Finding strategy fit

An exploration of what we do and why.

Over the past few years, Dustin Mix and I have spoken with many students in the process of discerning whether they wanted to be investors, and if so, what kind of investors they wanted to be. We have gone through (and are going through) the same process ourselves. It struck us that the first part of the question receives far more focus than the second. Aspiring investors often convince ourselves that discernment in professional investing is a purely rational pursuit. We will be guided by the invisible hand to the place our risk tolerance and return desires intersect.

As we have wandered toward investment careers, however, we have been disabused of this notion. Discernment in investing is only valuable if it is specific, and so we have tried to delineate types of investment practically. We have come to see investing as a series of questions frequently asked, and a set of behaviors to turn the answers into money. The questions for aspiring investors become "which questions can you ask for a long time, and which behaviors can you repeat?" We find this not only relevant to investors discerning which styles might be a fit for them, but also critical to investors wondering which type of market might support their investing styles (us).

The X axis of our framework represents diligence questions. Which questions are we capable of underwriting and which are we willing to answer?

The Y axis represents the method by which these questions are answered and turned into money. No strategy exercises complete control, doesn't stop us from trying. Control in this context refers only to control available to investors (and considered a zero sum game). Where control is high, it is exercised by investors over other stakeholders. Where control is low, it means that more agency is available to other stakeholders, at the expense of investors.

Equity strategies can offer significant diversity on the types of questions asked from the same type of security.

There is diversity in method as well. Venture studio and private equity strategies own control stakes, conferring similar rights despite different diligence and operating environments.

Variation in securities and market environments change questions and behaviors as well. Many macro investors try to hedge things they can't control, avoiding precarious positions. Credit investors rely on confrontation, locking the door when things go poorly. "Now you's can't leave."

This framework is far from comprehensive, though we would argue the primitives are all here. Real estate investing for example is some blend of Credit + Private Equity + Macro (even Public Equity) depending on the strategy.

Additionally, these strategies move and expand/contract over the course of the cycle. In peak venture cycles, for example, control can decrease substantially for most investors. At various points in the cycle, as well exploration can decline or increase. Oddly, we would note that this seems to have a counter cyclical bent, as in peak markets, relatively known business models in well understood markets can achieve exceptional valuations (and then need efficiency to grow into them). As Bryce Roberts would say, "The hardest thing to make is an edgy movie with a $200M budget." In down markets, creativity is required to do more with less, and under-explored market segments tend to show their value.

In most market environments, however, Quadrant III remains empty. This has something to do with value and cost.

Basic logic would demand that as cash flows become more certain, a broader market emerges. This drives discount rates down and prices up.

According to many pricing models, control rights also confer value. They certainly confer cost in the form of headcount, surveillance, lawyers, etc. Cost can be explicit in the form of fees or implicit in the form of overcapitalization. These costs make sense, as investors assume that control erodes with maturity. They wish to position themselves strongly to participate in and exercise control over future value.

A spectrum emerges of cost relative to value. In reality, no stark line exists. As a general rule, however, the further into the top quadrant you are, the less patient you can afford to be. Value creation must outpace control cost.

When presented with low value asset, investors face a choice. They can manage the asset at a sustainable, low cost and potentially sacrifice control in the future, or they can manage the asset with a high control strategy that may impose outsized cost relative to the current asset value. There are many reasons that this might be a false dichotomy, for example Praxis' model of redemptive entrepreneurship, which recognizes that setting down control may be the best way to build influence over outcomes. Additionally, venture capital is beginning to reckon with the reality that startups may appreciate in value more deliberately, and should be more sustainably capitalized.

In recent years, however, many investors preferred a race to significant control over high market value assets rather than a sustainable management structure around assets with less clear market value. This had dramatic consequences for ideas, teams, companies and communities that did not capture market value as quickly as their cost structure demanded. In many cases, not only was the future sacrificed, but present assets were too. Young people discerning their course should question whether they want to be in a race against the clock, or whether they wish to be patient with their investments. Communities investing in their futures should ask the same questions.

We observe that most economies are built on low value transactions that produce attractive cash-on-cash returns, and occasionally, reflect those returns in substantial market value. The future of the internet may lie in such economies. The future of small physical communities certainly does. An investment structure built for such environments may prove uniquely suited to such economies.

Cooperative investments turn the costs of control into non-cash expenses, extending the runway of exploratory investment strategies. We also find cooperatives at maturity resemble something between equity structures and macro economies.

Cooperatives have not been an attractive place to invest over the past several centuries because the market has either refused to recognize the value they create, or when it does, higher cost, higher control structures have more efficiently collected that value.

In its truest form, venture-backed startups were much like co-ops. Many people came together to contribute labor, skill, and other non-monetary assets in return for an ownership stake. Even venture capitalists had to bring more than money to the table in order to be a part of the endeavor. We have gotten away from the goal of ramen profitability for most startups. That's not a value judgement. It's just a reflection that most venture capital is not a fit for most businesses and market problems. We would also observe that bootstrapping (with equity well distributed across a team) resembles co-ops as well.

We find ourselves drawn to the motions of cooperative investments, and find technological and financial reasons for optimism about their future. We hope to find others who feel the same.

Regardless of where you find yourself on this chart, the world needs more of it. Best of luck on the journey.

Want to learn with us?

Sign up to get an email every time a new article is published. We share interviews, primary source data, books that provoked us, and reflections on emerging themes.