Good points, Fred. I've been reading Alice Schroeder's new biography on Warren Buffett, and I've been struck all over again by his insistence on putting himself "on the same side of the table" as his investors. Starting from his early investing partnerships in the 1950s, if he didn't make money for you, he *lost* money. The more money he made for you, the more he made for himself. For his investors, it made it all the easier to trust that he would do the right thing by them.
Jens
· 11 months ago
Agree 100%
Reminds me of what Milton Friedman once said:
There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you're doing, and you try to get the most for your money.
Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I'm not so careful about the content of the present, but I'm very careful about the cost.
Then, I can spend somebody else's money on myself. And if I spend somebody else's money on myself, then I'm sure going to have a good lunch!
Finally, I can spend somebody else's money on somebody else. And if I spend somebody else's money on somebody else, I'm not concerned about how much it is, and I'm not concerned about what I get.
dfriedman
· 11 months ago
Sorry, this post does not make a lot of sense. Both Martha Stewart Living Omnimedia and the New York Time Company have stock structures that allow minority shareholders to have controlling interests in the companies; the majority of these minority shareholders' wealth is tied up in their company.
Neither of these companies is well run. Merely having your money invested in a company or fund you run is no guarantee of good performance.
aweber9
· 11 months ago
I don't think the point of Fred's post is/was that having your own money at stake is a guarantee of good performance; I believe he's saying that having your own money at stake is likely to make you more thoughtful about the decisions you make....which would tend to lead to better performance.
I lament the fact that we seem to have so many people at companies, funds, etc. who seem to act out of their own self-interest rather than out of the interests of those who have provided the money, the company to run, etc. (as pedalpete suggests below).
dfriedman
· 11 months ago
In retrospect, you are probably correct: I misinterpreted Fred's point. Apologies.
Brian
· 11 months ago
Right on about leverage, but the lenders should also be investing/lending like its their own money. See, the lending boom of recent years with Subprime, PIK toggles, Covenant-lite, etc and all the problems the banks are having right now. I think you're making a much bigger point about accountability and consequences here.
I had a funny conversation trying to explain how an LBO works the other day and why banks were in trouble. The response I got was, "So the company itself takes on 4X as much in debt as much as the guy trying to buy the company puts up? I hope he was a really great manager"
jeremystein
· 11 months ago
i think the title of this post is a little bit misleading. it should be along the lines of "skin in the game solves a lot of problems"
bijan
· 11 months ago
great post fred.
i feel the same way.
but my favorite about this post was the timestamp. looks like you published it around 11am instead of 5am. so your new plan is off to a good start!
Steven Kane
· 11 months ago
hi fred & bijan
i agree with this strongly also
but then... do we lso agree that the VC business is in horrible shape, if for no other rteason then that the avst vast majority of partners have little or no meaningful exposure to their own funds risk of failure?
the typical VC partnership "invests" 2% of the firm's fund, over the entire course of the fund, usually 7-10 years (the other 98% is invested by LPs)
but their management fees provide them 2% of the fund EVERY YEAR.that is, they collect 14-20% of the fund in fees while only being obligated to invest 2%
moreover, almost no VC partners I know invest above and beyond that 2% requirement
so for a large majority of VC prtners, LP's management fees fund their commitments to invest in the fund
so most VCs have zero or near zero real skin in the game
fredwilson
· 11 months ago
It¹s a big problem steve, but in many of the best firms the partners own
Steven Kane
· 11 months ago
Did your reply get cut off?
Own what?
Any case, I only know a few firms but I don’t know of any that exceed 2%
Other than USV, can you cite any examples?
fredwilson
· 11 months ago
From what I¹ve been told, benchmark, kleiner, sequoia all have very large %s of their fund in the hands of the GPs
I have not verified this, nor would I be able to
Steven Kane
· 11 months ago
I have invested in several LBO and real estate and hedge funds ― and all actively promoted how much GP capital was in their fund.
And as you clearly point out in your post, “skin in the game” is a big deal ― so one would think if it were true a fund would not hide that fact
So common sense would suggest that the fact that VC funds ― even the ones you mention -- do not actively (or at all) promote their own “skin in the game” should make one suspect they do not have any meaningful skin in the game.
Worst, so many VCs go around berating others to put “skin in the game” when they themselves do no such thing.
An industry housecleaning may be long overdue.
fredwilson
· 11 months ago
Yes it is
Jay Levitt
· 11 months ago
"Skin in the game" is important, but I disagree that treating it like your *own* money is the right mental model. When I spend my own money, I'm making an emotional decision. Am I buying something that will give me enjoyment? Will I be happier tomorrow, or next year? Will the other kids start liking me now?
When I'm spending my company's money, it's a financial judgement. Will we get a good ROI? Is this the best use of our resources? Is it a long-term or short-term investment? It's a dollars-to-dollars comparison. (Though I've often said that "You can't put a dollar value on money.")
Spending investors' money as if it were my own would be very bad. We'd have secret tunnels in the office, laser tag, some really nice skis, and quite possibly some really nice ski resorts. But no revenues.
pedalpete
· 11 months ago
My thoughts exactly Jay.
Investors have an expectation of a return on their investment, and it is our responsibility to give them back more than they gave. That should be the same rule for a hedge fund manager, stock broker, or company executive.
nycstartupfiend
· 11 months ago
I could not agree more and you said it perfectly. I'm almost at the extreme of not believing in the "corporate america" model of a board with minuscule ownership supervising a company run by managers who are looking out for their own interest where that interest is not, due to lack of ownership, the same interest as the company doing well in the long term. The financial services industry has been only the worst example of that but many other industries are effected and it's one of the single biggest reasons I am so skeptical about small companies changing from a founder/CEO to a hired gun CEO. You might get someone who is more experienced but that new person is almost certainly of the employee/hired gun mentality and will look at the world through that lens. There are, of course, exceptions but it's hard to overcome the fundamental difference between an ownership mentality (this is mine and I treat it as such) vs the employee mentality (I work for a boss who I want to impress and please this board meeting and next and next). The latter has a series of implicit short term incentives and mercenary nature that are very very hard to remove. The very best "hired help" entrepreneurial CEOs are good at impressing upon others that they have the right long term view - and some surely do - but the underlying incentives are there regardless.
In financial services, when will they claw back the money that people made as a result of blowing up the company's they worked for (but did not own)? In my world, if i blow up a company, I lose my job and my net worth, and my time, and I have not made a dime along the way. On wall street, they pay you 10s (or in the case of O'neal, 100's) of millions for the privilege of having allowed you to destroy the company in one felt swoop. That is not a model that works and has to come to a permanent end.
hypermark
· 11 months ago
I totally agree with your sensibility, Fred. Good common sense. The counter side to this is that the market crash has made many good people with historically solid track records feel like frauds, liars and cheats, something underscored in an article I read in yesterday's SF Chronicle:
Reading it was a bit of a bookend to the Lewis/Einhorn piece, which was great.
Stan James
· 11 months ago
My first startup raised a modest angel round, about $600K. But nothing prepared me for the emotions of seeing the copies individual checks including in the closing documents; checks from individual people, coming from their own bank accounts. Suddenly the money became a lot less abstract. These people were trusting me and our team with their money, for many of them it was not a trivial amount. I knew I would have to work hard, not only for my sake, but because there were very real people behind those scrawled signatures.
Facebook User
· 11 months ago
In the spirit of wikifying your blog posts, fred, the author's name is David Einhorn (of Greenlight Capital / short LEH fame) rather than Daniel. This minor typo does nothing to diminish the quality of this post, which is excellent. It clearly doesn't make sense for you to have all (or even most) of your net worth tied up in a VC fund, but as an LP I would absolutely feel better knowing the GP had significant skin in the game.
In point of fact, while I myself am not on the buy side, my clients frequently are (I work at a restructuring shop). The project I'm currently assigned to involves a PE fund who made an investment that has since gone south. As the fund has significant GP capital invested in it, its managers are very active investors and are working their damnedest to save the company (that's why they hired my firm!). I am not a sophisticated investor yet, but when I get there this is going to be one of my primary criteria for investing.
fredwilson
· 11 months ago
Great catch. I¹ll fix it asap. I wish you could have fixed it earlier today.
ventureblogalist
· 11 months ago
I agree. No investment bank owned by its employees would have levered itself 35 to 1.
Khyron
· 11 months ago
This probably explains the discomfort I felt when GS went public in '99.
The IBs used to be partnerships, and the partners had non-trivial amounts of their net worths tied up in the partnerships. The compensation models, and risk taking, got seriously screwed up as they went public. Goldman was the last to do so. This has been commented on in other spheres, but Fred's thoughts apply to the IBs (of the past) as well.
petersteinberg
· 11 months ago
Great post, but I'm surprised to hear you characterize Google as one of the "best-managed companies."
Really great products? Well, a few really great products, a few great products and dozens and dozens of mediocre ones.
Wildly profitable? Absolutely. But might it be far more profitable if they showed the slightest bit of focus or fiscal discipline?
"It's really tempting to put more money in because if you don't, you'll get wiped out. But if you do put money in, and the investment still fails, then you've lost even more of your own money and your partners money. The bigger personal check you have to write, the more likely you'll make the right decision. If you don't have to write any checks and all the money you are investing is other people's money, then it's incredibly tempting to "pour good money after bad.""
Fantastic reminder. In fact, that's one lesson I've taken away from B-School and will always remember: Never consider sunk costs in a decision.
druce
· 11 months ago
possibly relevant nitpick - the important number is what percentage of the manager's net worth is in the fund. If a manager pitched an investment in a $200m fund in which he had $5m which was substantially all his net worth, that would be more meaningful than if Warren Buffett offered to let me invest in a $200m fund in which he invested $50m.
then again... a partner of Thierry Magon de la Villehuche invested all his net worth and then borrowed more to invest in their fund of funds, which was invested with Madoff -
sometimes even when the cook eats his own cooking it's still bad.
fredwilson
· 11 months ago
Right, there is no cure all for sure
And you are right. It¹s about % of net worth, not actual dollars
reiboldt
· 11 months ago
I think this is a fundamental contributor to our current crisis. Too many fund managers were not judicious with the funds they managed. They treated those assets with reckless risk and as such lost a lot for their investors. I am not just talking about the extreme case of Madoff either. Far too many fund managers have been guilty of this. If I lose one dime of my investors' assets, it eats me up inside. I also put my own money in it, so it actually does hit me at home. Any manager that won't put their own money aside their investors' assets doesn't deserve your money.
Blogger
· 11 months ago
I do agree with you, our company got recently bought over by a bigger firm. Now I understand some of the thought process from the investors point of view - but I guess accountability should not be the sole guiding line. I might be wrong, still learning the ropes of the trade.
Alex Iskold
· 11 months ago
Fred, to me, this quote:
If you don't have to write any checks and all the money you are investing is other people's money, then it's incredibly tempting to "pour good money after bad."
Sums up exactly why Wall Street gone belly up.
This lack of feedback in combination with arrogance, self-certainty and sense of entitlement is what caused the crisis. You on the other hand are always humble and appreciative of everything that happens to you.
The way I see it - polar opposites.
Chris Yeh
· 11 months ago
Great post, Fred. I added my own corollary:
"If you always treat money like it is your own, other people are more likely to trust you with their money."
People know that I am so cheap that I cannot bear to waste money, even if it isn't my own. And when people invest in one of my startups, they know I'll do my best not to spend their money unless it's absolutely necessary, even if it doesn't always make me the most popular guy in the office.
I'm most interested in seeing how the ideal of "treating money like it is your own" works as companies evolve and grow. Apple and Fox, as examples of well-managed companies, are also examples of companies that are run (micromanaged?) by their founders and figureheads.
Can a diffuse, open, large organization provide the kind of transparency and incentives required to give people the opportunity to "treat money as their own"? What kind of organizational structures do we need to create that kind of culture? I think we've all learned that stock options and "keeping skin in the game" aren't enough on their own.
fredwilson
· 11 months ago
This is a huge issue
Maybe companies shouldn't get so big
Khyron
· 11 months ago
Was just thinking about this earlier this morning.
More companies should stay private. There should be provisions to spin-out/off new or unrelated businesses. Growth at any cost has been far too dangerous. It would also help employ more people. Let a decent size business flourish providing valuable services to their customers. Let the employees of the parent firm participate in the new firm via equity post-spinoff.
Not all companies need to be public, nor should they be. Seems to cause a fair number of problems. If the logic is there, then do it. Doing it just to do it, or to create an exit for investors seems like a waste of time, energy and talent, and leads to growth at all costs far too often.
Chethan Thimmappa
· 11 months ago
i agree
Joel Strellner
· 11 months ago
Out of all of your recent posts, this has to be the one that has hit home the most. Thank you for the incite.
We are looking to raise a small round right now, despite the economy, and this is one of those posts that I think I will keep rereading and thinking about during any purchases, well into the future.
Thanks again.
gregorylent
· 11 months ago
would love to hear your thoughts on the concept of "exit strategy" vs. sustainability ..... is planning for an exit strategy different than the planning for building a long lasting business? .... in the same way that we can say that managing for the next quarter's results is not the best way to run a company or a culture?
All Comments
Reminds me of what Milton Friedman once said:
There are four ways in which you can spend money. You can spend your own money on yourself. When you do that, why then you really watch out what you're doing, and you try to get the most for your money.
Then you can spend your own money on somebody else. For example, I buy a birthday present for someone. Well, then I'm not so careful about the content of the present, but I'm very careful about the cost.
Then, I can spend somebody else's money on myself. And if I spend somebody else's money on myself, then I'm sure going to have a good lunch!
Finally, I can spend somebody else's money on somebody else. And if I spend somebody else's money on somebody else, I'm not concerned about how much it is, and I'm not concerned about what I get.
Neither of these companies is well run. Merely having your money invested in a company or fund you run is no guarantee of good performance.
I lament the fact that we seem to have so many people at companies, funds, etc. who seem to act out of their own self-interest rather than out of the interests of those who have provided the money, the company to run, etc. (as pedalpete suggests below).
I had a funny conversation trying to explain how an LBO works the other day and why banks were in trouble. The response I got was, "So the company itself takes on 4X as much in debt as much as the guy trying to buy the company puts up? I hope he was a really great manager"
i feel the same way.
but my favorite about this post was the timestamp. looks like you published it around 11am instead of 5am. so your new plan is off to a good start!
i agree with this strongly also
but then... do we lso agree that the VC business is in horrible shape, if for no other rteason then that the avst vast majority of partners have little or no meaningful exposure to their own funds risk of failure?
the typical VC partnership "invests" 2% of the firm's fund, over the entire course of the fund, usually 7-10 years (the other 98% is invested by LPs)
but their management fees provide them 2% of the fund EVERY YEAR.that is, they collect 14-20% of the fund in fees while only being obligated to invest 2%
moreover, almost no VC partners I know invest above and beyond that 2% requirement
so for a large majority of VC prtners, LP's management fees fund their commitments to invest in the fund
so most VCs have zero or near zero real skin in the game
Own what?
Any case, I only know a few firms but I don’t know of any that exceed 2%
Other than USV, can you cite any examples?
of their fund in the hands of the GPs
I have not verified this, nor would I be able to
actively promoted how much GP capital was in their fund.
And as you clearly point out in your post, “skin in the game” is a big deal
― so one would think if it were true a fund would not hide that fact
So common sense would suggest that the fact that VC funds ― even the ones
you mention -- do not actively (or at all) promote their own “skin in the
game” should make one suspect they do not have any meaningful skin in the
game.
Worst, so many VCs go around berating others to put “skin in the game” when
they themselves do no such thing.
An industry housecleaning may be long overdue.
When I'm spending my company's money, it's a financial judgement. Will we get a good ROI? Is this the best use of our resources? Is it a long-term or short-term investment? It's a dollars-to-dollars comparison. (Though I've often said that "You can't put a dollar value on money.")
Spending investors' money as if it were my own would be very bad. We'd have secret tunnels in the office, laser tag, some really nice skis, and quite possibly some really nice ski resorts. But no revenues.
Investors have an expectation of a return on their investment, and it is our responsibility to give them back more than they gave. That should be the same rule for a hedge fund manager, stock broker, or company executive.
In financial services, when will they claw back the money that people made as a result of blowing up the company's they worked for (but did not own)? In my world, if i blow up a company, I lose my job and my net worth, and my time, and I have not made a dime along the way. On wall street, they pay you 10s (or in the case of O'neal, 100's) of millions for the privilege of having allowed you to destroy the company in one felt swoop. That is not a model that works and has to come to a permanent end.
Cautionary story of fund manager's suicide. http://bit.ly/H9Ex
Reading it was a bit of a bookend to the Lewis/Einhorn piece, which was great.
In point of fact, while I myself am not on the buy side, my clients frequently are (I work at a restructuring shop). The project I'm currently assigned to involves a PE fund who made an investment that has since gone south. As the fund has significant GP capital invested in it, its managers are very active investors and are working their damnedest to save the company (that's why they hired my firm!). I am not a sophisticated investor yet, but when I get there this is going to be one of my primary criteria for investing.
today.
The IBs used to be partnerships, and the partners had non-trivial amounts of their net worths tied up in the partnerships. The compensation models, and risk taking, got seriously screwed up as they went public. Goldman was the last to do so. This has been commented on in other spheres, but Fred's thoughts apply to the IBs (of the past) as well.
Really great products? Well, a few really great products, a few great products and dozens and dozens of mediocre ones.
Wildly profitable? Absolutely. But might it be far more profitable if they showed the slightest bit of focus or fiscal discipline?
Peter
http://www.FlashlightWorthy.com
That was one of my wishes for 2009 actually
Fantastic reminder. In fact, that's one lesson I've taken away from B-School and will always remember: Never consider sunk costs in a decision.
then again... a partner of Thierry Magon de la Villehuche invested all his net worth and then borrowed more to invest in their fund of funds, which was invested with Madoff -
http://www.bloomberg.com/apps/news?pid=20601109...
sometimes even when the cook eats his own cooking it's still bad.
And you are right. It¹s about % of net worth, not actual dollars
If you don't have to write any checks and all the money you are investing is other people's money, then it's incredibly tempting to "pour good money after bad."
Sums up exactly why Wall Street gone belly up.
This lack of feedback in combination with arrogance, self-certainty and sense of entitlement is what caused the crisis.
You on the other hand are always humble and appreciative of everything that happens to you.
The way I see it - polar opposites.
"If you always treat money like it is your own, other people are more likely to trust you with their money."
People know that I am so cheap that I cannot bear to waste money, even if it isn't my own. And when people invest in one of my startups, they know I'll do my best not to spend their money unless it's absolutely necessary, even if it doesn't always make me the most popular guy in the office.
http://chrisyeh.blogspot.com/2009/01/always-tre...
Can a diffuse, open, large organization provide the kind of transparency and incentives required to give people the opportunity to "treat money as their own"? What kind of organizational structures do we need to create that kind of culture? I think we've all learned that stock options and "keeping skin in the game" aren't enough on their own.
Maybe companies shouldn't get so big
More companies should stay private. There should be provisions to spin-out/off new or unrelated businesses. Growth at any cost has been far too dangerous. It would also help employ more people. Let a decent size business flourish providing valuable services to their customers. Let the employees of the parent firm participate in the new firm via equity post-spinoff.
Not all companies need to be public, nor should they be. Seems to cause a fair number of problems. If the logic is there, then do it. Doing it just to do it, or to create an exit for investors seems like a waste of time, energy and talent, and leads to growth at all costs far too often.
We are looking to raise a small round right now, despite the economy, and this is one of those posts that I think I will keep rereading and thinking about during any purchases, well into the future.
Thanks again.
It's worth doing a good post on it
Thanks for the suggestion