so it was a great opportunity to write that up and so I wrote that one in 1990 I think I wrote another one in 91 then I wrote one in 93 there was no regularity and one of the things I like to mention David is that for the first 10 years I never had a response. Well not only did nobody say it was good nobody ever said I got it and these were male this was pre facts this was the old days of male but they only went to our clients so probably a few hundred now it's a few hundred thousand by the subscriptions and by the way you can't imagine podcast these things are also available in podcast form under something called the memo originally enough in any podcast player will link to it so if you like to listen you can listen I like to read so it was the sporadic thing it was no plan well the other thing that I think is great is I mean you wrote it with a lot of consistency or with some consistency but you got no feedback whatsoever but you kept writing it was doing it for myself the damn broke one day and it ultimately picked up steam well I wrote one on the first day of 2000 call bubble dot com and that one had to advantages number one was correct and number two it was correct quickly because if you do something correct but it turns out to be correct six years later nobody remembers you but this one of course the tech bubble crap out in mid 2000 and so I like to say that after 10 years I became an overnight success were you posting them publicly always no I think we probably started posting probably around 2000 maybe when we got on the internet which was of course a little earlier but when we started oak tree they gave me a computer I said I only want excel and word and that's all I had but that was 95 then I think we moved in 98 I said okay I'll take that other stuff for the life of me I couldn't figure out the difference between explorer and email but I got there eventually this explains why Andrews the tech investor exactly and why he had to fix my computer if you were to graph committed capital from clients by year is there a correlation with the distribution of how widely your letters go out once you started posting them publicly and committed capital from clients that meaningfully help the firm marketing well you never know one thing that's interesting to that point those that you've dramatically limited your fun sizes and certain parents and then raise your hand and then raise them a lot in other periods yeah we tend to increase our a.m. in bad times and of course that is the best time to put money to work or when you think there's going to be a bad time yes that's right in advance of bad times yeah thank you the job is still open for you most firms if they have a very successful fund will follow it up with another fund which is larger on the back of that but if you think about it if you had a success in a given area the good performance of that fund is synonymous with appreciation in other words everything in that area is now more expensive so I would say you should raise less money not more and that's the way we operate and if you look at our funds you know we've been in business three or four cycles there were debt crisis or crises in general in 90 91 oh one oh two oh eight oh nine and then of course a brief one in 2020 and the biggest funds we raised were the funds that invested in those years usually because we had some foresight about what lay ahead and then having made a lot of money in those well timed funds the next fund is always smaller and we're very proud of that we don't always say oh no this is the time for our strategy what's the perfect time for us oh now sometimes it is and sometimes it's not and we take great pride in telling people which is which well and we've talked a lot about where folks can find things that your dad has created over the years where can people find you or TQ ventures yeah well you can find TQ at our website number one we try to make it fun but number two it's pretty sparse and we mostly focus on our companies but you can also always email me Android TQ or LinkedIn or whatever I'm actually not on other social media your social media or a voider yeah so that's the best way to reach me and say congratulations on truly winning the social media game by opting out well I was on Twitter for a little bit again you just have to do what makes sense for you some people have the ability to be like I'm only going to do this for 15 minutes or whatever and it's just really tough for me and so I was just sort of an all or nothing and I think nothing's better especially if I want to keep my marriage and be a good father to my kids my wife and I both quit Instagram this summer and we seem to be doing OK without it will on that note Andrew Howard thank you so much thank you thank you guys it was a lot of fun and it's been a pleasure and David and I've been looking forward to this and glad we did it like was with that are thank you to Vanta tiny and Brex and a huge thank you to Andrew and Howard for coming on total blast to get to talk to them so fun to talk to a family doing this what a cool special experience to get to do something great professionally with your parent is a child and with your child as a parent I can think of no more fulfilling experience in life it's just so cool well listeners if you are wanting to discuss these topics with us after listening because there's some really meaty stuff in here and I can't wait to chat about it with everyone here come to the acquired slack acquired dot fm slash slack we will be talking about it we've got merch available merch finally at acquired dot fm slash store you can listen to the L P show by searching acquired L P show in the podcast player of your choice or you can get episodes early at acquired dot fm slash L P David anything else no all right with that listeners we'll see you next time see you next time who got the truth is it you is it you is it you who got the truth now