Black Swans and Venture Capital
Last week as I was returning from my unexpected trip to the UK, I picked up a copy of Nassim Taleb's most recent book – "The Black Swan". The 10 hour flight back from Heathrow gave me plenty of time to get into the book and think about the role of the Black Swan in venture capital.
Black Swan is the name Taleb gives to a highly improbable event with three main characteristics – unpredictability, massive impact and, after the fact, our desire to make it appear less random and more predictable than it was.
The home run successes in venture capital are positive Black Swans and exhibit all three of the characteristics. In many cases, any single company is exposed to multiple black swans during its evolution. Sometimes these can be positive events while others are curved balls thrown with great velocity at the management team. Consider some of the negative black swan events that companies have had to contend with over the last 5 or so year – the implementation and compliance requirements of Sarbox, changes in accounting rules regarding stock options to name but two.
Taleb makes one footnote comment on venture capital that should be reflected upon by both VCs and entrepreneurs alike.
Make sure that you have plenty of these small bets; avoid being blinded by the vividness of one single Black Swan. Have as many of these small bets as you can conceivably have. Even venture capital firms fall for the narrative fallacy with a few stories that "make sense" to them; they do not have as many bets as they should. If venture capital firms are profitable, it is not because of the stories they have in their heads, but because they are exposed to unplanned rare events.
If you are in the mood for an exploration in philosophy as it applies to our system of risk taking, the Black Swan is well worth a read.