Classic Business Principles Matter-Especially For Venture Returns

Every so often in frothy environments, people think they can bend rules and bend curves.  We are seeing that in real-time these days.  Yesterday I posted about venture returns vs stock market returns.  Historically, both asset classes are doing a lot better than normal.

One of the reasons for froth is the consistent basically zero interest rate policy of central banks around the world since 2009.  That changes risk preferences.

But, I am not going to talk about or argue about the reasons why where we are here.  I am interested in the future.  This post is less about specific areas to invest in and more about the culture of companies you want to invest in.

As an investor in startups, I feel like you have to have a keen eye to how you think things will be ten years from now.  For example, as Covid has enveloped the world, people are waking up to “How can I invest in video conferencing, alternative education, telemedicine, co-working alternatives?”

Those bets were made 3-7 years ago.  Maybe more.  If you want to invest in companies like that, be patient and wait for them to go public.  Build them into a diversified portfolio.

The companies that are in those spaces that are doing well are adhering to classic business principles.  They worry about getting a return for shareholders, increasing operating margins, and delighting their customers.

What they do not do:

• They do not worry about their role in the broader world.
• They don’t worry about making a virtue statement.
• They do not take deliberately take money that would normally go to shareholders or employees or customers and give it to charity.
• They do not keep their cost structures in place when there are cheaper alternatives.
• They do not toss money into “of the moment” charities disguising them as marketing expenses.

What they do:

• They execute like they are on a mission and that execution drives leadership which attracts amazing people who want to be a part of their company
• They consistently talk to their customers and innovate for them to satisfy and delight them so the customers want more.
• They create value every day for their customers.  Enough value that their customers happily pay for it in some way.
• They don’t necessarily care about “fill in the blank color by number” diversity, but they actively recruit employees from all kinds of places who thrive in a business culture that values merit and achievement over victimhood.  They value each and every employee.
• They understand how to motivate employees.  Sometimes it’s not more pay but more autonomy or more responsibility which values their dignity.
• They allow for open conversations in the workplace, but they are not overtly political.  Politics is for the home.  Their concern is their customer and the shareholder.

Successful companies grow revenue.  They grow it fast. I thought this part of this video by Professor Deutsch was great. I have seen exceptions, but her generality in this part of the video is correct.

It is alarming to see the Chamber of Commerce pivot to caring about things other than providing the utmost value to shareholders and customers.  It is alarming to see the venture community worry about things other than funding innovation that can propel society forward and create new markets and value where none existed before.

The longer that this ethos persists, the more danger there is in lower returns.  As I showed yesterday, the risk in venture is great because of variance.  They can’t afford low returns.

I am not saying don’t invest in certain founders.  I am not saying that businesses shouldn’t care about employees or if their business is adversely affecting the environment or something else.

Know how great businesses care of both those things?  By executing and taking care of delighting their customers and shareholders.  Employees always have a choice to work for someone or not. Conversely to popular opinion which is wrong, there is no race to the bottom in capitalistic societies.  Competition along with freedom of choice takes that option off the table.

I am also not saying to avoid investing in things solving a “social good” problem.  It may be there is a market there that didn’t avail itself before.  Daily, we are churning out new technology and analytical data that uncovers new ways to go to market and create businesses.  Maybe five years ago that market was unseen.  Maybe it wasn’t possible to build a business there but the company has figured out a way to monetize that market in a way that no one else has tried.  Facebook might be a good example of that since the company monetized people’s time and personal data.  People gave it away freely in return for what they could do on Facebook.  That hadn’t really been done in that way before.

If you watched the video I posted, you will see I disagree slightly with Waverly.

The invisible hand of the market is unforgiving.  It rewards achievement and it penalizes failure. When business leaders decide to make an active choice to avoid following classical business principles that have sustained businesses since the beginning of time, they will eventually be disciplined by that invisible hand.

My prediction: the businesses that get slapped by that hand will do one of two things; make excuses for themselves or get back to basics.  The ones that make excuses will go out of business.

I think Milton Friedman articulated these basic principles in the best ways so that everyone could grasp and understand them.  He’s not so popular these days with the elites but I think he’s still correct and the principles he articulated are all sympatico with the ethos of B Corporations and the rest of the drek we read about today.

For me, I am looking for founders that are interested in building a business that totally delights their customer and eventually will reward the shareholders who took early risk investing in them.  I won’t invest in anything else.

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