Folly to forecast startup performance?

Several days ago, Paul Graham, co-founder of noted Silicon Valley accelerator Y-Combinator (YC), wrote an exceptional post, "Black Swan Farming," observing how crazy difficult it is to predict success in the start-up space, and noting that just two companies - Airbnb and Dropbox - account for about 75% of the total value created by all YC-associated companies.

Yesterday, Dave McClure (the white-hot seed-stage Silicon Valley investor, familiar to readers of this column - see this discussion of his small bets style in connection with digital health) responded in a post titled (what else?) "Screw the Black Swans" that his investment model (at 500 Startups) is slightly different. 

While most VCs are looking for the big score, McClure said, he's deliberately seeking singles and doubles, which he basically expects will result in a similar expected value for his portfolio but reduce the chances of getting shut-out.  He anticipates and is hoping for a greater number of successes (albeit more modest ones) than achieved by other VCs.

This will be a familiar dialog not only to investors but also to those in biopharma (who perhaps should be thought of as investors as well), as they continuously need to decide whether to go for a risky potential blockbuster or more of a sure-thing that ostensibly may be associated with a smaller market.

I've been fascinated with this exact question for a while (see here and here), and I've always looked at the problem a bit differently than McClure - which, if I'm right, may actually be good news for him.

While robust data are difficult to come by, so much of what I've seen in the two exception-dominated spaces with which I'm most familiar - startups and in drug development - suggest that Paul Graham (and Nassim Taleb - see this recent WSJ piece arguing most successful investors are lucky not good, nicely summarized here by Business Insider) are right: success, and particularly the magnitude of success, is virtually impossible to predict. 

The folly of forecasting, if taken seriously, is a mind-blowing concept that is at once viscerally uncomfortable and operationally nearly impractical; as a result, most investors and businesses effectively ignore it, and basically (as I've discussed in perhaps my favorite piece) "assume a can opener."

Now add to the mix the well-described tendency of startups to pivot like mad, and you have a situation where I suspect it's not at all clear whether you have a potential single or homerun on your hands, even if McClure (who usually acknowledges the limitations of forecasting) believes he can accurate predict this.   Yet (as McClure certainly recognizes), many incredibly successful companies in the valley started off focused on a very narrow problem, then subsequently realized their solution or approach could be applied or redirected to a larger opportunity.

Sure, I appreciate that the idea of trying to solve huge problem seems more likely to be massively successful than if you're trying to solve a trivial problem, and I also believe that while you can't predict the magnitude of success, you can certainly increase the probability of failure - wrong team, wrong problem, even wrong advice from investors.  And let's be honest - there are a large number of entrepreneurial efforts that are overtly, painfully trivial; it's just that I don't see McClure going after them. 

Having highlighted the problems with predictions, let me go ahead and make a counter-intuitive one: in 10 years, the best performers in McClure's portfolio could very well create more value (to use Graham's standard - and note this value may or may not be realized by the seed-stage investor) than the top performers at YC.

Further Black Swan reading:

WSJ book review of The Black Swan (written before I met Taleb)

Financial Times commentary about serendipity and drug discovery (co-written with Taleb)

 

Also Visit
AEIdeas Blog The American Magazine
About the Author

 

David
Shaywitz

What's new on AEI

We still don't know how many people Obamacare enrolled
image The war on invisible poverty
image Cutting fat from the budget
image Speaker of the House John Boehner on resetting America’s economic foundation
AEI on Facebook
Events Calendar
  • 15
    MON
  • 16
    TUE
  • 17
    WED
  • 18
    THU
  • 19
    FRI
Tuesday, September 16, 2014 | 5:00 p.m. – 6:00 p.m.
The Constitution as political theory

Please join us for the third-annual Walter Berns Constitution Day Lecture as James Ceasar, Harry F. Byrd Professor of Politics at the University of Virginia, explores some of the Constitution’s most significant contributions to political theory, focusing on themes that have been largely unexamined in current scholarship.

Wednesday, September 17, 2014 | 8:10 a.m. – Thursday, September 18, 2014 | 1:30 p.m.
Third international conference on housing risk: New risk measures and their applications

We invite you to join us for this year’s international conference on housing risk — cosponsored by the Collateral Risk Network and AEI International Center on Housing Risk — which will focus on new mortgage and collateral risk measures and their applications.

Thursday, September 18, 2014 | 2:15 p.m. – 3:00 p.m.
Speaker of the House John Boehner on resetting America’s economic foundation

Please join us as Speaker John Boehner (R-OH) delivers his five-point policy vision to reset America’s economy.

Friday, September 19, 2014 | 9:15 a.m. – 11:00 a.m.
Reforming Medicare: What does the public think?

Please join us as a panel of distinguished experts explore the implications of the report and the consumer role in shaping the future of Medicare.

Event Registration is Closed
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.
No events scheduled this day.