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Tornado Traffic
My daughter and I were parking the other day at a soccer complex in Illinois that is susceptible to severe traffic jams when everyone tries to leave at the same time. Some relevant information here is that the last time we were at this soccer complex, her game got blown dead due to a tornado warning and then no one could escape as the sky turned green and the sirens started wailing because we were all waiting to merge into one lane of traffic and make a right on red.
“Eff this,” I finally said and drove up over the curb and onto a bike path that took us to safer ground.
The reason this is relevant information is that as we were parking this time I said to my daughter, “Do you want to park near the field and risk getting stuck in traffic when the tornado hits or should we park near the exit and have to walk a ways to the field?”
I, of course, would prefer to park near the exit and walk because (1) optionality and (2) I’m an Apple Watch psychopath.
But she said, “I don’t think a tornado is likely, so let’s park near the field. That way we’re sure of getting something good.”
So I said, “I love that you’re thinking about risk and reward and you’re probably right about a tornado, but I think you’re overvaluing the reward of parking close and undervaluing the risk of getting stuck in traffic.”
And she turned and looked at me funny, so I parked near the field because (1) I know I’m crazy and (2) I didn’t want her to be late.
Yet I still think I was right (even after leaving out the benefit of getting more steps in, which admittedly has more value for the geezer about to sit and watch a soccer game than it does the young person about to run a handful of miles playing in one). The reason is that earning gains of one magnitude without being cognizant of the potential magnitude of losses said gains expose you to regardless of the infinitesimal likelihood of said losses materializing is a good way to eventually end up on the wrong side of a bet.
In other words, getting a great parking spot is not worth being stuck in your SUV when it’s sucked up by an F5. While that seems obvious in this context, I can assure you it is not in the real world. People look at you funny after 10,000 instances of being angry, tired, and behind schedule because you parked out in left field when you keep suggesting you park there to escape from a tornado that has never materialized.
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From Here to There
One saying we have around our office is that what got you here won’t necessarily get you there. What this is in recognition of is that projects, businesses, and people are all works in progress. In other words, what you did to get where you are today may not scale and, in fact, may be working against you with regards to getting where you want to go next.
For example, after years of thinking about it, we finally (now that we have a qualified CFO) implemented Expensify in our own office to better track, reimburse, and manage expenses that employees were incurring on behalf of Permanent Equity as well as promulgate an official expense reimbursement policy. Previously, this process was manual and we trusted the judgment of individual employees to decide what was an appropriate amount to spend on something. With 10 employees, that was fine. With 15, it started being a hassle. As we approached 20, it became a pain point.
Process and policies, of course, mean less flexibility, which might be irksome to some, but also enables faster scaling. The reason that’s so is because fast, decentralized decision-making relies on trust. Absent process and policies, the only way to build trust is through careful hiring and relationship building over long periods of time. And that’s one way to do it. But if you want to go faster, you need process and policy so that new folks can understand what success looks like and what is expected of them. But also everyone needs to abide by the same rules because having two (or more) classes of employees will never beget a strong culture.
Here’s another example: We saw another business that had scaled to high heights and promoted several long-tenured employees into leadership roles. Normally, this would be a massive success story and a desirable situation. The problem was that these employees were hired before the business had to document their immigration status and no one knew what that status was.
For a small, closely-held business that may remain an unasked question one can live with. But for a large business taking outside capital, it’s a non-negotiable.
This isn’t to judge anything anyone has done to build their business. Decisions are always made in context and looking back, most that I’ve encountered have been defensible. But some decisions have half-lives and others get outgrown. That’s important to remember and revisit because scaling on top of a shaky foundation is a good way to sow the seeds of your own destruction.
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Risk and Recovery
I know I’m repeating myself when I say that one of the benefits of writing daily about things that interest you is that other people read about the things that interest you and then curate the internet on your behalf by sending you things they think might interest you, but it really is a nice perk. So it went the other day as I opened my email while drinking my morning coffee to find a note from Johnny that said “From James Clear…Seems like something that would be of interest to you…”
And it was!
If you don’t know James Clear, he’s an author and authority on habits and decision-making. He has books and a newsletter, and it was from his newsletter than Johnny passed along this:
One filter I use for making decisions: How much can I influence the outcome after the initial choice is made?
When I can do a lot to influence the outcome, I’m less worried about risk. Even if the choice appears risky on the surface, I can likely create a good outcome with effort.
When I can’t do much to influence the outcome, I’m more risk averse. Even my best effort won’t move the needle. Your ability to influence the outcome after a decision is made is a crucial thing to consider.
On its face, this seems like sound advice. If you have more agency, try to do more, because (1) your ability can make good things happen and (2) if good things don’t happen, it was your fault anyway.
But what this advice ignores is how consistently (1) people overestimate their ability to influence outcomes and (2) how often the world conspires against our best efforts.
I try to avoid politics in this space, but I don’t think it’s political to point out that when Russia invaded Ukraine in February 2022, it thought the war would be over in 10 days! There’s really no situation where someone can think they have more agency than a global superpower choosing to invade another country, but here we are.
Taking it down a notch, our COO Mark feigns offense whenever I tell someone that when we underwrite an investment, we don’t assume that we can do anything to make the business better. But it’s true (and no, that’s not me disrespecting our Ops team). Rather, it’s acknowledgment that even when you think you have 100% agency, you probably don’t and further that making any prediction come true is an incredibly difficult task.
Does this mean you shouldn’t take risks? Heck no. But I think the better framework for thinking about them is: Can you recover if they materialize or will there be permanent damage done? In other words, if I were to revise James Clear’s advice, I’d put it this way:
One filter I use for making decisions: If my choice is a bad one, can I recover from the consequences of it?
When I can recover from the consequences, I’m less worried about risk.
When I can’t recover from the consequences, I’m more risk averse. Your ability to recover from the risk you are taking after a decision is made is a crucial thing to consider.
– By Tim Hanson
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The Most Dangerous Danger
Our managing editor Sarah pinged me recently because she realized I had to update my bio on our website. I was no longer CFO, she pointed out, and she asked if anything else had changed.
Reading it again, that brief bio from when I started way back in 2018 said that I enjoyed “running, gardening, biking, paddling, and soccer-ing.” So I wrote her back and said that she could delete biking and paddling because I really don’t do those any longer.
“What happened?” she asked.
“As I age, I streamline my activity set,” I responded.
And it’s true. When it comes to physical activity, I know I’m one wrong foot away from a debilitating injury at this point so I only try to do things that I’m willing to risk being crippled by. Just as in finance, there is no medium risk, so try to traffic only in activities that give you upside.
The analog to this is that it’s the unintended bets that will get you, because they’re the bets you don’t know you’re making. For example, if you recently picked up pickleball because it seemed fun and you didn’t think it could cripple you, well, you’re wrong. Pickleball is expected to cause $400M worth of injuries this year. And that’s surprising because pickleball, on its face, doesn’t seem as violent as something like football or hockey.
But that’s what makes it so dangerous!
The Wall Street Journal reported recently on this study, which found that on the job accidents “are most likely to occur under moderately hazardous work conditions.” In other words, as measured by likelihood of injury, safe jobs are safe and really dangerous jobs are safe, but kinda dangerous jobs are really dangerous. And that makes perfect sense when you put these ideas together and realize that if you take any risk, you are taking catastrophic risk, and if you don’t realize the risk you’re taking, you make it more likely that that risk will materialize.
That’s the most dangerous danger, so stretch before you play pickleball and have a great weekend.
– By Tim Hanson
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How to Hold Cash
We are fortunate at Permanent Equity to have a strong balance sheet, and we prefer to keep it that way. Of course, the downside of holding “excess” cash, particularly in an inflationary environment, is that you have to find something to do with it.
Or do you?
Our founder and CEO Brent dropped by my desk not long ago and asked what we were doing with our cash and if nothing, should we buy treasuries to take advantage of the high interest rate environment? The cash was sitting in some safe bank products earning reasonable (but not great) rates, so he was right that if we bought six-month or one-year treasuries we could earn quite a bit more. The question was did we want to take the duration risk?
I’ll be honest here: Duration risk terrifies me. Having money and not being able to use it or being forced into taking a loss because it’s today and not tomorrow seems like it would be both painful and humiliating. Further, this is the kind of risk you don’t realize you’re taking that can blow you up – as duration risk did to Silicon Valley Bank. That said, it’s also painful to watch the value of our money get eroded, so how might one balance these two suboptimal outcomes?
I’ve talked before about The Four Important Roles, and one of those is the person who’s constantly creating opportunities for an organization to take risk. At Permanent Equity, that’s Brent, and he’s great at it. What he’s not great at though – and the reason he’s not great at this is because he’s so great at creating opportunities – is predicting when he will create said opportunities.
So after thinking about it, what I said to Brent was, “I don’t think the incremental interest income is worth being handcuffed if we get the opportunity to make a really big investment we don’t even know about yet.” Yes, I know we could borrow against treasuries and so on and so forth, but then you are also bringing in other decision-makers and risks, and we like to keep things in house.
He ultimately agreed so we continue to keep more capital on the sidelines today than we probably should. But we think that’s because what we’re not earning today will be more than made up for when we get that opportunity to finally do something with the money.
As for how much cash you should keep on the sidelines, that answer will be different for everyone depending on the risk-free rate of return and your ability to create high-returning opportunities. If you don’t think any big opportunities are on the horizon, lock it all up in treasuries. But if something big might happen, you’ll want your cash to be ready to go.
That being said, no matter how big an opportunity there is, never go to no cash because you’ll always want three-or-more months of operating expenses on your balance sheet just in case there’s a pandemic or something.
– By Tim Hanson
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Governance, Hygiene, and Growth
When it comes to running a business, we’ve found that there are three core areas operators can focus on: (1) Governance; (2) Hygiene; and (3) Growth. Further, it's possible to view these areas as legs of stool, which is to say that if a business focuses on one more than another, it’s going to topple over. What’s interesting, however, is that rarely do we find a business that pursues all three in balance. But before I get to why that is, let’s define terms:
Governance is the setting up and maintaining of systems that reliably generate accurate information that tells you how your business is doing. (Example: If you operate a business but don’t bother looking at your financial statements because they’re not helpful, you don’t have good governance.)
Hygiene is the deliberate ongoing improvement of best practices in key areas that leads to steady-state improvement. (Example: If your cash consistently lags earnings because you’re not on top of AR collection, you don’t have good hygiene.)
Growth is the generation, prioritization, and execution of new and compelling strategies that leads to a step change in trajectory. (Example: If you haven’t hired and/or promoted 10% of your organization in the past year, you don’t have good growth.)
As for why it’s hard to do all three at once, growth is fun while governance and hygiene are not. Business operators of the more aggressive and visionary kind know this and will pursue growth without regard for governance and hygiene. The problem there is that if you grow without good governance and hygiene, that growth will break your business.
Governance and hygiene, on the other hand, aren’t fun, and what’s worse is that they can be incredibly time consuming. More risk averse operators will focus on these areas and end up not growing either because they don't have the time to think about how or because they consistently see inadequacies in the business that make it uncomfortable to pursue growth. For those folks it’s important to understand that business hygiene can be a black hole in terms of inputs and outputs, so know the difference here between perfect and good enough.
I’ve talked in the past in this space about the four important roles. These are the people who (1) create opportunity; (2) decide which opportunities to pursue; (3) execute opportunities; and (4) measure results. You can also bucket these functions with regards to governance, hygiene, and growth. (1) and (2) drive growth while (2) and (3) watch hygiene and (3) and (4) keep good governance.
Yet for it all to work, the functions need to respect one another and maintain balance. As for how to do that, again, it’s rare, but being aware of the forces at play is step one.
– By Tim Hanson
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Peoples is Peoples
There’s a rumor going around town that the reason there is one really strict school bus driver who keeps giving out “bus tickets” that prohibit poorly behaved students from riding the bus is because he’s trying to make it so he has the fewest number of passengers so he can finish his route faster and get home while getting paid the same amount. If true, this is a slightly different flavor of quiet quitting, and it’s as insidious as it is brilliant.
Further, this guy must be in cahoots with the delivery person who keeps dropping packages vaguely near the end of our driveway rather than take the five minutes to go up to the house because that’s a job that’s paid to finish routes on time as well. As business philosopher Charlie Munger says, “Show me the incentive, and I will show you the outcome.”
While perhaps we can argue that the school district should propose a more market-based approach where bus drivers are paid based on the number of students they pick up and drop off rather than by the day, the fact is that the labor market is tight. I think many have experienced the reality that businesses and organizations today are hanging onto people despite performance just to keep the lights on.
The stress from worker shortages had previously been considered a temporary phenomenon attributed to knock-on effects from our collective response to Covid-19. Yet The Wall Street Journal argued recently that the crisis is, in fact, a long-term one and that it’s not going to get better. I didn’t know this, but the labor force participation rate peaked in 2000 and has been declining ever since.
What will we do in a world with fewer workers? I think we’re seeing it today: Pay more for lower performance.
There’s another line of thinking that says technology will solve this problem for us, with gains in efficiency more than offsetting losses in manpower. I actually think that technology stands to make the problem worse. After all, technology creates problems that people have to solve. It’s now frictionless, for example, for a customer to register a complaint with a business, and your boss can find you with a gripe at any hour on any day. And I don’t know what your experience has been, but people are far superior at solving my problems than software (No, AI Chatbot, your answer is not satisfactory).
Where does that leave us? We need people, and we need to invest to build them up.
– By Tim Hanson
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Use Words Wisely
If you don't follow English football, then you may not have heard about the massive refereeing error that cost Liverpool a goal against rival Tottenham. The short version is that Liverpool scored but a player was judged offside by the referee on the field. The call went to video review and that official saw that the player was clearly onside and that the goal should count. So he said, “That’s fine. Perfect,” meaning the goal was fine and perfect.
But!
The referee on the field thought the video reviewer meant the original offside decision was fine and perfect. So he didn’t give Liverpool the goal and restarted play in a match Liverpool ultimately lost 2-1. And when the video reviewer realized what had happened, he said a bad word.
That makes sense in a league where goals are rare and winning and qualifying for the Champions League is worth tens of millions of dollars. In other words, this is consequential stuff, and real damage was done here by someone not taking the time to be helpful and precise with their words.
This is something we are working on with my daughter’s soccer team as well. That’s because while we were practicing, I noticed players with the ball getting confused by all of her teammates yelling “Here!” when they thought they should get the ball.
Because where exactly was “here?” And what kind of pass should the player with the ball make? This would also be useful information!
So we stopped and talked about using words that might be more helpful and precise. Instead of saying “Here” (which gives no information), one could say “Drop” or “Switch” or “Far post” (which does). And that incremental improvement in communication enables the player with the ball and the player calling for the ball to exponentially better collaborate.
Serendipitously, I was rolling all of these thoughts about effective communication over in my head when I lucked into the opportunity to spend a couple of hours talking with 5 Voices co-creator Steve Cockram. He and his co-author Jeremie have a new book coming out about communication codes and how to use them to have more productive conversations personally and professionally. The preview is that there are five material ways to communicate: critique, collaborate, clarify, care, and celebrate, and that you should have a shared understanding about which you’re doing with the person you’re communicating with in order to have the most productive conversation.
For the girls on the soccer team, it’s using words to collaborate with their teammates in order to play the best possible ball. For the referees who botched the Liverpool goal, it should have been clarifying what they saw and then what they heard before confirming the next course of action.
Because at the end of the day, words matter, and Steve and Jeremie’s frameworks are an interesting way to think about them and also use them wisely to maximize their value.
– By Tim Hanson
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Would You Buy Stock In Yourself?
One interesting way to think about the value of anything is to ask if you would buy stock in it. For example, would you buy stock in Unqualified Opinions? What about Permanent Equity? Capital Camp? Columbia, Missouri?
Me? I’d buy stock in all four of those things, which is why I live where I live and spend my time doing what I’m doing.
I’m also long Sporting Columbia 2012G Navy, The Interrupters, and mushroom hunting, but that’s fodder for another day.
Now I know an easy objection here is “What’s the price?” And that’s fair. Price matters to the success of a transaction. But for the sake of argument here, let’s just assume fair terms.
The reason I think this is an interesting framework is because it forces you to consider whether or not you would give something capital. That’s powerful because providing capital to a person, place, or enterprise is one of the most meaningful things you can do. Not only does it fund that entity, but it shows that you have confidence in it, that you trust it and expect it to increase in value over time, and that you want to spend your time learning more about it or being helpful to it.
It’s been a weird, dystopian idea for a while now but every now and again someone will set up an exchange where people can sell stock in themselves. This is uncomfortable for a lot of reasons, but I think it keeps popping up because the kernel of it is interesting and comes from a place of positivity.
But no, I’m not proposing it.
Instead, I’d suggest making a list of all of the things you spend time on and the people you spend time with and ask and answer the question, “Would you buy the stock?” And, of course most importantly, “Would you buy stock in yourself?”
Have a great weekend.
– By Tim Hanson
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Competitive Hugs
If you follow him on X, then you probably know that our CEO Brent has been on a bit of a health kick this year. And while I absolutely will continue to make the joke that cholesterol is the biggest existential risk facing Permanent Equity, it’s a pretty impressive feat that he’s gotten close to running a sub-seven-minute mile. What’s more, that is going to make Permanent Equity’s annual Run to Rocheport “fun run” (happening tomorrow!) a bit more interesting.
But you know who else has gotten close to running a sub-seven-minute mile? My 13-year-old son! This has me worried because I have never lost a Turkey Trot in the Family Division, holding off decades of challenges from siblings, cousins, nephews, uncles-in-law, etc. Is this the year that record falls?
I’ll tell you what: I’ve been working my butt off to make sure it isn’t. With both Brent and my son shedding time, I’ve reintroduced more painful speed and interval workouts into my routine to make sure I am still able to run a mile closer to six than seven.
This is the healthy side of competition. It’s a force that can help us all get better at something together.
Yet being competitive is also a trait I have struggled with during my career at the office. In what areas should I compete? How competitive should I be? And in what areas has being competitive helped my career vis a vis areas where being so has hurt it?
After more than 15 years of working with our COO Mark, I think it’s safe to say that he is less competitive than I am. But he’s just as successful, if not more so. How does that work?
It’s with that as background that I had to tweak him when he posted the following cartoon:
“Why do you hate winning?” I responded.
In truth, Mark doesn’t hate winning, and that’s actually what makes us reasonable coworkers. We approach the world with different mentalities, which makes for what Mark calls a “productive dichotomy.”
In order for a dichotomy to be productive, however, you need to respect that the differences you have with a colleague are both valid and interesting. Further, if you’re competitive, like I am, it’s also becoming self-aware that a competitive streak does not give you license to be an asshole.
Candidly, 20 years ago, given the same set of circumstances if either Brent or Ben ran me down in a race, I’d have been pissed. If it happens this year or next, I’m going to give them a hug.
– By Tim Hanson
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Tell People You’re Different
I am doing you a solid here by letting you know that if you ever get the invitation to travel with our COO Mark, you should politely decline. The reason is he’s cursed. His flights are always delayed, impacted by weather, landing at the wrong airport, etc.
The silver lining of this is that it gives him a lot of time to unleash lengthy threads on Twitter (or whatever that Musk guy is calling his platform now). So it went the other day when he had another long layover and invited people to ask him anything because I guess he was bored.
One interesting question he received was from Ben Tiggelaar who wanted to know “What’s the Permanent [Equity] strategy around all this focus on social? So interesting given no [private equity] firms really focus on content.”
It was a good question and an astute observation, but the answer is a simple one: Because it makes sense.
As Mark replied, we know it adds value because both he and I first encountered Permanent Equity on Twitter and also because our funds originated as a result of a relationship Brent first built on the platform.
And as I added, we know that online content scales conversations and find that it’s an advantage for people to know us and what we’re going to say before they actually know us or we say anything. That’s because our value proposition and approach to investing are consistent, and we try to always do what we say we are going to do. At the risk of making a straw man argument, I suspect other private equity firms don’t publish content about what they do because either (1) they don’t want people to know or (2) they want the latitude to say whatever it takes to get a deal done.
Something that’s interesting is that if you have a problem, there are usually lots of solutions that will work once, but it’s harder to find a solution that will work sustainably. With regards to making investments, attracting investors, and recruiting, by laying a long trail of content that describes what we do and how we do it, we believe that things in those categories that would be a good fit for us will eventually find us. And also that that approach is superior to doing what it takes to capitalize on available opportunities. That means going long stretches without doing anything sometimes, but also never doing anything we don’t know or want to do.
So in short, be different and genuine because you can always be that, and if you are, tell people about it. But also, never travel with Mark.
– By Tim Hanson
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Beer Money
Back during Season One we occasionally published a piece called CIMple Truths, which was a compilation of ridiculous claims and presentations we’d seen recently in deal teasers. I retired the template for Season Two because (1) the gag didn’t resonate like I thought it would and (2) we haven’t been seeing as much ridiculous stuff. (1) is on you guys because I thought they were hilarious, but (2), I think, is a product of higher interest rates and a more subdued dealmaking environment keeping weird stuff away from the market (Trump and Chamath and all of the other weirdos would never launch SPACs now).
But!
I am unretiring the format today because I have never seen anything as ridiculous as this:
I left out the numbers because they don’t even really matter, but what is the thought process behind presenting three different kinds of “contribution margin”? Because a business’ level of profitability before accounting for marketing and distribution costs is not only not a thing, it’s irrelevant!
The reason that’s so is because without marketing and fulfillment, there is no business.
I’m dating myself here, but I am old enough to remember Groupon and ACSOI. ACSOI was a measure of that company’s profitability if you didn’t include what it cost to acquire customers or what it paid employees in stock-based compensation. Again, no customers or employees, no business! There is no world where you should add back or adjust out critical functions. And don’t get me started on adding back hypothetical earnings from counterfactual “optimizations.”
This is why we measure the value of a business in terms of how much beer money it produces. You could also call this really free cash flow. This is the money, all of the accounting shenanigans and GAAP yada yadas aside, that you have leftover at the end of the day that you can withdraw from a bank account to buy beer with. And, if you have a lot of it, cheers.
– By Tim Hanson
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An Unavoidable Opinion
I’ll come clean: when the FTX and Alameda complaint against SBF’s parents was released, I hoped it would provide fodder for the rest of Season 2 of Unqualified Opinions. Unfortunately, nothing in that complaint was funny or clever or even interesting. Instead, it was gross, with the epitome of grossness being SBF’s dad complaining in an email to his son that he wasn’t being paid enough to do nothing and cc’ing SBF’s mom to solve the problem. Yuck.
So that meant I also wasn’t that interested in reading Michael Lewis’ new book Going Infinite about the whole sordid and illegal (and gross) affair. That is until Matt Levine of Money Stuff started excerpting from it and then the trial started and then it was everywhere, and so I was unavoidably pulled back in.
Now, as chair of Permanent Equity’s Matt Levine fan club, you can rest assured that I don’t find fault with most of what’s published in Money Stuff, but this whole SBF/FTX saga has been so bizarre (and gross) that it’s prompted people to take some unexpected positions. For example, here was Levine opining on SBF’s first employer, investment firm Jane Street, and its practice of requiring interns to learn how to bet against one another:
It is optimal for a firm like Jane Street with a lot of traders to encourage each of them to take a lot of positive-expected value risk, because Jane Street has enough of them to benefit from the law of large numbers. With enough independent positive-expected-value bets, it will make money, even if some traders lose money.
And then here he was carrying that line of thinking through to a discussion of public company CEO compensation:
This is analogous to why corporate chief executive officers are often paid with stock options: It encourages them to take the amount of risk that is appropriate for their shareholders. A CEO generally has a huge chunk of her human and financial capital wrapped up in her job, and it is very important to her not to lose it. So she will naturally be conservative, preferring steady mediocrity to risky expected value maximization. But her shareholders are diversified funds who own lots of companies and want each one to maximize expected value. So they adjust her utility function by giving her stock options that pay a ton in the upside cash and nothing in the mediocrity case.
Say what?
In the case of Jane Street, yes, that math can work for some period of time, maybe even a lifetime, but the reasoning falls victim to the fallacy that a lot of independently stupid decisions can sum to a broader good decision (they can’t!). Further, it underestimates the likelihood that if one bad thing happens, it will make it more likely for other bad things to happen. For example, if the market got wind that some Jane Street traders were getting smoked, it would likely start actively trading against the other Jane Street traders.
In the case of executive compensation, the CEO in this strawman, who is probably already financially secure, has every incentive to be reckless in order to get those options to pay off because she stands to gain a lot and lose very little. This is why so many public companies lever up to repurchase shares. Doing so risks up the business, with that risk being borne by shareholders, in order to jumpstart the stock price, with that reward being reaped by the options-holding CEO.
Yet Levine isn’t the only one that SBF/FTX has gotten to think funny. The aforementioned and previously unassailable author Michael Lewis (Moneyball remains a classic) seems to have fallen victim to a con, writing 288 pages about a visionary who was actually just a criminal and not bothering to verify any number of wild claims. Moreover, he seems to be doubling down in recent interviews that SBF, despite an objectively incriminating fact pattern, is simply some kind of misunderstood. Asked point blank if he believed SBF was a serial liar, Lewis responded, “I think he’s a serial withholder. Unless I asked exactly the right question, I did not get the full picture.”
Which, you know, is what happens when someone is a liar.
Anyhow, there is still more trial to come, and everyone is assumed innocent until proven guilty, but my opinion, in case you missed it, is that it’s gross.
– By Tim Hanson
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They Blew Up the Bridge
Not long ago they blew up the Rocheport Bridge, which was how Interstate 70 crossed the Missouri River near Columbia. We live near there and have river access and friends with a boat (which is way better than owning a boat in terms of risk/reward profile), so we went down that morning to get a good view of the explosion. Not only did we get that, but we also got video, and I have been racking my brain ever since about ways to connect that video to some kind of business, finance, or investing lesson so I could share it in this forum because it’s pretty freaking cool.
Nothing worked, though, so I finally decided, “Screw it. Sometimes it’s fun just to watch stuff blow up.” So here you go and if you’re able to find a business, finance, or investing lesson in here somewhere, (1) all the better; and (2) let me know what it is.
Have a great weekend.
– By Tim Hanson
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What’s Partnership Worth?
We had an exchange the other day with some folks who were trying to decide between selling some of their business to us or doing nothing and just keeping it (which is our biggest competitor). To help them make that decision, a spreadsheet got built that looked at how the business might perform in the future and then compared the cash flows that the sellers might receive were they to sell some now and own less later versus sell none now and take all of the distributions later.
It should go without saying that if the sellers kept 100% of the business, they would receive more money over time than if they sold. The reason for that is that any buyer requires a return on their money and that return is what you as the seller are foregoing in order to put the buyer’s money in your pocket today. But a today dollar is worth more than a future dollar and particularly so if the prospects of earning that future dollar are uncertain, so you need to discount those unpredictable future dollars to make an apples to apples comparison.
This is all vanilla present value/future value stuff, but where it gets interesting is when you start to think about how much of a discount those future dollars deserve. The reason this topic arose is because we modified the spreadsheet to show that we believe that it was worth about the same in total present value for the sellers to sell some to us rather than keep it all themselves.
To which they reasonably replied, “Well, sure, but you are using a lower discount rate on the scenario where we sell and a higher discount rate where we don’t. If you use the same discount rate, not selling is worth more.”
To which we reasonably replied, “Well, yes, we are using different discount rates, and while we could debate what the discount rates should be, we feel strongly that they should at least be different.”
And the reason they should be different boils down to the value of partnership. If you’re running a business on your own, without access to outside capital, and with no team of experienced professionals standing by to be helpful, are you less, equally, or more likely to achieve growth and success than if you do?
If your answer is less or equally, think hard about why you’re bringing on a partner. Because if you’re bringing on a partner, the answer should be an emphatic “Yes, the business is more likely to achieve growth and success with this partner than without it.”
And so your discount rates are different…
And so partnership is worth more…
As for how much more, well, that’s why this stuff is more art than science. But don’t just take my word for it. I’ll give the last word here to our friend and business owner Mike Botkin, who said this about a good partnership:
“Having a partner…is a cheat code. It’s a true 1+1=100. From nitty-gritty, to brainstorming, to strategic decisions, to just BS-ing on the phone…Having a partner in business, like life, is crucial and critical.”
– By Tim Hanson
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Relevant, Useful & Beautiful
Our resident curmudgeon and chief legal officer Taylor Hall recently passed along this article that reported that “the vast majority of NFTs are now worthless” with the commentary “Did NOT see that coming.” Of course, I can’t let Taylor take a victory lap here without also bringing up the fact that at one point he was knee-deep in NBA Top Shot.
“Knee-deep,” though, is not as deep into NFTs as a lady we met in New York was, who made the case that because NFTs were the only things in the world that were truly non-fungible and unique that their value was inherent and that everything in the future would be “on chain.” I hope she didn’t quit her day job.
The stats, though, are nuts:
95% of NFTs are worth zero.
23 million people hold worthless NFTs.
79% of NFTs never even got sold due to the massive supply/demand imbalance.
The report concludes “In order to…have lasting value, NFTs need to be either historically relevant, true art or provide genuine utility.”
The point here is not to dunk on NFTs or the people who bought them, though it’s obvious in hindsight that all of the signs of a bubble (suspension of disbelief, rising prices, FOMO, inexperienced market participants, etc.) were there. Rather, it’s to point out that that framework is a pretty good way to think about the value of anything. For something to be truly valuable, it has to be relevant, useful, or beautiful, and ideally more than one or all three.
Your house? Relevant because it gives you somewhere to call home. Useful because it keeps you safe and warm. And I hope you find it beautiful. Clearly valuable.
Money? Relevant to all of your transactions with others and useful because it buys the things you need. And there’s a reason numismatics is a thing. People have taken time to make something as valuable as money beautiful too.
Stocks, you might argue, are none of those things, but stocks are derivatives of beauty, utility, and relevance. A share of Apple, for example, represents that an iPhone is all three of those things to its users.
This is all to say that NFTs aren’t inherently valuable or not. Nothing manmade is, unless it’s well-made, thoughtfully, and with a purpose.
– By Tim Hanson
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You’re Winning? Stop Watching.
Danny and I were chatting recently about Mizzou’s subdued (until they defeated Kansas State on a thrilling last second 61-yard field goal and started rolling, last weekend excepted) start to their football season when he admitted that he stopped watching at halftime of their narrow week 2 victory over Middle Tennessee State. The reason, he reasoned, was that if he kept watching, the best case was that they eke out a win and the worst was that they blow it, neither of which seemed like entertaining options, so there were better ways to spend his time.
I admitted to doing the same mental gymnastics when the Georgetown Hoyas basketball team would go into halftime with a big lead (though that hasn’t happened in a while). With the range of outcomes being a benign second half to a disastrous collapse, there really wasn’t any reason to watch further (unless you’re a masochist).
This is what happens when one views the world in terms of upside and downside.
A good book about investing is The Dhando Investor by money manager Mohnish Pabrai, which is mostly remembered for its observation that you want to buy into situations where your risk and reward are asymmetric. Or as Pabrai puts it, “Heads I win; tails I don’t lose much.”
Of course, the issue with that is that you can always lose everything, as Pabrai himself found out years after The Dhando Investor was published with his investment in Horsehead Holdings, a metals business that seemed cheap by any measure but ultimately declared bankruptcy. Explaining the outcomes to partners, Pabrai said:
We ended up with a trifecta of low probability events in unison. They ran into very significant ramp-up difficulties on a proven process. At the same time, zinc prices collapsed to levels not seen since the financial crisis. Nickel prices have collapsed to a multi-decade low. All of these decreased profitability and increased the need for cash at the very same time their liquidity was becoming quite stressed.
The learning is that we underestimate the probability of negative, low probability events happening at the same time. I’ve newly minted this the Hurriquake Principle, which is to say that just because you’re experiencing a hurricane doesn’t mean you can’t also have an earthquake. But when it comes to business, I’d go a step further and assert that experiencing a negative event makes another negative event more likely to occur because stress begets stress.
Now, I know you can’t just turn off a business, but the point is that if you find yourself in a situation where the upside is capped, walk away! That’s because limited downside is an illusion, so you can only be compensated with upside. It’s the same asymmetric orientation as Pabrai’s, but inverted to account for the fact that bad things can always happen – a reality well-known to Mizzou football and Georgetown basketball fans alike.
– By Tim Hanson
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Hard Skills and Self-Discovery
After she read “Be Ambitious,” Kelie (our Director of Talent Acquisition) responded with an article about “squiggly” careers. This is the idea, named by authors Helen Tupper and Sarah Ellis, that the best career paths are non-linear because they lead to rounder development and greater possibilities. A decade back, then Facebook COO Sheryl Sandberg made a similar argument, but used the analogy that you should think of your career path like a jungle gym, where you can climb anywhere, rather than a ladder, where you can only climb the next step up.
Broadly, I agree with this thinking and have tried to live it.
What’s interesting, though, is that all of this opining on the importance of de-regimenting career paths comes at a time when it seems to be the case that college students are more likely to pick majors that would put them on a more regimented career path. For example, here are the five college majors that gained the most market share over the past 20 years:
The major with the most market share remains business, at 18.9%, but that’s down more than 2% from 20 years ago.
As for which majors have lost the most share, aside from business, it’s education (-4.7%), social sciences and history (-3.1%), English (-2.6%), and liberal arts (-1.2%). As an English major who graduated from a liberal arts college, I weep for our future. (You can find the data here.)
Not really; I’m an optimist when it comes to things like economic growth and development. Moreover, and at the risk of generalizing, I don’t think this seeming inversion in trends (humanities majors happy to be on stable career paths versus hard skills majors who pine for self-discovery) means we are as different now from then as we might think (despite all of the shade different generations like to throw at one another).
Rather, I think it’s the case that people want to be both well-rounded and successful. Perhaps in the past, when college was less expensive, there was less pressure to learn a marketable trade because you could find structure in your career. Now that it’s more expensive, I know many feel the pressure to graduate into a career path. Yet just because someone learned to code doesn’t mean that that person isn’t also interested in people and philosophy. Except for the software developers we all know who have no interest in people or philosophy.
Yep, we know who you are.
– By Tim Hanson
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Hey. Pick Up the Phone.
There’s a big difference between illiquidity and insolvency, but the former can feel pretty stressful when there’s a bill to be paid and nothing but assets that aren’t cash on the balance sheet. “Can I pay you with this inventory I haven’t sold yet?” is not something your suppliers want to hear.
So it was at one of our companies that was cash poor with $1M of bills to pay and several million of AR on the balance sheet. In other words, the money was there, but it wasn’t in cash, so we were on the verge of a crisis. Yet by the end of the week, we’d paid our bills and stacked more than $1M on the balance sheet.
What happened? We picked up the phone.
As it turns out, when we were told that the company had done everything to collect its overdue receivables, “everything” including everything but picking up the phone to call the people who owed us money. We had texted them, emailed them, slacked them, emailed them again, and complained loudly to others in the office that we hadn’t been paid yet. Shocker, none of that worked.
In an era when someone can communicate at length without ever actually having to talk to someone else, I think we’ve lost sight of the power of conversation. My experience is that if you need to persuade, cajole, convince, ask, tell, flatter, or correct, it’s all better done over the phone or in person. And in our line of work, we see the power of a phone call over and over again.
Why has actually talking to people gotten so hard? Heck if I know. But we’re all guilty of it. Just pull up your cell phone and compare the last time you texted someone to the last time you actually talked to them.
Or compare the number of texts you’ve sent to the number of phone calls you’ve made. Sure, you might argue that texts are shorter and more efficient, but sometimes we should value quality over quantity. Think about the value of calling someone and saying “Hey, I was just thinking of you” and hanging up. That’d probably make their day.
I think a new best practice is if someone you haven’t talked to in a long time texts you, instead of texting them back, call them back immediately and have a real conversation. I bet both of you will be glad you did.
Have a great weekend.
– By Tim Hanson
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Big Pops
If you’ve been watching closely, you may have noticed a change in Permanent Equity’s content strategy. While we’ve always been passionate about sharing thoughts and ideas with the world, there are lots of ways in which to do that and we have tried (and failed but also succeeded) nearly all of them.
If you go back to this time last year, our attempted cadence was generally a podcast or an essay per week that resulted in a semi-regular topically-driven email. While this was fine, the metrics told us that while we were engaging existing audience, we weren’t reaching much, if any, new audience. And, qualitatively, it felt like we were forcing things to fit the calendar, publishing even if we didn’t have anything compelling to say, but also not giving ourselves the time to really dive deep when we did.
So we all got in a room and asked what is a compelling, measurable, and achievable stretch goal for our content? What we came up with is that we wanted to publish content that would get us invited to speak somewhere. The reasoning was that if this happened it probably meant that we had reached new audience, produced something that had compelled someone to reach out to us in a meaningful way, and opened up a new avenue for opportunity.
That was why we made the decision to refocus energy and resources on one very in-depth piece.
But!
We also didn’t want the world to forget about us while we were diving deep.
When it comes to negotiating deals, we love the middle ground, but when it comes to risk management and strategic initiatives, we generally loathe it. That’s the barbell; the idea that there is no medium risk nor medium effort.
The way that manifested itself in our content strategy is that we stopped publishing kinda long podcasts and essays weekly and started doing something daily and punchy (that’s this) complemented by something infrequent and unpredictable, but remarkable (that was “Do Diligence,” the open sourcing of our diligence process that our CEO Brent called the best piece of content we’ve ever produced).
So now we’ve got a steady state with the potential for big pops, and that feels more right.
That has got me thinking about how we might apply this concept to our businesses. In other words, is there something that we could be doing that’s small, frequent, and relatively straightforward that would cover our costs, freeing up resources to do something big, but infrequent, that when it happened would drop straight to the bottom line? Or, if it’s a more volatile business that already trafficks in big pops, is there a service line we could start that would make the time in between pops less stressful?
Because it’s important to go big, but you also never want the world to forget you exist.
– By Tim Hanson