Why are most movies crap? Why do venture capitalists ask you whether your company can become a billion dollar business or not? And why do they invest in companies run by people in hoodies (Zuckerberg) or people who don’t shower (Jobs)? The answer is: Statistics.
The biggest secret in venture capital is that the best investment in a successful fund equals or outperforms the entire rest of the fund combined. This implies two very strange rules for VCs: First, only invest in companies that have the potential to return the value of the entire fund. [Second], because rule number one is so restrictive, there can’t be any other rules.
A super successful startup is what Nassim Taleb calls a “positive black swan” – an event that is extremely positive but practically impossible to predict. And because only one company might be responsible for an entire fund’s return and there’s no way to tell which company it will be, investors have to build a portfolio of companies where each and every one has the potential to win the lottery.
Paul Graham, who’s Y-Combinator fund was an early investor in Dropbox and Airbnb, calls this “black swan farming“. And the reason for Thiel’s rule number two is, as Graham puts it, because “the best startup ideas seem at first like bad ideas”. Ideas may seem crazy and the founders may smell like they should shower more often, but a startup’s potential to be a blockbuster is the only thing that matters to an investor.
This is also the reason why film studios make so many crap movies. Their portfolio has to be full of potential blockbusters that will make up for all the loss-makers. And there’s no way to tell what movies will succeed. They’re in the business of black swan farming as well. So they hire a big name actor or actress and make sure the script has a high-speed car chase, all in 3D, and cross their fingers.
I highly recommend Thiel’s book. It’s based on the wildly successful Blake Masters online notes from Thiel’s Stanford lectures. It’s original, entertaining and thought provoking. And importantly, it’s not too long. If Thiel can be bothered to write another one, I look forward to reading it.