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Notes from Venture Deals (Brad Feld, Jason Mendelson) – Part II

Part I is here.  In a hurry? Italics in the post represent key dos and don’ts for founders.

How VC firms work

  • One management company (franchise) – this is the name of the VC firm you hear.
  • Under them are several “general partnerships” (no longer a “general partner” i.e. single person, this is a separate legal entity of its own ). Each “general partnership” has different funds – LPs (limited partnerships) under it.
  • Interest of VC firm != interest of the GP/LP always, particularly when new people join or MDs leave.
  • How VCs raise money
    • LPA – limited partnership agreement
    • Fund amount is not actually with the VCs. A capital call is made each they want to invest in a startup, and the LPs are obligated to respond to the capital call in two weeks.
  • Capital calls can fail or result in lower funding than expected .2008-like situations: LPs include HNIs who may be struggling with illiquidity themselves, banks who, like in 2008, may be dissolving themselves, endowments/pension funds etc who are facing capital crunch due to general market conditions.
  • Average total fee over a 10 year period: 15% of the fund. VCs are expected to make capital gains and recycle those gains to cover up for the fees.
  • Partners see base compensation with every additional fund raised.
  • “It takes 10 years to kill a venture fund.” – additional funds / rounds can be raised while the performance of the first few isn’t clear.
  • Carry: VCs get a 20% of the profit cut, which is known as “carry”. This can be reinvested (and is expected to be reinvested, at least till it covers the management fees).
  • Friction within a VC firm – Firms don’t equal allocation between partners- seniority matters. An individual partner can make X times the amount allotted, but still get no carry because of allocation style and poor performance of the overall firm or fund.
  • GP Commitment: LPs want VCs to invest a cut as well – 99% money comes from LPs, 1% from the VCs. Has gone up to 5%.
  • Clawback: VCs can pocket the carry in the middle of the fund (say 20% of 50 mn in profit) and then the overall fund turns out to not do so well. VCs have taken more than the deserved carry and LPs demanding for this back is ‘clawback’.  Harder to pull off across multiple partners.. (e.g. one partner got divorced, paid half to spouse. All partners paid taxes on the carry).
  • Time impact of fund activity
    • If you are raising with a VC fund that closers to closing, higher pressure for an exit.
  • Wary of ‘zombie’ VC firms (no new funds to raise, carrying on their existing funds). Just ask when their last investment was.
  • Wary of ‘secondary sale’ – VC can sell their entire portfolio to someone in a secondary sale.
  • VCs close to end of the fund can also redistribute the portfolio to LPs – hassle for founder if there are too many LPs.
  • Reserves – VC have a fraction of the fund (30-50%) in ‘reserve’ i.e. for future investments with their portfolio companies. Ask upfront for details on this.
  • Cashflow – how does the VC maintain their cashflow? Are they recycling the carry appropriately to make up for the management fees? ([KR]: How does this affect the founder?)
  • Cross-fund investing – bad idea, since there are multiple sets of LPs and multiple kinds of terms involved.
  • Figure out what happens if and when the partner who invested in you departs – does it trip a ‘key-man clause’? (LP can ask for recall of funds).
  • Understand your VC’s fiduciary duties – they are serving you/your board, the VC firm, their own GP/LP and a bunch of other people. Not all VCs are direct about what they have on their plate, making their behavior confusing.
  • Understand your investors motives and financial incentives. Have an open, if difficult conversation about it now, to avoid surprise and trauma later.

Venture financing

  • Funding Negotiations: Prisoner’s dilemma applies, but only somewhat. (Acquisition discussions are closer to prisoner’s dilemma).
    •  Multiple-instance game.
    • Win-win is possible.
  • Ask VCs upfront before the term sheet arrives what their top three concerns are. Articulate yours if asked.
  • During the back and forth, point out that the VCs top asks are being met. (much easier to call them out once you have the original info).

Negotiating Styles

  1. Bully/Yeller: Ignore – this one never gets anywhere. Sign of immaturity.
  2. Nice-guy / Car Salesman: Will talk a lot, seemingly never get to the point. Be clear and direct about what you want, introduce a little bully if needed.
  3. Technocrat: Gets lost in details. Make sure you focus on the points you care about, and make sure you are looking at the overall picture of give-and-take across all points.
  4. Wimp: Might be easy to get his wallet, but remember you’re stuck with him on your board. You’ll end up having to negotiate for him too – an incompetent partner can be worse than a real adversary.
  • In a multi-round game, be the nicest, transparent version of yourself that you can be. Single-round (like acquisition) – “just win it” attitude works.
  • Know what your limits are – when do you walk away? This comes from the BATNA (best alternative to a negotiated agreement). As you walk-away, be clear what your walk-away reason is. If you are sincere, and the other party really wants a deal, they’ll come back with something you can stomach. Else it wasn’t meant to be.
  • Don’t ever make a threat during a negotiation that you aren’t willing to back up.
  • Get each VC you’re talking to, to deliver a term-sheet within roughly the same timeframe.
  • Do not share names or term-sheet details, unless you actually want the VCs to collaborate (that is usually what happens -they’ll start comparing notes with each other).
  • Anchor on particular terms, to build leverage, and be willing to let go of the rest.
  • Feed the ego of the partner – applies to any negotiation.
  • Don’t go point-by-point – pick an ordering of the terms based on your priorities.
  • Never make the first offer.
  • A bad deal can be fixed
    • Next round of financing – the new VC is motivated to improve your terms.
    • Acquisition – tricky, be careful, here since the acquirer has reasons to wedge you and the investor.

Issues in each round

  • Seed: Empirically, there are more cases where the founders got too a deal, than a bad one. Bad because makes raising the next round painful if you don’t live up to the expectations.
  • Early Stage (Series A/B): Watch out for liq. pref (sets a precedent for all future rounds) and protective provisions (maintain a single class for all investors).
  • Mid/Late Stage: Board and voting control matters.
    Valuation – dont have too good a deal, else VCs will force a hold-out on the exit.
  • Seed preferred/Light preferred: Happens if you have angels who favor you a lot and don’t need the regular preferred shares (board, voting control etc). These are “preferred shares” with fewer rights. IRS 409A prevents you from selling common stock to investors (makes common stock expensive for employee stock options).

Letter of Intent

  • The other term-sheet. Acquisition offer first step.
  • First page of LOI
    • Apparent purchase price – usually not the actual one.
    • Escrow – ‘Holdback’ amount that gets cut if certain expectations/provisions are not met. Amount and terms of escrow and indemnity provisions are important.
    • 10-20% of purchase price, period 12-24 months.
    • Working Capital – (KR Question: Why is the seller expected to have a certain amount of working capital?)
    • Earn-outs: Allows buyer to underpay at closing time, and pay later if some conditions are met.
    • Management retention pool: Can be baked into purchase price or added separately. Allows buyer to shift focus away from the capitalization table (founders and investors) which may or may not be to their liking. Easy way to drive a wedge between founders and investors.
  • Expect escrow period to be between 12-18 months. Stand behind your ‘representations’ and ‘warranties’ until then. Escrow can get unreasonable, beware: uncapped indemnity, personal liability of founders/directors, even the ability to capture back more than the deal offered.
  • Asset deals: e.g. selling patents or selling ‘assets’ like hardware/factory. Buying a company without really buying a company. Messy, suggest avoiding – take years for the firm to close down after an asset deal.
    •  Buyers like asset deal because of shielding from liability.
    •  Stock deal: Actually buying the company.
  • Being bought for stock
    •  Private company buyer: obviously risky. You don’t know their cap table, liq pref. etc, so don’t know what common stock of the buyer really amounts to.
    • Public company buyer
      •  Is the stock freely tradable, registered or subject to lockup agreement?
      • What registration rights will you have?
      • Tax considerations.
  • Detailed LOIs are better than vague ones.
  • Employee Option Plans
    • Immediate vesting on acquisition: Great for employees, buyer has to figure out retention incentive.
    • Sometimes buyer will insist on employee options holders to convert to common stock before the acquisition and deal with them like common shareholders.
    • Catch up stock options: The deal should account for (option value – option basis), not just the face value of the option. e.g. 5 mn of option unvested have a value of 2 mn because 3 mn is the basis price. Who pays for these 3 mn?
  • Reps and Warranties
    • Guarantees about the health of the business that the buyer and seller give each other.
    •  Founder tip: Agree to everything as long as it’s ‘to the extent currently known’.
    • Do not agree to “The company shall make standard representations and warranties and provide standard indemnification to the Acquirers.”
  • Check the conditions to close – too many, too detailed is a sign of a picky buyer. Identify important ones and address upfront.
  • No-shop clause: Don’t agree to more than 60 days. Should terminate automatically if buyer declines deal.
  • Fees: Seller can ask a break-up if buyer is competitive and the LOI seems like a fishing expedition. e.g. T-Mobile
  • Shareholder Representative: Unlucky person to get sandwiched between buyer and seller for no personal gains to himself. As seller, don’t appoint some employee/founder who will be employed by buyer in the future (guy gets sandwiched) or a VC (won’t have enough time to represent). Hiring professional firms is a good option. Authors have set up a firm.

Legal Tips for founders

  • Make sure everyone you hire is an at-will employee (else firing is hard).
  • Prebake severance terms into the offer letter.
  • Know a good employment lawyer.
  • Raise money from accredited investors, non-accredited ones can force you to buyback shares anytime they want? (right of rescission).
  • Must file an 83(b) election
  • IRS 409A – gave business to a new accounting sub-industry, made stock options more expensive for employees. Nothing else changed much.

Notes from Venture Deals (Brad Feld, Jason Mendelson) – Part I

In a hurry? Just skim over the italics in this post – they represent key dos and don’ts for founders. Part II of the post is here.

Resources

Term Sheet

  • Typically 8-ish pages (~2012).
  • Two key aspects, everything else is secondary, don’t waste too much time on other terms:
    • Economics terms
    • Control terms.
  • Signs of the VC not being entrepreneur friendly appear during the term-sheet negotiations.

VC History

  • Early VC example: AR&D:  70k for 78% of the company. Post-money valuation becomes 90k.
  • Individual VCs today own less than 50%, no effective voting control. They negotiate provisions that give them control over the major decisions made by the company.
  • VCs investing at different stages in the company => different ownership percentages, varying rights, diverging motivations.
  • Founders should direct and control the process of financing – leave as little as possible outsourced for the lawyer.
  • Capitalization-table (Cap Table): spreadsheet that defines the economics of the deal.

VC hierarchy

  1. MD/GP: Managing Director or General Partner. They make the final decisions and sit on the boards of the companies they invest in. Prefixes “executive” or “founding” may be applied to indicate seniority.
  2. Principal/Directors: Have deal responsibility, need a MD involved to take the final decision. These are junior partners making their way up to MD.
  3. Associates: Not deal partners, they work for the partners. They do: scout new deals, due diligence on existing deals, write internal memos about prospective investments. Associates likely spend the most time with the cap table.
    – Many VC firms have a 2 year associate program – after that, the associate leaves to go to B-school, work for a portfolio company or start up her own company. Star associates may go on to become principals.
  4. Analysts: Bottom of the ladder, crunch numbers and write memos.
  5. Other people involved in VC:
    1. Venture partners/Operating Partners: Experienced entrepreneurs who have a part-time relationship with the VC firm. May take an active role in managing the investment as chairman or board member.
    2. EIR (Entrepreneur in residence): Experience entrepreneurs who park themselves at a VC firm while figuring out their next company. Help the VC with intros/networking and due diligence. Last 3-12 months typically. Some VCs pay the EIR , some just offer office space and an implicit agreement to fund the next company.

What information does an entrepreneur need about the VC firm?

  • Who am I talking to?
  • What kind of decision-making power does the person have?
  • What process do we go through to get the investment approved?
  • Best source for this info:
    • Talk to other entrepreneurs who the VC has funded in the past.
    • Piece together what you can from the VC firm’s website.
    • Less likely to get completely accurate information talking to folks down in the hierarchy of the VC firm.
    • Insist on developing a direct relationship with an MD or GP.

Angel Investors:

  • Active in the seed stage.
  • Can be professional investors, successful entrepreneurs, friends or family members.
  • Figure out if the VC is comfortable investing with angels.
  • All VCs don’t share the same view of angels.
  • Not all angels are created equal.
  • Pay-to-play and drag-along rights are designed to help VCs force a certain type of behavior on the angels (and other VC investors) in the difficult financing rounds.
  • Angels are typically HNIs. SEC rules require them to be accredited investors. Founders should make sure this is true – each of the angels should be accredited or have an appropriate exemption.
  • Super angels:
    • “Promiscuous” angels who make a lot of small investments. Typically these are people out of startup exits themselves.
    • When super angels raise funds themselves, they are micro VCs. Have the same fiduciary responsibility as VC

What the founder needs to keep in mind with angels

  • Angels shouldn’t be in a position to determine the company’s direction.
  • Set up a special purpose limited-partnership controlled by one among the group of family and friends. This will be a vehicle for them to invest. This avoids you having to chase many signatures in the next financing round or while selling.
  • Don’t make social meetings with family and friends an investor-relations meeting. They should treat their seed contribution as a lottery ticket.

Syndicate

  • Collection of investors. Includes anyone that ends up purchasing equity in the financing.
  • Has a lead investor. Typically it is one of the VCs. There may be two or three co-leads.
  • Lead in the syndicate negotiates terms for the entire syndicate with the founder.
  • Its the founder’s responsibility to communicate with each and every investor during the process – don’t assume the lead will do so.

What the founder should do dealing with a syndicate

  • Make investors agree that the lead speaks for the whole.
  • Don’t negotiate the same deal multiple times (by-product of the above line).

Lawyers

  • A lawyer experience with VC financings is invaluable. Founder should have one to arm against the imbalance (VCs do financing all the times, even the most experienced founders have seen very few financings).
  • Avoids the founder getting hung up on subtleties that a VC has thought through many times.
  • Good lawyer avoids the founder from being distracted over insignificant negotiation terms.
  • Bad/Inexperienced lawyers will focus on the wrong issues – running up the bill on both sides.
  • The lawyer affects the founder’s reputation.
  • Lawyer fees (as of 2012): Fees can be capped ahead of the bill, though they bill by the hour. Early (seed?) stage for 5-15k. Typical financing: 25-40k. Costs increase if you have items to clean up from the past.
  • Standardization in documents has ensured that lawyer fees stay the same as a decade ago despite doubling of hourly fees (lawyers are spending less time on the deal).
  • A good entrepreneur can ensure that the lawyer be paid out of the proceeds of the deal.

Mentors

  • Every entrepreneur should have a group of these. Helps if they know the VC.
  • Stay away from “advisors” who offer to help raise money and then take a cut of the deal as compensation.
  • Most great mentors do it because they enjoy it. Having fees isn’t required, though a share in equity could help cut off the obligation on the founder’s part. Use options, as long as you have control over the vesting of the options based on the mentor’s performance as an advisor. ([KR]: Advice about equity for mentors reinforced by several folks like DP).

What the founder should do while fund-raising

  • Pre-assume success. Don’t meet an investor saying “trying to raise money”, “testing the waters” or “exploring different options”.
  • Determine how much you are raising. Focus on a length of time you want to fund the company to get to the next meaningful milestone.
    •  Don’t exceed what you need. Bad situation to have: you want X, VC is interested in you, but only wants to invest X/4. They won’t because they don’t know yet where the remaining comes from.
    • Instead, try to create a situation like: I need X, I have 3X/4 and I have room for one or two more investors.
  • Give a specific number. Don’t give ranges like 5-7 million – makes you immature in front of the VC. Determine what you need and give that specific number, you can always end up raising more.
  • Fund-raising materials:
    • Elevator pitch – a few paragraphs you can email, not to be confused with executive summary.
    • Executive Summary – 1-3 page of idea, team, product and business.
    • Powerpoint presentation (legacy thing).
    • Business plan or Private Placement Memorandum (PPM): More common in late stage investments.
    • Demos/Prototypes – good VCs always like and prefer these. Especially needed for early-stage companies.

Tips:

  • Quality of presentation matters, but don’t overdesign.
  • Work hard on the executive summary – its the first impression, it is what gets passed around in the VC office and it will be used to judge how deeply/critically you’ve thought of your business and how good your communication skills are.
  • Executive Summary content:
    • What problem are you solving, why is it important?
    • Why is your product awesome, and better than what’s on the market?
    • Why is your team the right one to pursue it?
    • High-level financial data. Have sensible expectations.
    • Exec summary is what you should follow up with if you meet a VC for coffee or at a conference.

Presentation

  • Recognize your audience (single partner, full VC firm, or 500 investors at a demo day event?) and tune your presentation accordingly.
  • Well-designed and well-organized slides are more important for a consumer facing product.
  • Invest in a good designer for this.
  • Most good presentations are done in 10 slides or fewer.

PPM

  • B-plan wrapped in legalese.
  • Waste of time and money for early stage.
  • Only use if investment bankers are involved.

Financial Model

  • Mostly useless.
  • VCs might ask it for one purpose- they are in the business of pattern recognition, they will apply their experience to understand how much you grasp the financial dynamics of your business.

Demos

  • Should tell a story about your product/business.
  • Watch the VCs very carefully while they play around with these.

Due Diligence

  • Asked for, mostly after term sheet : Cap table, board meeting minutes, contracts and material agreements, board meeting minutes.
  • Formal due diligence process starts after signing term sheet.
  • # of docs depends on how long you’ve been in business.
    • Deal with messy stuff upfront.
    • Full disclosure early on – a good VC will help you work through any issues that you may have.

If you are a hot company

  • You’ll have your pick of investors.
  • Do your homework and judge based on
    • who will be most helpful to your success
    • who has a temperament and style compatible with yours.

Grouping VCs

  • Leaders, followers and everyone else.
  • Leader: leads the round, most active new investor.
  • Four kinds
    1. Most interested, wants to lead.
    2. Not interested, wants to pass
    3. “Maybe” – keep this person warm by continually meeting and updating.
      They won’t catalyze your investment, but you can bring them into the mix.
    4.  “Slow nos” – always in react mode, will sporadically respond. Ditch them and move on.

Are you swimming upstream? (while dealing with the VC)

  • Are you in the demographic they like? e.g. first time entrepreneur v/s experienced one.
  • Is your point of contact a weighty name at the firm? You need a GP/MD interacting with you.
  • You’ll learn a lot about the attitude and culture of the VC firm by the way they conduct their due diligence.
  • Before you jump through hoops in the due diligence, make sure you are dealing with a partner. Don’t be an associate’s fishing expedition.
  • Due diligence works both ways – ask other entrepreneurs what they think of the VC.
  • Best VCs will give you a list of ALL the people they’ve worked with in the past. Will ask you to pick a few for reference checks. Pick ones where you can understand how the VC deals with messy situations – founder swapped out, company went through hard times etc.
  • Be wary of the VC who goes from hot->warm->cold, but never says no. They might just be keeping their options open.

Closing the deal

  1. Signing the term sheet
  2. Definitive documents, and getting the cash.
    (1) almost always leads to (2). Messy internals of a company and poor lawyer handling can derail (2). Keep a tab on what both sides of lawyers are up to.

Term Sheet

  • Determines the final deal structure
  • Blueprint of your future relationship with your investor.
  • Economics – what the VC gets in a liquidity event
  • Control – how does the VC exercise control over the business or veto certain decisions the company can make.
  • Anyone who doesn’t focus on one of these two (eco and control) isn’t going to be good deal with as owner, board member or compensation committee member.
  • Founders: common stock.  VCs: preferred stock.

Economics

  • Not just valuation
  • Components:
    1. Price
    2. Liquidation preference
    3. Pay-to-play
    4. Vesting
    5. Employee Pool
    6. AntiDilution
  • Pre-money: Valuation before investment. Post-money: Pre-money + total investment amount
    Basic Trap: “Invest X at Y valuation”. Y is usually meant post-money. Clarify this.
  • Option Pool/Fully diluted
    • The option pool that the VC expects is usually covered in the pre-money valuation, lowering the pre-money valuation (usually).
    • Option pool is a key pricing point of the negotiation – the VC will insist on expanding option pool before funding, and its in the 10-20% range.
    • Either ask for smaller option pool or increase pre-money valuation to accommodate a larger pool.
    • Make an option budget. This is a list of hires you expect to make between this funding round and the next, and the approximate options you will need to land each.
    • Be prepared if the investor wants an option pool higher than your budget, but not by too much.
  • Warrant
    • Another way to sneak in lower financing.
    • Warrant: Similar to a stock option. It is a right for an investor to purchase a certain number of shares at a predefined price for a certain number of years.
    • Example: 10 year warrant to buy 100k Series A stock at $1 per share. (what happens when these 100k shares are worth very little because of dilution?)
    • Warrants create accounting headaches. Negotiate for lower pre-money in exchange for no warrants.
    • Warrants artificially inflate valuation – they affect how liquidity proceeds will be handled, but they are not calculated as part of the valuation.
    • Warrants are justified in “bridge loan” rounds.
  • Bridge Loan
    • Existing investor wants to fund, but is waiting for additional investors.
    • Will issue funding as convertible debt, which will convert into equity at the next financing.
    • He either gets a discount (upto 20%) or warrants that effectively offer the same discount. These are justified.
  • Liquidation Preference
    • Important in the case where company is sold for less than the amount invested.
    • Generally at 1x. Used to be at heights of 10x in the dot-com bubble days.
    • What it means: in a liquidation event, investors will get X times the amount invested back, before common stock holders. e.g. Investor bought preferred stock at $20 – they get $20 per share back in a liquidity event before common stock owners are compensated.
  • Participation
    • Full Participation: Liquidation preference + whatever you deserve after conversion to common stock.
    • Capped Participation: First get the liquidation preference, and then get proceeds from the conversion to common stock, up to a limit. e.g 1x liquidation preference + additional upto 2x return from conversion to common stock.
    • No Participation: Either/Or: Either you get the liquidation preference, or you convert to common stock and investors get the proceeds on an as-converted basis.
  • Participation feature has lot of impact at relatively outcomes and lesser impact at higher outcomes. This makes sense – at higher outcomes, the conversion to common directly gives you the best outcome :)
  • Participation feature matters more as more money is raised that has this feature (Series B, C).
  • Liquidation preferences: easy to understand with only series A.
  • Multiple Rounds:
    • Stacked preferences: Series B gets preference first, then Series A.
    • Blended preferences: Series A and B share proratably until the preferences are returned.
    • Example loss case with 2 rounds: 
      • Series A: 5 million at 10 pre (liq pref: 1x)  Series B: 10 million at 20 pre (liq pref::1x)
      • Total investment: 25 mn. Company sold at 15 mn.
      • In case of stacked preference – the B investor gets all the 15. In case of blended preference – the A investor gets 3 and B gets 12 (20% and 80% – the ratio of the capital put in by them).
      • In both cases, the entrepreneur or employees get nothing, irrespective of participating or nonparticipating.  Why? They raised 25mn at a preference, and company is being sold for less.
  • Keep it simple and lightweight in early rounds
    •  If the seed investor has liq. pref + participation in the seed round and doesn’t participate in future rounds, he stands to suffer, since future rounds will have at least the terms of the previous rounds.
    • Greater the liquidation preference, lower the value of management or employee equity.
  • Kick-outs: Used to be there in the 1990s, where participation goes away as long as you can provide a 2x-3x return to the VC. This should be reinstated!
  • Pay-to-play: Became widespread after 2001.
    • Relevant in down-round
    • Useful when the company is struggling and needs another financing.
    • “Pay” (participate pro-ratably in future financings) in order to “play” (not have your preferred stock converted to common stock).
    • Pay-to-play is good: Only continuing (read: committed) investors continue to have preferred stock, and the rights that come with preferred stock.
    • Conversion to common stock on not paying is OK.
    • What to avoid: A pay-to-play scenario where the VC has a right to force recapitalization of the company if fellow investors don’t play into a new round. ([KR]Would love to have an example of this).
  • Vesting: Industry standard: 1 year cliff (25%) and monthly vesting (remaining 75%) thereafter for next 3 years. Applies to founders too.
    • Founders can sometime get one year of vesting credit right at the closing of the financing (you can vest back to the inception of the company – getting credit for your work earlier on).
  • Unvested stock:
    • Founder stock: Disappears into the ether, everybody else’s shares increase in pro-rata fashion.
    • Employee stock: Goes back into the employee option pool, for future employees.
  • Founder buy-back: Own their stock outright through a purchase right when the company is established. Different from vesting. ([KR] Would appreciate examples on this).
  • Founder tips:
    • How your stock vests is important
    • Consider allowing yourself to purchase unvested stock at the same price as the financing if you leave the company, protects your position for a termination “without cause” ([KR] Needs examples).
    • Treat your vesting as a “clawback” with an IRC Section 83(b) election so you can lock in long-term capital gains tax rates early on. ([KR]: Needs explanation + examples).

What happens to vesting schedules upon a merger or an acquisition?

  • What is accelerated vesting?
    • Single-trigger: Merger itself leads to accelerated vesting.
    • Double-trigger (more common): Merger + employee in question should be fired by the acquiring company.
  • Acquisition case: Acquirer has two choices:
    • Offer unvested equity: motivation to stay around for X time after acquisition.
    • Offer a “management retention piece” as part of the deal – VCs obviously don’t like this because this will be included in the deal value and effectively reduces the value of equity, and hence the proceeds that the VCs or any founders no longer with the company will get.
    • [KR]: How do vesting provisions guarantee that a founder who walks away or is fired, gets to hold some of his equity, while giving the founders who are staying back a differential ownership?
  • Time to exit has huge impact on relevancy of vesting. e.g. in late 90s companies would exit in <2 years, today with companies taking 5-7 years, by the time of the exit, everyone is fully vested (4 years). 

Anti-Dilution

  • Antidilution clause: Protects investors in case of a future down-round.
  • Two varieties: weight average and ratchet-based.
    • Full-ratchet: Reduce the earlier round price to the new issuance price, if the new round is a down-round. (KR: would be good to work with a simplified example here). Partial ratchets are less harshly, but are rarely seen (1/2 or 2/3rds ratchets).
    • Weighted-average anti-dilution: number of shares issued at the reduced price is considered in the repricing of the previous round.
    • Conversion Price Adjustment.
      • Broad-based v/s Narrow-based adjustment: do you count all common outstanding stock (after conversion of preferred, other options, rights etc) or just currently outstanding stock for the “conversion price adjustment”?
  • Anti-dilution “carve-outs”: Classes of stock where the anti-dilution clause doesn’t apply. For the company/entrepreneur – more exceptions are better, and good investors will accept them.
  • An important carve-out is one which allows majority shareholders to waive anti-dilution rights. This is helpful when minority investors sit on the sidelines, don’t participate in the future rounds, and rely on anti-dilution to get a larger stake. :)
  • Case in point: Series A at $1 a share, Series B at $5 a share, C at $3 a share. A didn’t ask for anti-dilution. B did. Claim is that B benefitted at the expense of A. ([KR]: Needs more details).
  • Founder tips:
    • Don’t get hung up in trying to eliminate the anti-dilution provisions.
    • Focus on minimizing their impact (how does one calculate this) and build value into the company so that they don’t ever come into play.
  • Recent trend: Tie anti-dilution calculations to milestones that the investors have set for the company. Anti-dilution occurs automatically if the company doesn’t meet its goals, unless investors waive it after the fact (KR notes: sounds like a bad idea!)

Control Terms

  • VCs care about control terms not only to keep an eye on the investment, but also because of the kind of investors who invest in VCs (LPs?), federal tax statutes apply where control terms matter.
  • VCs mostly own less than 50% of the company, but they have a variety of control terms helping them.
  • Key control terms:
    • Board of directors
    • Protective provisions
    • Drag-along rights
    • Conversion.
  • Process of electing board of directors.
    • Think about proper balance between the investor, company, founder and the outside representation on the board.
    • Board = inner sanctum, strategic planning department, judge, jury and executioner, all at once. VCs who are good people and good investors can make terrible board members.
    • Many VCs will include a board observer as part of the agreement.
    • Be wary of board observer – they don’t vote but they can sway the discussion. You don’t want to be a pre-revenue company and have a 15 people board.
    • Many VCs ask for CEO to be a board member.
    • Sample early-stage company board: Founder, CEO, VC1, VC2, and outside board member. (equal representation for founders (if CEO is a co-founder) and VCs, and the outside guy resolves the disputes).
    • Mature boards: 7-9 members, mostly the additions are outside guys, experience executives in the domain.
    • Private board members don’t get cash compensation. Outside board members are compensated with stock options, just like key employees, and are invited to invest money in the company alongside the VCs.
  • Protective Provisions
    • Veto rights for investors to prevent the company from doing something
    • Strive hard to put all your investors in the same protective provisions category, else you are dealing with multiple stakeholders with varying interests and multiple kinds of veto rights.
    • Some of these protective provisions only make sense if your Series A investors hold enough of your cap table to be relevant (e.g. change size of board of directors, sell the company).
    • Avoid the term “material” or “materially” qualifier in your protective provisions – figuring out what “material” means is a legal rabbit-hole.
    • Be wary of inappropriate veto rights for small investors (e.g. someone who holds 10% shouldn’t be able to veto key decisions).
    • Can’t argue that the VCs board seat will imply their representation and therefore veto/protective provisions should be removed – the guy representing the VC on the board needs to act in the interests of the company while the VC firms’ interest as shareholder might be different.
    • DO NOT NEGOTIATE protective provisions thinking only about your current relationship with your current VC. You are negotiating the deal on behalf of the company (no matter who runs it in the future) and with the investors (whoever they are).
  • Drag-along rights
    • A subset of investors have right to ‘drag along’ other investors and founders to sell the company.
    • Required in case of downturns – when company is sold for less than liquidation preference.
    • Your ownership situation decides whether drag-along is worthy of worrying for you or not.
    • Acquisitions don’t need unanimous consent, buyer will want 85-90+ percent consent though.
    • State laws: California: Majority shareholders of each class agrees. Delaware: Majority shareholders on an as-converted basis agrees. ([KR] How is this “majority on as-converted” basis computed?)
  • Conversion: Only term that is actually non-negotiable in a financing deal
    • Preferred to common stock.
    • Events where this happens –
      • Conversion to common is more beneficial to investor than liq pref + participation.
      • Convert to common to increase stake and influence a decision like a sale.
      • IPOs – most investment bankers will insist on conversion to common for everyone before IPO.
    • [KR] Is conversion always 1:1? When is it X:1? What are the industry norms today?
    • Automation Conversion on IPO: Key terms : it will occur for no less than X times the purchase price of the preferred, and if the offering is at least Y million.
    • Your investors from different Series should always have same automatic conversion threshold else it is a headache for you. Rely on the board to convince a VC to waive automatic conversion stance, if required. (e.g. you want to IPO at 100 mn, Series A has threshold at 80, Series B has threshold at 120). 
    • Apart from conversion, using “this is non-negotiable”, “this is how we always do deal”, “this is the market way” is lame on part of the VC. Run from this. 

Other terms (Non-economics, non-control)

  1. Dividend: More common in PE, VCs dont care.
    • Where it matters: Large investment amount, and lower the expected exit multiple.
      e.g. 40 mn investment at 100 mn post-money valuation, 80 mn sale at end of year 5. Dividend was 10% (annual, assume not compounded) On the sale investor gets 40 for 1x liq pref, and 20 (4 mn year x 5) for dividend. Bad!
    • Ensure that dividends have to be approved by a majority of the board of directors.
    • Be wary of dividend paid in stock – it becomes another form of anti-dilution protection.
  2. Redemption rights: Company pays back the investor their original purchase price (redeeming the preferred stock) after X years.. This is a liability on the company’s balance sheet – whether it can pay or not is a different story.
  3. NEVER AGREE TO: “Material adverse change redemption clause” – basically says whenever things go bad (subjective) investor can redeem his preferred stock + unpaid dividend. This is loan shark behavior, not VC.
  4. Condition precedent to financing
    • Watch out for ways out of a deal. This section shows investor mindset.
    • Term-sheet is non-binding, these conditions matter.
    • Do not agree to pay VC’s legal fees unless the deal is completed.
    • More relevant if you are signing a term-sheet with no-shop clause.
    • Key employment terms for founders not being spelt out is a red flag.
    • “Approval by investors’ partnerships” is a red flag – shows the VC firm isn’t unanimous on the deal yet. Uncommon today.
  5. Information Rights
    • What info VC has legal access to and what timeframe it should be provided in.
    • Don’t bother about these at all – run a transparent ship. Get a strict confidentiality clause to go along with the information rights.
  6. Registration Rights
    • Long and tedious, defines investors’ right to register shares in an IPO event
    • Totally ignore in early stage.
  7. Right of first refusal
    • Investor gets right to purchase X times # of shares they bought in current round, before anyone else, in the next round. X =1 (pro-rata) is fair, X>1 is (super pro-rate) is not.
    • Give this only to major investors.
  8.  Voting rights clause: This is just an FYI section.
  9. Restriction of Sales
    •  Defines sales of common shares while company is a private company.
    • This clause goes in the company bylaws
    • [KR] How is second-market trading enabled with this clause?
  10. Co-sale agreement
    •  Important for founders. It says if a founder sells stock, investors should get the chance to sell a proportional amount of stock as well.
    • Structure this such that you get some leeway to sell stock for a house if you need. Fair deal – let the investor have the right of first refusal on purchasing stock from the founder, which the purchase price set to a fair-valued outside offer. 
    • Obviously don’t agree to excluding everyone else from buying. ([KR]: Travis Kalanick’s FailCon 2011 intro covers this story).
  11. Founders activities
    • Only experienced founders with lots of credibility can wriggle out of it.
    • Puts down in legalese that 100% of your time goes to this company.
  12.  IPO Purchase
    • Forget this one. Used to exist traditionally “investor gets right to buy atleast 5% in event of an IPO”. No longer relevant – if investor has to buy during IPO, this signals a crisis. If company is going to IPO – investor is making enough money anyway, so they are happy even without this.
  13.  No-shop clause.
    • Obvious. “Stop looking for an investor and close the deal” applies at some point in the process.
    • Best case: 30 days. Usual case: 45-60 days. longer is unreasonable.
    • Author’s/VC’s tip: Quality and character of the people involved matters way more here, than the legal no-shop clause itself. Substantiated with examples from their experience.
    • Ask for a no-shop clause that expires if the VC terminates the financing offer (protection against evil VCs). Also, ask for a carve-out for acquisitions (though good VCs will almost always let you pursue the acquisition). 
  14.  Indemnification
    • Most VCs will ask for this.
    • Get D&O (Directors and Officers) liability insurance for founders + VCs/board members.
  15. Assignment
    • Allows VCs to transfer stock, to partnerships or funds managed by itself.
    • Assignment should be allowed as long as the transferee abides by the same terms of the deal as the original. 

Capitalization Table

  • Term sheet contains a summary cap table.
  • What is known – total pre or post valuation, VC stake in %, employee pool %.
  • You solve for – founder stake post investment, price per share, # of shares for VC and employees.

Convertible Debt

  • Used at seed. Many angels opt for only this.
  • Loan that converts to equity when the next round is raised. Includes discount on the next round price.
  • Relevant terms
    • Discount
    • Valuation cap
    • Interest rate
    • Conversion mechanics
    • Conversion in a sale event
    • Warrants – Convertible debt for late stage
    • When is debt dangerous to use?
  • Valuation Cap: “I’ll take a 20% discount on the next round, if the valuation is <= $X. If its > $X, then my valuation is $X.”
    • Series A investors can refuse to fund until the seed investors remove or change the cap. (KR Questions: Has this been seen in practice?)
    • Consider a convertible debt deal with (a) bound timeframe for Series A / or any equity financing (b) if that time bound isn’t met, forced conversion with a floor, not a cap/ceiling on the valuation at that price. ([KR]: Is this easy to achieve?)
  • Discount: Range 10-30%. 20 is most common. You can have it time-varying (10% for next 90 days, 20% after) but better to keep it simple.
  • Usually there’s a minimum amount of equity raising to happen before notes can be converted.
  • Interest: The discount makes up for the seed guy’s risk, so there’s a no reason to go high on interest. Look up the AFR (applicable federal rate) and propose something slightly above it.
  • Conversion Mechanics
    • Debt holders have great leverage in a negotiation ([KR]: Why cases like SurveyMonkey – heavily debt-financed then?)
  • Two parameters to convertible debt terms:
    • Term/Length: Founder wants longest possible, max VCs will agree to is 1 year (can’t issue debt for longer than that).
    • Amount: Min. equity raise needed for debt to convert. Founder gets to decide this.
      i.e raise $1mn in equity within 180 days for automatic conversion to occur.
    • If the milestones are not achieved, the debt stays outstanding unless the debt holders agree to convert their holdings.
  • Conversion in case of a sale
    • Company is sold before conversion to equity happens
    • Lender gets back either of (a) money + interest (b) money + interest +some multiple (2-3x) of the original principal amount. (c) some kind of conversion of debt to equity.
    • Founder Tip: Acquisition while there is debt outstanding is a tricky case. Address how conversion will occur (do you convert debt to equity at last preferred price? how do you convert debt to acquirer stock?)
  • Warrants
    • Not advisable during seed. Perhaps use during later stage convertible debt.
    • Warrants and discounts on the next round are either/or. Never agree to both. e.g .100k convertible debt. Investor gets 20% in warrants i.e. Instead of 20% in discount on the next round, you have 20k worth in options to purchase a certain number of shares at a pre-determined price. Which shares? Either the last round at the last round’s price or the next round at the next round’s price.
    • Key terms of a warrant:
      • Length: exercisable for 5-10 years. Longer the better for investor. Shorter the better for company.
      • What happens in an acquisition: This is a key factor. Acquirors dont want to deal with the mess of pending warrants.
    • Warrants must expire on acquisition.
    • Accounting caveat: IRS needs something to be paid for, for the warrant.
    • Warrants add complexity (legal and financial), they are used, among other reasons, because they are not factored into the valuation, discounts are.
  • Other terms in convertible debt:
    • Super pro-rata rights for next round: be careful with these. (e.g. 200k in debt, pro-rata rights won’t help if you do the next round at 50mn valuation).
    • Liquidation preference: same as how preferred stock works.
  • Keep in mind while considering convertible debt:
    • In case of raising equity, the company is solvent (i.e. not under debt). The fiduciary duty of founders and board is to increase shareholder value.
    • In case of raising debt (convertible note), the company is insolvent. The fiduciary duty is higher towards lenders for the founders and boards and this increases personal liability on them.
    • It becomes tougher to justify that they were acting in the best interests of the lenders.

Notes from The Power of Positive Thinking

Caveat Emptor: Great book, but throws in way too much Christianity/religion in the face of the reader. IMHO, it is much easier for humans to place absolute confidence and faith in an abstract higher power, than it is to place faith in their innate prowess. Substitute “prayer” and “God” in this book summary for something similar that works for you.

  • Six point action plan to stop fuming and fretting:
    1.  Get in a relaxed physical position.
    2. Visualize: Your mind is the surface of a lake, tossed by waves and in tumult. But when the waves subside, the surface of the lake is placid and unruffled. This imagery should help you calm down.
    3. Spend two-three minutes thinking about the most beautiful and calming nature scenes you’ve witnessed.
    4. Repeat, slowly to yourself, words along the lines of “tranquillity”, “serenity”, “peace” and let the effect of them sink in.
    5. Make a list of times in your life when you were worried and anxious, and things turned out fine (for the more religious, “God took care of everything”).
    6. Rely on a higher power to take charge of the situation and fix it.
  • “Imagineering” – the use of mental images to build factual results.
    • Children are more imaginative and more effective at fighting away negativity – a child responds to the game of kissing away a hurt.
  • Develop the right mindset to see the possibilities:  
    a. Golf Ball example – the obstacles are only mental. The author was worried about a golf shot which had landed in the grass in an obstacle position. Had it been flat, clear land, that position would have been perfect for the next shot. Close scrutiny from a friend showed that the golf ball ‘obstacle’ position could be overcome – the author was worried about the grass, but he was forgetting that the location was still conducive and that the grass was soft and chewable, so a sharp hit from the club would easily overcome the grass.                                                                                                     b. Construction example – a construction tycoon met his workers on a coastal area where they had been doing work with heavy earth-moving machinery. They were disappointed that recent floods/storms had covered the machinery in swamp/mud and months of work had been destroyed. He smiled and pointed to the sky – it was clear blue and sunny, and that made him realize that in a few weeks, the swamp/mud would dry off in the sun and they would be able to recover and proceed again.
  • Worry is the most subtle and destructive of human diseases. Break the habit of worrying – you become a worrier by practicing worry.
    • Remind yourself that it is a really bad mental habit.
    • With all the strength and perseverance you can muster, start practicing faith.
    • Many people fail to overcome worry – they allow the problem to seem complicated and do not attack it with simple techniques.
    • Long-held and habitual worry is like choking up someone putting fingers around their throat and pressing hard.
    • Married people live longer than singles. Claim: a married couple can divide the worry.
  • Overwork is of no use:  The author offered a doctor who seemed to always deep-in-work, the ‘prescription’ of taking half-day off each week and spending it in a cemetery. He was to ponder on souls who were there permanently, and realize that they too thought only they could do certain things, and once they left, the world goes on about its business.
  • Longevity: Study of long-living people shows the following habits:
    1. Kept busy.
    2. Used moderation in all things.
    3. Ate lightly and simply.
    4. Got a great deal of fun out of life.
    5. They were early to bed and early up.
    6. Free from worry and fear, esp. fear of death.
    7. Serene minds and faith in God.
  • Steps to fight anger:
    • Anger is an emotion, and an emotion is hot. Cool it down. Its difficult to get mad lying in a chair, or with your mouth gaping open or with your palm open and fingers stretched. Do all of these.
    • Say aloud to yourself: “Don’t be a fool. This won’t get me anywhere, so skip it.”
    • Mentally say the first ten words of your favorite prayer.
    • Anger is an accumulation of a multitude of minor irritations. Make a list of everything that bothers or irritates you. Dry up the tiny rivulets that feed the great river of anger.
    • Make each separate irritation a special object of prayer. Get a victory over each, one at a time.
    • Each time you feel the surge of anger, you say, “Is this really worth what I am doing to myself emotionally?”
    • When a hurt-feeling situation arises, get it straightened as quickly as possible.
    • Apply grievance drainage to your mind
    • If all else fails, pray ~500 times for the person who has hurt you. Its hard to maintain resentment after so many prayers!
  • Problem-solving steps:
    • Believe that there is a solution.
    • Keep calm. Tension blocks the flow of thought power.
    • Don’t try to force an answer. Keep your mind relaxed.
    • Assemble all the facts impartially, impersonally and judicially.
    • List these facts on paper – this clarifies your thinking, bring the various elements into an orderly system. You see as well as you think.
    • Pray about the problem, affirming that ‘God’ will flash an illumination into your mind.
    • Trust insight and intuition.
  • 3 step plan for easy-does-it: Practice the easy-does-it method for reducing tension.
  • Analyze people who are really efficient and they always seem to do things easily, with a minimum of effort. In doing so, they release maximum power.
    1. Collapse physically. Think of yourself as a jellyfish, getting your body into complete looseness. Form a picture of a huge burlap bag of potatoes – and then cut it and let the potatoes roll out. That is you – your mind and your body.
    2. Drain the mind.
    3. Think spiritually.
  • Reduce the number of worry and sorry words in your conversation: Example: “I am worried that I will miss the train” – start early enough! The uncluttered mind is systematic and is able to regulate time.
  • Ten rules for effective prayer:
    1. Set aside a few minutes each day to think about God.
    2. Talk to God in your own language. Tell God what is on your mind.
    3. Use minute gaps in the day to shut out the world, and concentrate briefly on God’s presence.
    4. Do not always ask when you pray, spend most of your prayer giving thanks.
    5. Sincere prayers can reach out and surround your loved ones with God’s love and protection. Pray with this belief.
    6. Only positive thoughts in prayers get results.
    7. Be willing to take what God gives you – it may be better than what you asked for.
    8. Do your best and leave your results confidently to God.
    9. Pray for people who have mistreated you – resentment blocks your spiritual power.
    10. The more you pray for other people, the more the prayers come back to you.
  • Steps to overcome negativity:
    • Force yourself to speak hopefully for 24 hours about EVERYTHING.
    • Do this a few times,now allow yourself to be “realistic”. What seemed “realistic” a week ago will now come across as “pessimistic” to you.
    • Feed your mind as you feed your body – positive thoughts.
    • Spend time with positive friends
    • Avoid arguments – but whenever a negative opinion is expressed, counter it with a positive and optimistic opinion.
  • Anger Management: When you find yourself getting angry – observe yourself in the third person, and lower your tone down. It is hard to have an argument when you’re whispering. It is hard to get mad when your fingers extended and stretched out or open your mouth to breathe deeply (you can’t clench your fists or your teeth).
  • Be in control: Dale Carnegie, on purpose, leaves his office when busiest. This demonstrates control of time, rather than being controlled by it.
  • Keep a daily ritual – to mark the end of a day. It could be the turning a cup upside down. It could be tearing off the daily sheet from the calendar – the day is over. You did the best you could out of it. You accepted what God gave you, and it’s now time to make peace with it. Practice emptying your mind daily before sleep. Or filling in the right thoughts. During sleep, thoughts tend to sink in more deeply into the subconscious.
  • Practice happy thinking – fill your mind with peaceful, happy experiences you’ve had and pass them through your mind several times a day.

Powerful Quotes:

  • Practically speaking, there are only a few human stories, and they have all been enacted previously.
  • Every great personality I’ve ever known, anyone who has demonstrated the capacity for prodigious work has been a person, not necessarily pious, but extraordinarily well-organized from an emotional and psychological point of view.
  • The longer I live, the more I am convinced that neither age nor circumstance needs to deprive us of energy and vitality.
  • The surest way to not become tired is to lose yourself in something in which you have a profound conviction.
  • You only lose energy when life becomes dull in your mind.
  • People who lack energy are disorganized to one degree or another by deep, fundamental emotional and psychological conflicts.
  • God runs a beauty parlor – comes from the author’s experiences that showed women with a kind and warm personality, lots of faith and prayer looked better and more beautiful, more inviting.
  • People are about just as happy as they make up their minds to be – Abraham Lincoln.
  • A clean engine always delivers power. A clean mind, like a clean engine, always delivers power.
  • A man is what he thinks about all day long.  – Ralph Waldo Emerson.
  • Enough sleeping pills are sold each day to put 1/12th of Americans to sleep at night (and this is an outdated  figure, has probably gotten worse).

Work empowers personality

“Bill O’Reilly who precedes me on our channel, is like a superhero. Because if you meet him in person, he is kind of shy, quiet. He would never dominate your dinner table. But you put that guy behind that desk, and he grows into this larger than life personality. And I have a little bit of that. When I sit in front of that desk, I don’t care who’s across of me, I don’t care if its a Republican or Democrat or President. It doesn’t matter. I only have one master and that’s my audience. I will serve that audience and if you try to dodge or weave, you will get pinned down. So I feel very empowered. In person, I am not a shrinking violet, but I don’t have quite as much, uh, power.” 

– Megyn Kelly, 2014 interview

Notes from Thinking Fast and Slow

This post is a collection of insightful concepts and statements I found in Daniel Kahneman’s Thinking Fast and Slow. Apologies for the lack of coherence towards the end – the volume of the book ensured I got down to just jotting down the meat of the matter without any context or detailing.

  • Fundamental premise of the author’s work: Economics says humans are mostly rational and their thinking is sound. The departures from rationality only occur due to emotions such as fear, affection and hatred. The author documents systematic errors in the thinking of humans – these are errors due to how our cognitive machinery is designed, not a corruption of our thoughts by emotions.
  • Expert intuition: Thousands of hours of practice in anything (mostly your work) in a controlled environment with a good feedback loop can set you for taking good decisions just by “blinking” instead of having to “think”. A good example is a firefighter anecdote, where an experience guy ordered his team to head out of a  house with no visible signs of danger. Only in hindsight did he realize that his subconscious was processing subtle danger signs related to smoke and fire. Note that this only works with controlled environment, with no underlying randomness (cases of firs are different, but there is an underlying pattern to the kinds of houses and kinds of fires they deal with, and the behavior of materials reacting to fire) as opposed to environments with fundamental randomness, such as stock markets. The stock traders doesn’t have a reliable, non-random feedback loop – so he cannot develop such “blink”-style judgement expertise.
  • Notion of two Systems: A human mind has two systems – System 1 is intuitive, guided by associative memory (and hence affected by feelings) and FAST. System2 is deliberate, responsible for complex logic, reasoning and calculations, any kind of decision-making that needs effort, but it is also SLOW and LAZY. Much of the book focuses around understanding these two systems, how most humans rely more on System1 than they need and the errors arising due to biases wired into System 1. System 1 is flawed, yet it also very good at constructing coherent stories.
  • Notion of two selves: The “experiencing self” and the “remembering self”. Human memories are not perfect reconstructions of reality. Humans are guided by the remembering self and this makes them expose themselves to unnecessary pain.
  • Limited attention power of humans: As demonstrated in the selective attention experiment.
  • “We can be blind to the obvious and we are also obvious to our blindness.”
  • Illusions: Muller-Lyer illusion is a famous example of how our cognitive machinery is flawed (even after understanding the concept, it presents a reality that is hard to accept). Not all illusions are visual – many are cognitive, and those are the costly ones.
  • Example of a cognitive illusion: Psychotherapists often have a strong attraction for a patient with a repeated history of failed treatments, thinking that they may be the ones to succeed in curing him. (Hint: the patient is a psychopath!).
  • Flaws of System 2: System2 is lazy and reluctant to invest more effort than is strictly necessary. It believes it has chosen thoughts and actions, but these choices can be, in reality, guided heavily by System 1. The concept of priming is an example of this.
  • On pupils and psychology: The pupil of the eye is a window into one’s soul – if you perform a slightly non-trivial calculation with a periodic frequency with a camera focused on your eye, it will record very regular pupil dilation and contraction events. The pupil dilation is an indication of mental effort – pupils contract immediately when a person gives up or finds the solution.
  • On why training matters for System 2: Unlike a house’s circuit breaker, which completely breaks down in case of overload, System2 will focus its attention on the most important activities, letting go of the rest. The selective attention test video linked to above is proof of that. With training and over time, as you get more and more familiar with a task, fewer brain regions are involved.
  • State of flow: Flow is a state of effortless concentration,  so deeply focused on whatever one is doing at the moment that one loses a sense of self and all one’s problems. Flow leads to optimal experiences. All variants of voluntary effort – cognitive, emotional or physical – draw atleast partly from a shared pool of mental energy.
  • “Ego depletion”: This demonstrates the “shared pool of mental energy” concept. People instructed to stifle their emotional reaction to an emotionally charged film will later underperform on a test of physical stamina. Another example – studies show that favorableness of results from judges increases in the short time after lunch. Tired and hungry judges tend to fall back on the easier default possibilities of denying requests for parole.
  • Over-riding intuition takes hard work: The insistent idea that “its true, its true” coming from System 1 makes it difficult to check the logic. Lots of mental effort goes into training your System 2 to kick into action more often, whenever needed, but its worthwhile. Some lucky people are more like System2, most of us are more like our System 1.
  • Strong link between self-control and cognitive aptitude: The Stanford marshmallow experiment is a good example of this.
  • Concept of Priming: If you saw the word EAT and then saw SO_P, you are more likely to complete it as SOUP. If you saw WASH and then saw SO_P, you will complete it as SOAP. The experience you are subjected to (reading a word) triggers a portion of your associative memory, and so now your retrieval is biased.
  •  Priming as applied to experiences: Priming is not just about words, ideas and thoughts. In an experiment, young people who were asked to assemble a sentence from scrambled words related to old age, walked slower than the others in part 2 of the experiment when they had to walk down a hallway.
  • Influencing of an action by an idea – the ideomotor effect. Clasp both your hands together and index fingers of both hands pointing at each other, now think of the line joining the tips of the two fingers and see how your fingers twitch!
  • Reciprocal priming: Thoughts/ideas/words influence actions – that is priming. The inverse of it is reciprocal priming. Smiling naturally invokes positive, optimistic emotions and thoughts.
  • “Act calm and kind regardless of how you feel” – you are likely to be rewarded by actually feeling calm and kind.
  • Useful resources on priming: understanding how you are less in control of your actions than you think, and how priming affects your performance.
  • Money-priming leads to increased self-reliance – money-primed people (exposed to thoughts of money) persevered almost twice as hard in trying to solve a very difficult problem. Money-primed people are also more selfish.
  • “They were primed to find flaws and this is exactly what they found.”
  • Cognitive ease – when things are going normally. Cognitive strain – when you need more help from System 2.
  • The cognitive ease inflow-outflow machine: Things that lead to cognitive ease are repeated experience, favorable conditions such as a clear display and good font, primed idea (such as, being introduced to the concept through a nice subtle watermark in the background) and a good mood. What comes out of cognitive ease is the following feelings/emotions – “feels true” , “feels good”, “feels familiar and effortless”
  • “Cognitive easy is good and recommended in some cases, but dangerous in other cases (where it prevents System 2 from kicking in and makes the wrong judgements via System 1).” As an example, the performance of Princeton grads in puzzles went up by a notch when the font worsened, causing cognitive strain and system 2 to kick in.
  • Cognitive Ease: Pros: More creative. Cons: Makes judgement errors due to familiarity.
  • Cognitive Strain: Pros: More vigilant, suspicious, invests more efforts. Cons: Feels less comfortable, leads to less intuitiveness/creativeness.
  • “Illusions of remembering”: You think David Steinbill (made-up name) is a celebrity just because the experimenters exposed you to his name in a casual setting before the experiment!
  • “Illusions of truth”: If you are put at sufficient cognitive ease by the mood and environment around you and by previous similar questions,  you may agree to the phrase “chicken has 4 legs”. It takes a while for System 2 to kick in and tell you this is not true.
  • “Anything that makes the cognitive machine run smoothly will also bias beliefs”
  • “Familiarity is not easily distinguishable from truth”
  • “If a statement is strongly linked by logic or association to other beliefs or preferences you hold, or comes from a  source that you trust or like, you will feel a sense of cognitive ease.” This is because the lazy System2 will just accept the suggestions of System 1 and march on.
  • Awesome example of cognitive ease effects: Stocks with pronounceable tickers perform better than the tongue-twisting ones! (like PGX or RDO). 
  • Mind is biased toward “causal thinking” and doesn’t understand statistics or regression to the mean easily. Good example of regression to the mean – ask a bunch of people to take 2 attempts at darts. The ones who did the best in the first attempt will get worse (relative to themselves) in the second attempt. This causes instructors to (faultily) conclude that admonishing leads to better performance in the next attempt and praise leads to worse performance in the next attempt.
  • Intensity Matching: Humans unknowingly transfer evaluation from one situation to another (which merits a different way of thinking/evaluating) applying “intensity matching”. Trivial example – give a long description about a school girl really sharp at reading and then ask the audience to predict her college GPA. Reading skills at age 7-10 have nothing to do with GPA, yet instinctive answers from the audience indicate “intensity matching”.
  • Common human fallacies while making predictions (or forming “intuitions” about situations): neglect of base rates, and insensitivity to the quality of information.
  • Intuitive predictions tend to be overconfident and overly extreme.
  • Moderating the extremeness of intuitive predictions is not always a good thing – example, venture capitalists need to call extreme cases like Google correctly, even at the cost of overestimating the prospects of many other ventures.
  • Consider the range of uncertainty around a most likely outcome. (KR note: This is reminiscent of Aswath Damodaran’s recent lecture at Google about valuation – where he defines a range of variation on every single parameter in his valuation, so his end prediction for the stock price of Apple is a large histogram)
  • The most valuable contribution of the corrective procedures that the author proposes to fix “wrong” intuitions is that they force one to think about how much they know.
  • WYSIATI – Human mind’s bad fallacy – what you see is all there is.
  • Asked to reconstruct our former beliefs, we often bring up our current ones instead and many cannot believe they ever felt differently.
  • Hindsight bias – people cannot reconstruct their past beliefs accurately. This makes it difficult to evaluate a decision properly – in terms of the beliefs that were reasonable when the decision was made.
  • The worse the consequence, the greater the hindsight bias (KR note: reminiscent of parents saying “I told you so” when things go south in a marriage they were arm-twisted into agreeing to).
  • Hindsight and outcome biases foster risk aversion.
  • System 1 makes us see the world as more tidy, simple, predictable and coherent than it really is.
  • Halo effect: Depending on whether the company has been doing well or not recently, the same CEO will be called “flexible, methodical and decisive” or “confused, rigid and authoritarian”.
  • Therefore, you can’t do pattern mining to identify what works for successful companies. Examples of this kind of failure are “Built to Last” and “In search of excellence” (companies/theses mentioned in both the books melted down in a short period following the book).For some of our most important beliefs, we have no evidence at all, except that people we love and trust hold these beliefs!
  • Amazing experiment the author does with 25 top financial advisors – he gets a spreadsheet that has them ranked (with data on how much returns they generated), on an annual basis, for 8 consecutive years. He studied correlations between year 1 and 2, year 1 and 3…. and so on until year 7 and 8 (28 correlation coefficients, one for each pair of years). The average of the 28 corelation coefficients was 0.01!!
  • People with the most knowledge are poorer at forecasting than people with some knowledge of the field/domain/situation. With knowledge, the person develops an enhanced illusion of skill and becomes unrealistically overconfident.
  • Simplicity is often way better than complexity. Paul Meehl’s “little book” – simple, statistical rules are superior to intuitive ‘clinical’ judgements. Book by Gary Klein – “Sources of Power” – Analyzes how experienced professionals develop intuitive skills. Malcolm Gladwell’s book “Blink” is along the same lines.
  • Emotional learning is similar to Pavlo’s experiment – the dog had “learned hopes”. Learned fears are even more easily acquired (KR note: perhaps more applicable to women, being the more emotionally susceptible gender).
  • Lesson learnt: Train yourself hard, in a regular environment with a good feedback loop so that the “expert intuition” that you are developing, actually holds true.
  • When you see data that seems to define a BASE RATE, ACKNOWLEDGE IT, LET IT CHANGE YOU.
  • Planning fallacy – overestimate benefits, underestimate costs.
  • How to overcome the planning fallacy – Develop an “outside view” by involving a ton of “reference class data” about similar projects.
  • Sunk-cost fallacy – You didn’t have a reasonable baseline prediction when you started out, and when you get the baseline you ignore it because it’s too late in the game and you’re already invested.
  • More optimistic people are the ones who are inventors, politicians, military leaders etc. They take more risks than they think they are capable of.
  • Entrepreneurs are inherently more optimistic. Chances that a small business survives in USA for > 5 years are 35%. 60% of new restaurants are out of business after 3 years.. yet people still open new ones and are optimistic about them.
  • Study shows CFOs are grossly over-confident about their ability to forecast the market.
  • Pre-mortem: Just before an important decision has been finalized but not committed – you imagine you are in the future, the decision has failed, and look at what could have wrong. The main virtue of the premortem is that it legitimizes doubts.
  • “What rules govern peoples’ choices between simple gambles and between gambles and sure things?” Amos and Kahneman set out to understand humans make choices, without assuming anything about their rationality.
    Econs (perfectly rational, selfish, stable taste) & Humans (WSYIATI, tastes change, not fully rational or fully selfish).
    Bernoulli’s experiments/conclusions: “A risk-taker with diminishing marginal utility for wealth (which is most of us) will be risk-averse.”
    – Flaw in Bernoulli’s theory: You need to know the reference before you can predict the utility of a given amount of wealth.
  • People become risk-seeking when all their options are bad.” :-) This is insightful. Simple example – which would you pick – lose $100 for sure or lose $200 with 50% probability?
  • Loss aversion ratio for most people is in the range of 1.5-2.5 (potential gains have to be that factor higher than potential losses).
  • Brains of humans and other animals contain a mechanism that is designed to give priority to bad news.
  • Goals are reference points. Avoiding the failure to meet a goal is a stronger motivator than the desire to exceed it.
  • Perceptions of fairness are based on our reference points.
  • “Altruistic punishment” (punishing a stranger for behaving unfairly towards another stranger)
  •  Smart negotiation tactic: falsely hold on to something as very precious or important to you, thereby showing that you’ll stand to be pained a lot by giving it away, when in reality, you were prepared to give it away all along.
  • Consistent overweighting of improbable outcomes – a feature of intuitive thinking, leads to inferior outcomes.
    – Opportunities to frame a fact differently, such that one way of framing evokes a different mental/emotional response. (e.g. probability of DNA testing failure – defendant will say “1 in a 1000″, accuser will say “0.01” – because accuser wants to show DNA testing works for certain, defendant wants to create doubts in the jury’s head).
  • Human nature tends to be risk averse for gains and risk-seeking for losses – it is COSTLY to do so! You should favor taking risks in gain-scenarios and reduce risk-seeking when it comes to losses.
  • Countering the “loss aversion” mentality that you were wired with – take a $100 loss with 50% chance, $200 gain with 50% chance gamble. Offered one gamble you will probably pass it ($100 loss will feel more painful than $200 gain). However, if offered 100 of these, no fool should reject it (compute the expected value there – the chances of you losing money are insanely low- like 1 in 32000).
  • So, the next time you think of loss aversion, think of life as a bunch of these small gambles – you win a few, you lose a few, but the chances of you losing overall in the long run are slim.
  • Be rational enough to avoid your loss aversion.
  • “Combination of loss aversion and narrow framing is a costly curse.”
  • Mitigating loss aversion: evaluate your portfolio only a quarter, else loss aversion will make you overtly sensitive to minor fluctuations and make you react on daily lows.
  • Investors sell more losing stocks in December, when taxes are on their mind. The tax-loss harvesting advantage is available all year, but then mental account prevails more during the other 11 months (“disposition effect” -think you did well by selling a gainer instead of a loser).
  • The “sunk cost” fallacy is both identified and taught as a mistake in business and economics courses, and there is evidence that graduate students in these fields are more willing than others to walk away from a failing project.
  • “Losses evoke stronger negative feelings than costs.” e.g. “Would you accept a gamble that offers a 10% chance to win $95 and 90% chance to lose $5?” or “would you participate in a lottery ticket worth $5 where you have a 10% chance of winning $100 and 90% chance of winning nothing?” The two problems are identical but people like the second one way way more.
  • Interesting example: Credit card industry lobbied hard to make vendors say it’s a “cash discount, not a credit surcharge.” (if you are paying different amounts for cash v/s card). People will much more easily forego a discount than they will take a surcharge.

Nora Denzel’s advice to women in CS

Happened to watch this GHC 2012 keynote from Nora Denzel, someone who’s broken the glass ceiling in a number of ways. The gist of her advice to women in CS is in 5 crisp points, worth archiving, so here it goes:

  1. Fix your attitude – if 5-7 years into your career, things aren’t going as you’d like, step back and check if the problem is with your attitude. There are no ‘career paths’, just ‘career obstacle courses’  and you need to have the right attitude to counter those.
  2. Get comfortable with being uncomfortable always – Growth and comfort are OR-ed bits, not AND-ed bits. You can either be “comfortable” in your career or “growing”. The times when she was most scared or felt most challenged were the times when she was growing the most. The times when she felt relaxed, over phone-calls and meetings that she didn’t have to pour herself into – those were the times when she was stagnant.
  3. Act as if  – When you are uncomfortable and feeling scared/getting into self-doubt, “act as if”. She cites Sally Ride who was extremely scared on her space ride because she knew all the failure points of the system, but acted and came across like a confident, smart and well-put together astronaut.
  4. Control your PR agent – and that’s you yourself! Every message, piece of speech or act/conduct coming from you is your PR statement.  She cites examples of women in her organization who were doing well, but when complimented by senior execs, instead of saying thank you, replied by emptying all their self-doubt  (I wasn’t good here, here and here).
  5. It takes a village – Enroll the help of others. Its not what you know, its not even who you know, its who knows what you know. 

“Only The Paranoid Survive”: Thoughts on the Andy Grove bestseller

Andy used to teach a strategic management class at Stanford GSB  while working as Intel’s CEO, so this book stemmed from both his experiences running Intel and his reflections on those experiences while teaching.

  • Only the paranoid survive is a phrase attributed to Andy in the valley. He strongly believes in the value of paranoia when it comes to business since business success sows the seeds of its own destruction.
  • The book focuses on strategic inflection points, times in the lifetime of a business when its fundamentals are about to change. These bring full-scale changes in the way a business is conducted, so merely adopting new technology or changing a few processes here or there don’t count.
  • A classic example of a strategic inflection point is when Intel went from being a memory technology company to a microprocessor company. This was an inflection point for Intel that later caused inflection points for many others – such as the mainframe industry, with PCs becoming ubiquitous.
  • The lessons of dealing with strategic inflection points are similar, whether you are dealing with a company or your own career.
  • No amount of planning can help anticipate these changes. This doesn’t mean you shouldn’t plan at all. Liken this to how the fire department works –  they can never anticipate where the next fire will be, but they can and do work towards being agile and efficient enough that they can deal with ordinary as well as unanticipated events.
  • For Andy personal, the Intel pentium division bug was a huge inflection point. It changed how he and other management folks thought of the company and interacted with their “customers” (or even who they thought their customers were!). This is reflected in the difference between how Intel initially dealt with the issue and later, after it had blown out of proportion. Intel was used to thinking of itself as a giant start-up, one that dealt with businesses and supplied to businesses (OEMs, computer manufacturers) and hence dealing with engineers in a closed room. The Pentium FDIV incident put them in a spot where they had the ordinary Joe customer calling up their support staff and asking for a replacement component. They realized the world at large thought of them as yet another “big corporation”. Initially Intel’s stance was “we will decide whether the bug affects you or not”, which was rationally valid. The FDIV bug wouldn’t have affected the ordinary home user anyway.. But they soon realized this would not work with the end customers and offered to replace every single chip shipped out. This cost them a whopping $475 million in those times (~750 mn today).
  • Andy’s statement from those times are fairly amusing. “We found ourselves dealing with people who bought nothing from us directly yet were very angry with us.” “Suddenly I found a CNN crew awaiting me.”
  • Top management or folks in leadership roles are usually late, even the last folks, to know about inflection points. Andy acknowledges this was the case with himself in the FDIV incident. “It took a barrage of relentless criticism to make me realize that something had changed – and that we needed to adapt to the new environment.”
  • He encourages listening to foot soldiers (marketing, sales crew out in the wild) and middle managers with a keen ear, watching out for signs of change. They are the first ones to feel the effects of a strategic inflection point and it shows in how they change the way they perform their jobs. This will inevitably happen – when Intel’s memory technology business was floundering, middle managers managing the foundries and assembly lines had quietly begun reducing the amount of resources dedicated to memory and increasing the proportion of logic components such as microprocessors, for that would help yield better results for their divisions and themselves.
  • A 10X change – Michael Porter’s 5 forces talk about the factors that can endanger a business – competitors, customers, suppliers, new entrants and substitute products. Andy adds complementors to that list – other businesses from whom customers buy the same products. They have the same business interests as you do and travel the same road as you. A very large change in one of these forces is what Andy calls a “10X” force.
  • The microprocessor and the personal computer were a 10X force in the computer industry, which changed the industry from vertically integrated players in early 1908s (IBM, DEC types – doing everything from low-level hardware, fab-bing in-house to high-level operating systems) to a horizontally spread (Intel, Motorola dominating chips,  Compaq, Dell and IBM doing the PC-making and Microsoft leading the software side) during early 1990s.
  • Jobs’ NeXT is an example of a company that refused to acknowledge this 10X force, but eventually bowed down to it, turning into a software-only company.
  • These inflection points affect not only the high-tech industry but all businesses around us. A wal-mart store opening in a small town is a 10X force for the small shops in that town.
  • It takes a great amount of determination and objectivity to move yourself (and your team, if there is one) through an excruciatingly tough series of changes. This happened at Intel in 1985, when they had been going through a tough time in the memory business for about a year. There were great emotions attached since this had the foundation stone of Intel as a company, but it wasn’t working out for them. Andy asked the co-founders what would happen if the board kicked them out and brought in a new CEO. “He would get us out of memories.” “Then why don’t you and I walk out the door, come back and do it ourselves?”
  • The word “point” in inflection point is a misnomer. It’s not a point – its a long, torturous struggle. Intel was being beaten by the Japanese in memories since early 1980s. Intel’s performance slumped badly around 1984. Andy and the founders got to decision making only in late 1985 and it wasn’t until mid 1986 that the switch was made. Its worth asking two things here – (a) is the same timeline even affordable in today’s world? Perhaps for the size of Intel or other tech giants, who have a lot of runway left, huge “war coffers”, perhaps such a timeline is still affordable. (b) is a similar timeline affordable when making career/life decisions in today’s fast-paced world?
  • Signal or Noise: When evaluating whether a change is a 10X force or not, false negatives are a big problem too. Andy walks us through his thought-process while evaluating the “RISC vs CISC” debate and while debating the implications the rise of the internet would have on Intel.  It is worth noting that ARM surfaced as a dominant competitor to Intel only after Andy stepped down as CEO – I wonder if this has to do with the fact that his judgement of RISC not mattering was right when he was CEO (mobile hadn’t emerged, power still wasn’t a concern in desktops, and memory/frequency walls had not been hit, and x86 was providing better performance than RISC) but the people who followed in his footsteps failed to change the judgement when the scenario changed.
  • Listen to the Cassandras – Cassandra was the priestess who foretold the fall of Troy. For a company these Cassandras are people who are out in the field, and can feel the pulse of the market, the situation. Field sales managers in remote markets will know a lot more about upcoming changes than the top management sitting in California. Who are these Cassandras when it comes to individual life/career decisions?
  • Debate a lot – When dealing with RISC vs CISC, Andy brought in senior folks, middle managers from all functions in the company, customers and partners. He was also careful to offset for the biases and interests of these different individuals. Sometimes its OK to factor in the biases and accept them – a business only succeeds when it can serve the interest of outside parties.
  • Arguing with data is a double-sided sword. “You have to be able to argue with the data when your experience and judgement suggest the emergence of a force that may be too small to show up in the analysis but has the potential to grow so big so as to change the rules your business operates by.”
  • Let people speak their minds without fear of punishment. Cultivate an environment where everyone is aware that someday, some development somewhere will change the rules of the game and everyone is on the lookout for those kinds of changes.
  • It is the fear (of losing) that gives me the will to listen to Cassandras when all I want to do is to cry out, “Enough already, the sky isn’t falling yet” and go home. Simply put, fear can be the opposite of complacency.
  • “From our inception on, we have worked very hard to break down the walls between those who possess knowledge power and those who possess organization power.”
  • Managing an inflection point is a two-step process – let chaos reign and then rein in chaos.
  • Dealing with an inflection point  and dealing with loss: “A manager in a business that’s undergoing a strategic inflection point is likely to experience a variation of the well-known stages of what individuals go through when dealing with a serious loss. This is not surprising because the early stages of a strategic inflection point are fraught with loss – the loss of your company’s presence in the industry, of identity, a sense of control over your destiny and most troubling, the loss of being affiliated with a winner.”
  • The difference: “denial, anger, bargaining, depression and ultimately acceptance” here becomes, “denial, escape or diversion and finally acceptance and pertinent action.”
  • Escape or diversion: Senior executives want to be legitimately occupied with things that demand their constant attention day in and day out and things that can provide a sense (illusion?) of progress , so that they can avoid looking at the small-ish signs that  foretell an impending strategically disruptive force. Grove hypothesizes that this is why several Japanese major consumer electronics companies acquired movie studios, the senior management wanted interesting diversions, rather than coping with a secular slowdown of the core business. He himself wrote “High output management” in the years preceding the memory crisis, and wonders if that was an accident. :)
  • The inertia of success: When people suffer from this, they believe that just working harder and doing the things that got them there will work, given enough time. “Just give us some more time” is a phrase that is often heard in this context.

Fortress

The iron gates, the daunting locks,

The nauseating chains, the bolts and knobs

Each of them checked, every path blocked

The guard let out a relieved sigh.

“Much at stake ‘ere, can’t afford to be lax”

Deep, dark secrets the fortress does hold

Of times when souls were axed

When kings turned rogue

In and out danced a sunbeam,

And the guard did sneer,

“Silly little thing, do as you fit deem,

You won’t be ruffling a thing here”

It manoeuvred through the crevices,

The guard looking on amused,

And then it spread into dark premises

Leaving its ‘blessing’ behind.

The iron gates, the daunting locks,

The nauseating chains, the bolts and knobs

Each of them checked, yet unsure

Nonplussed, the guard did look around

The fortress would never be the same here on.

How Will You Measure Your Life – Musings on Clayton Christensen’s book

Driving out of San Diego on a fine spring afternoon, enchanted by the amazing weather and the freeways crisscrossing in what seemed like an intricate pattern, I asked my friend at the steering wheel, “What would it be like to drive on a road where you couldn’t see/know anything beyond a short distance ahead of you?”  His response was prompt but deep, as if I had asked something obvious – “that’s called life“.  Clay Christensen’s book emphasizes this and offers some ‘frameworks’ to think about how to live and measure your life actions, both professional and personal.

Clay focuses on three  aspects – finding success and fulfillment in one’s career, having happy and deep relationships with one’s family, particularly with spouse and kids, and finally, leading a life of integrity and staying out of jail. The last one is interesting- it has a fair bit to do with the fact that many alumni from his Alma mater (HBS) end up there, and that Enron CEO Jeffrey Skilling was his classmate.

He claims he teaches you how to think, and not what to think, citing the example of how he taught Andy Grove to think about the research in “Innovator’s Dilemma” in the context of Intel. I have mixed feelings about whether I walked away after reading this book knowing how to think, but it certainly posed some difficult but life-altering questions to ask oneself before embarking on professional and personal ventures.

Usefulness of ‘theory’ in dealing with life

Clay encourages people to develop theories about what works and what doesn’t, in different aspects of their life. Having a theory that can explain what will happen, even before you experience it is valuable, since the only other options are to drift ad-hoc or make decisions based on data. Data is usually available only about the past. Relying on that data is  ‘like driving a car looking only at the rear-view mirror’. You don’t want to go through multiple marriages to learn how to be a good spouse or wait until your last child has grown to master parenthood. Having a good theory, one that dispenses advice in the form of “if-then” statements, is like having a compass to navigate.

The order of sections

Interestingly, Clay orders his sections into career, family (spouse followed by kids) and then integrity in that order. The choice of career over family is a debatable one, but Clay justifies it saying you’ll likely spend more hours at work than in any other aspect of life, so making sure you find fulfillment at work and are not making any compromises is vital.

The Balance of Calculation and Serendipity

“You have to balance the pursuit of aspirations and goals with taking advantage of unanticipated opportunities.  Managing this part of the strategy process is often the difference between success and failure for companies, and its true for our careers too.”

There are two distinct and conflicting approaches that one comes across in life – “have a plan for the next X years, know where you are going” and “take it as it comes”. Clay’s advice is that both of these approaches are valuable, and the key to happiness lies in knowing when to use which one. It is worth asking oneself – What are the circumstances where it’s best to be deliberate, to have a plan? Where does it make more sense to be emergent, to be open to the unexpected?

He provides the example of automaker Honda, who entered the US market in the hopes of selling large bikes that didn’t fare well against US competitors. While they were struggling to establish their presence in the target market, a certain lower-end almost toy-ish bike model became popular, by chance, in and around Los Angeles. Honda shifted its strategy to focusing on these smaller bikes and eventually wrote off the original business unit. This allowed it to not only survive in the US market, but also thrive in a niche segment that it had created for itself.

This balance of pre-planned measures and embracing opportunity is difficult to achieve. Success is difficult if the firm doesn’t focus on getting everyone to keep working together in a certain direction (if an incumbent strategy is working). At the same time, the same focus can cause the firm to dismiss as a distraction what might be the next big thing.

Also, shifting gears is only possible when the firm has money left-over to pivot and try another approach. In most cases of failure, the firm spent all its resources on the original strategy which failed. The same applies to decisions taken at an individual level, personal or professional, where you want to conserve some resources to be able to try alternatives and iterate, if things go wrong. Only a lucky few get things right at the first attempt, and that’s not bad. Success doesn’t depend on getting it right at the first go, it hinges on whether you continue to experiment until you find an approach that works.

The disconnect between what we think and tell ourselves, and what we actually end up doing

Firms often articulate a certain ‘strategy’, that describes their plans and intentions. But the true ‘strategy’ really comes out in the form of how the firm allocates its resources and people, at the level of minor individual decisions made on a day-to-day basis. There is often a disconnect between what is said or intended and what actually ends up being implemented. The same is true for us as individuals. Do our choices of what we do with our time, energy and resources actually reflect what our priorities are?

“The trap many people fall into is to allocate their time to whoever screams loudest, and their talent to whoever offers them the fastest reward. That’s a dangerous way to build a strategy.” 

Do our actions really match what we intend to do? A good example would be the number of people who end up in fancy-sounding consulting, IB, VC/PE positions post b-school with prestigious titles, but with no clear path to their stated goals. A number of these folks entered b-school with specific dreams, such as ending up at a CxO position in a certain industry. Clay addresses this point as he describes the example of Nolan Archibald, chairman of a Fortune 500 industrial tools manufacturing company.

“He built his career by registering for specific courses in the schools of experience. Archibald had a clear goal in mind when he graduated from college – he wanted to become CEO of a successful company. But instead of setting out on what most people would be the “right”, prestigious, stone-stepping jobs to get there, he asked himself, “What are all the experiences and problems that I have to learn about and master so that what comes out at the other end is somebody who is ready and capable of becoming a successful CEO?” He made some unconventional moves early on in his career, moves that his peers might not have understood on the surface.”

In Archibald’s own words – “I wouldn’t ever base the decision (of what job to take) on how much it paid or the prestige. Instead it was always – is it going to give me the experience I need to wrestle with?”

 

Knowing what really motivates us

“When we find ourselves stuck in unhappy careers, and even unhappy lives, it is often the result of a fundamental misunderstanding of what really motivates us.” 

Clay talks about his classmates who ended up being unhappy despite (or because of?) prestigious roles in Fortune 500 firms. They had trouble finding meaning in their jobs and/or had work lifestyles that prevented them from having healthy, well-nurtured personal relationships.

Happiness in work and life comes from two kinds of ingredients – hygiene factors and motivation factors. Aspects like compensation and work environment fall under the hygiene category while the motivation factors include intangibles such as recognition, responsibility and personal growth. Too many people because they over-emphasize the hygiene factors (“Let me get a high-paying job for now, once I am financially settled, I will do what I care about”) and downplay the motivation factors. Before they know, they are stuck in a rut and it is difficult to switch gears. Clay talks about this in a professional context, but it was hard not to think of Indian arranged marriages, where some people pay more attention than required to the hygiene factors (superficial ‘personality’ traits, financial status etc)  and the motivation factors (what would motivate the guy/girl involved to stay in a long-term relationship and do well in it) are almost ignored.

Clay plays up the role of managers in arranging for these motivation factors to work out. I wonder what the managers I know think of his statement – “If you want to make a difference in peoples’ lives, be a manager. You are in a position where you have 8-10 hours each day from each person who works for you. You have the opportunity to frame each person’s work so that, at the end of every day, your employees will go home feeling like they are living a life filled with motivators.”

“When you find out what really works for you, when you are in a place where both hygiene and motivation factors are satisfied, then its time for you to flip from an emergent strategy (take it as it comes) to a deliberate one (I have a concrete plan for the next X months)”. This is easier said than done.

“What’s important is to get out there, and try stuff until you learn where your talents, interests and priorities begin to pay off.” Nothing new or unheard of, but  golden advice nonetheless.

Clayton’s journey is well worth remembering here, he has had a mixed of planned and spontaneous decisions himself. He accidentally ended up a grad-student at b-school after years of consulting and a start-up, and his best work (“Innovators Dilemma” and “Crossing the chasm”), what will probably be his strongest legacy, came between ages 37 and 43. The numbers are worth remembering for people like me or my friend who recommended this book after a discussion on quarter-life crisis!

“What has to prove true for this to work?” and other important questions we fail to ask ourselves

As firms embark on something new, hockey stick charts and promises of growth are common. In all cases of failure, one of the major reasons is that the assumptions behind the promising models weren’t rigorously challenged or tested. While this is common knowledge in firms who actively try to counter it, as individuals we make the same mistakes in embarking on something in our lives. Some questions worth asking oneself before considering a new stint, personal or professional –

  • What are the assumptions that need to prove true for me to succeed in this assignment?
  • Which of these are within my control?
  • What assumptions have to prove true for me to be happy in this choice that I am contemplating?
  • Am I basing my position on intrinsic or extrinsic motivators? What evidence do I have?
  • Is there a way I can swiftly and inexpensively test if these assumptions are valid? How about making sure I am being realistic about the path ahead of me?

Life Investments cannot be sequenced

Some of us think of life as a progression – thinking about taking care of aspect X for a while and then turning our attention to aspect Y. That rarely works well in practice.

“The danger for high-achieving people is that they’ll unconsciously allocate their resources to activities that yield the most immediate, tangible accomplishments. This is often in their careers, as this domain of their life provides the most concrete evidence that they are moving forward.”

This can tilt and skew your priorities. Investing time and energy in building a long-term happy relationship with your spouse or kids are things that don’t offer the same immediate sense of achievement that a fast-track career does. It takes decades of investment before you can put your hand on your hips and say “I have had a great married life” or “We raised our kids well”.

The consequences of neglect aren’t immediate and quickly visible either. Few people know of the scientific study that discovered the number of words spoken to an infant and the manner in which they are spoken (“Language Dancing“, something that I suppose Indian mothers are naturally good at) make a huge difference in the child’s cognitive abilities all the way into their teens.

What job did you hire that milkshake for? – Understanding what is required of you in a relationship

This is an interesting case study on how Clay helped a breakfast chain increase its milkshake sales not by standard means such as knowing what customers to target or what offers/changes would lure them, but through a deep understanding of what ‘purpose’ the milkshake was being used for by these customers in the first place. The findings were far from obvious at first, but intuitive given that Clay had framed the problem in terms of “what job is it being hired for?”

Clay observes that a number of unhappy marriages are actually based on selflessness. He cites the example of a husband who comes home to a tired wife attending to young kids, and gets to work immediately with the dishes and household chores without her knowledge, only to realize that what she needed the most was some adult to talk to after a day spent around restless infants. The chores are the least of her problems and him doing them only adds to her guilt.

“If you study marriages from the job-to-be-done lens, we would find that the spouses who are most loyal to each other are those that have figured out the job that their partner needs to be done – and then they do the job reliably and well.”

“A relationship is not about finding someone who you think is going to make you happy. The path to happiness is finding someone who you want to make happy, someone whose happiness is worth devoting yourself to. It is natural to want the people you love to be happy. What can often be difficult is understanding what your role is in that.”

On Parenting

Think of development as composed of three components – resources, processes and priorities. Parents today are spending too much time and effort making sure their kids have the right resources (enrolling them in all sorts of classes, doing work for them etc) while hindering their kids from figuring out the right processes. The ‘processes’ are the ways in which the child realizes her priorities and what to do with the resources at her disposal.

“Start early by finding and giving them simple problems to solve on their own, problems that can help them build their processes and a healthy self-esteem. As I look back on my life, I recognized that some of the greatest gifts I received from my parents stemmed not from what they did for me, but from what they did not do for me.”

Encourage your kids to stretch – to aim for lofty goals.  Urge them to pick themselves up, dust themselves off, and try again. Celebrate failure if it’s a result of a child striving for an out-of-reach goal.

Not placing enough importance on the schools of experience – both as individuals and firms

Clay cites the example of fighter-pilots who are selected based on intensive tests that are intended to weed out all but the most gifted, the most skilled. What is really happening here is that the test experience and preparation for the test shapes how the pilots deal with setbacks or stress in high-stakes situations. What’s being mistaken for “high skills” is a “great skills along with a high degree of exposure to certain experiences”.

A survey among hiring managers, showed that by their own admissions, they didn’t do a good-enough job of picking the right candidates. Hiring managers who were interviewed said that 33% of their choices were superb, 40% were adequate and 25% turned out to be mistakes. Considering how important hiring is to a firm, the numbers are surprising.

Nolan Archibald’s example earlier is a good case-study of how it pays off to make decisions based on a possible experience-portfolio rather than superficial indicators.

On family culture and integrity 

When it comes to family culture, the examples we set for our spouse and kids are important.

“Most of us want to try to be consistent. But in the pressures of day-to-day living, that can be tough”. Left unchecked enough, “once” or “twice” quickly becomes the culture.

You know that several aspects in life will often switch to autopilot mode. You need to properly program the autopilot in your life and family by setting the right examples.

On marginal cost v/s full cost

“The safest road to hell is the gradual one – the gentle slope, soft underfoot, without sudden turnings, without milestones, without signposts.” Carol Lewis

We think in terms of marginal costs all the time, the incremental difference a small step will make. But we end up paying the full price, whether we like it or not.

Following your principles 100% of the time is easier than doing it 98% of the time.

 

How to identify and stick to a life-purpose

There are three parts to a purpose – likeness, commitment and metrics. Sketch out the “likeness”, which is like an outline or negative of what you see yourself and your life as. This will serve as the blueprint and guiding compass for your decisions and actions. Put in commitment to making that blueprint come to life. Instill the right metrics to track yourself, being careful not to get caught in the caveats discussed above.

“Take the time to figure out your life’s purpose, and if you do so, you’ll look back at it as the most important thing you ever did”

It is worth nothing that Clay advises his students to do this while they are still at school or early on in their post-school lives.

 

Credits: AT for recommending the awesome book,  Ashish for instilling the book summarizing practice and Sujeet for reminding me often to revive this blog.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Getting infected

“He didn’t sleep for four nights. Four whole nights. And if that trip had been his idea of a vacation, where, the psychologist wanted to know, did he work ? “

“He didn’t want to fight for petty wins when there was a bigger game in town. And the bigger game was pinball. You win one game, you get to play the next. You win with this machine, you get to build the next. Pinball was what counted.”

Its a tough task not to relate to the characters and the story that Tracy Kidder unfolds before you in The Soul of a New Machine. He depicts heroism in systems engineering and makes circuit designing sound like the sexiest job ever. He ensures that you, despite being a mere reader, get the kind of adrenaline rushes the 30-odd team did as they set out to build the next-generation 32-bit minicomputer over that one year period.

The book has a Pulitzer prize to its credit and has been called the “original nerd epic” by many critics. Given all that, attempting to write a review would be sheer folly. Several people have done a great job of it before. Below however, is an attempt to log what I learnt from the book and what I enjoyed the most. The post is long and verbose, but it doesn’t count.  The hope is that the (usually non-existent) reader will be inspired somewhere midway to give up on the post and grab the book instead.  :)

So what makes the book so likable ?

Bringing out something that is Transcendental

The technology that the book talks about is far outdated today. From minicomputers to  the age of handhelds, we have long taken for granted technology that the protagonists considered path-breaking. However, Kidder’s observations about the way engineers work, what keeps them driven, how teams deal with long-term challenging projects still remain valid in the current world. Even technically, there are certain insights he provides which really amaze you as they come true now . For instance, “A time would probably come when components would operate so quickly, that the distance the signals would have to travel would ultimately affect intimately the speed of most commercial computers“. Its something we take for granted now, but to have this insight 30 years back is brilliant.

The Author, his narration, his attitude
Hey, its a journalist trying to understand the computer industry. So on first thoughts, one probably doesn’t expect much of an insight on the technical side. I expected the book to be a “view from 20,000 feet above” of the intricate process. Wrong. The book taught me more interesting things than any course on computer design or architecture I took. The author claims that he struggled with the technical details, but eventually, in the book he brings them out as the most amazing analogies teachers could give. From microcode sequencing,page faults, instruction caches, logical  address spaces, privilege levels and protection rings – he has a simple, handy explanation in day-to-day parlance for anyone. He makes sure that not knowing the technicalities does not prevent the reader from appreciating the challenges that the engineers faced.

A peek into corporate dynamics
For those engineers who look at management with a sneer, this book is only bound to magnify that feeling. On one hand you have the brightest of people ever, facing impossible deadlines in designing something thats ground-breaking. On the other, there are the managers who seem to be practicing what they call the “Mushroom theory of management” – Keep them in the dark, feed them shit, and watch them grow.

  • A logic analyser costs ten thousand dollars, overtime for engineers is free.”

Bringing out a good technical product is about a lot more than making a good design  and getting it manufactured – thats the lesson one learns from the protagonist. Ah, the protagonist ! He is an engineer at heart but when circumstances demand, he strategizes, cooks up plots and gets more adorable with every move he makes. He is a perfectionist but also he knows when to move with the times, and write on his board – “Not everything worth doing is worth doing well”.

Dating the engineers, Up Close
Every now and then, you get something to keep you in awe of those people. It could be when the main designer spends twenty hours in the library hunting for quotes and flourishes to add to his ISA specs.

  • “They revealed the class of feelings that Wallach brought to his job. And with these, he had signed his name to his piece of the new computer.

Or it could be how the midnight programmers approached life.

  • Taking that machine apart was a fantastic high. Something I could get absorbed in and forget I had these other social problems.”

They talk and live engineering like a religion and their passion is contagious.

  • Writing microcode is like nothing else in my life. For days, nothing comes out. The empty yellow pad sits in front of me,reminding me of my inadequacy. Finally it starts to come. I feel good. That feeds it, and finally I get into a mental state where I am a microcode writing machine.”
  • “The pressure, I felt it from inside of me.”

Leadership
People (yours truly is a good example) keep fumbling and keep flailing around trying to figure what leadership is. In that regard, the protagonist here is a rather uncanny phenomenon as a leader. He leads by example, but he also does a lot to turn his own team against himself. No one really knows whats on his mind. And yet, he evokes respect.

  • West is interesting. He’s the main reason why I do what I do.”

Working in teams
Team dynamics can be interesting and confusing at the same time. The book teaches you to accept it in whatever form it comes.

  • “Often Guyer leaves at around three in the morning. Veres comes in a few hours later, looks at Guyer’s notes in the logbook, the pictures he has taken on the analyzers. And he instantly knows whats wrong and how to fix it. They make a marvelous debugging team, but only when not working together.”

Burn-out
It happens. To even the best of us. Accepting it seems to be the best way to deal with it.

  • “I am going to a commune in Vermont and will deal with no unit of time shorter than a season.”

Being distraught, yet being happy
Theirs is a tough industry. To put it in the words of the author, the industry’s short product cycles lend projects an atmosphere of crisis.Computer
engineering is arduous in itself, and this makes it more intense. Hours are long; emotions get taxed. The technology changes every year and its hard to keep up with the kids fresh out of school. A long-term tiredness can easily creep over by your thirties.

The fun part is that these guys still discover things that keep them going. Be it messing with each others’ files, programming ridiculous AI onto each others’ terminals or getting yourself an unencrypted copy each time your boss sends something encrypted to his server.
Masochists they are, but that doesn’t stop them from being fun people to be with.

Random Musing – Of computers, engineering and life

  • The protagonist can lie to himself  :)   – “I gotta keep life and computers separate, or else I ll go mad.”
  • Time in a computer is an interesting concept. When I sit in front of the logic analyzer, twelve nanoseconds is a big deal for me. And yet, when I realize how much longer it takes to snap my fingers,I have lost track of what a nanosecond really means.”
  • She’s romantic, foolish, unrealistic – everything an engineer’s not supposed to be. But I like her.”
  • He could write two to three hundreds lines of code in his mind, but he had a hard time remembering his own phone number.”
  • “I don’t care how computers get sold. I just build them”

You could say I am infected.  Seldom do you find a book which makes you fall in love with every alternate line.  For the reader (again, if existent) who bothered to read it all the way up to here – here is a list of books next on the infection spree (oh yeah, I am pretty free this semester or at least thats what the assumption is ) – It would be great to hear from you if you have views on the below list or other recommendations –

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