Month: January 2022

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In Love with Options

In his book The Unbearable Lightness of Being, Milan Kundera reminds us that “we can never know what to want, because, living only one life, we can neither compare it with our previous lives nor perfect it in our lives to come.” Given this reality of being human, we can understand our life choices in one of two ways. The first is to see our decisions as being quite “light,” for we are but one spec in the grand space of the universe and vastness of time. Alternatively, living only one life can leave us with a sense of the deep heaviness of any given choice, burdened with an awareness that even the smallest decision can have eternal consequences.

As anyone who knows me well would verify, I have a hard time deciding. Decisions are especially heavyaffairs. Any given choice can feel like death to all other options. Whether specific to where to go to college, what to do in my career, who to date or marry, my love of options and fear of choosing wrong hovers eerily over my decision-making process.

For people with this affliction, a natural response is to pursue a strategy of optionality – being drawn to paths that expand the total options one has available to pursue. After all, what is not to like about options? Take career, for example. Having a larger set of choices around what to do (A, B, C instead of A alone) would seem to increase your likelihood of finding a “better” option, whether defined by some objective metric (pay) or subjective property (perceived fit, or happiness). Imagine that your family expects you to take over the family veterinary business and make $100,000 a year (not a bad path!). A strategy geared around optionality might add to this list the possibility of becoming a high school teacher making $50,000 or a pharmaceutical sales rep making $125,000. The larger set of options should allow better matching by preference, whether that ultimately means aligning with family expectation (vet), maximizing income (sales rep), or doing something you have always wanted to do, such as working in a school (teacher).

Beyond matching at any particular point in time, a strategy of optionality seeks to optimize for the possibility of a better set of choices in the future. This is often what I find myself counseling students for, rightly or wrongly. “Have a decision? Pick the choice that expands possibilities for what is next.” Again, here, optionality has some benefits.  Let’s say you see variety as the spice of life. In this case, you might find a 40-year career of rotating roles every five years more energizing than maintaining the same role over time, even if the particular “fit” of the latter is higher. 

But if an optionality strategy is attractive for purposes of maximizing one-time fit or preparing you for a change of fit over time, this mentality has a shadow side. In his book The Wisdom of Finance, Harvard’s Mihir Desai puts it this way: 

I am no longer surprised to see students who end up remaining in companies—usually consulting or investment banking firms—that were initially intended as way stations that would create more optionality on the path to their actual entrepreneurial, social, or political goals. They often end up saying to themselves, “Why not stay another year and create more options for down the road?” The tool that was supposed to lead to more risk-taking ends up preventing it. Any commitment necessarily must overcome the loss of option value that choices close off… It is not uncommon to hear people in finance talk about marriage as the death of optionality. Implicitly, the act of marriage is characterized as the loss of something—future choices—rather than the beginning of something. As a result, a focus on the creation and preservation of choices can ironically lead to an inability to make choices. 

This shadow-side of a life of optionality should not be underestimated. One challenge faced by those who love options is that stable optionality is a fiction. This can be because you overestimate the likelihood of your ability to realize the options that you want to pursue later. A couple puts off starting a family as they pursue a set of careers under the assumption that it will be easier to get pregnant than it turns out to be. An aspiring academic tells themselves they will pursue a Ph.D. later while not realizing that the Ph.D. committee likes younger candidates because they have a longer window of research ahead of them. A career change becomes more difficult as financial obligations in life pile up.

An additional challenge of expanded options is how awareness of those potential paths can make any given decision all the more difficult. When unable to easily “optimize” given all the potential decisions in front of them, the economist/psychologist/political scientist Herb Simon argued that people often “satisfice” by finding the best option available, even if not the best of all time. But the more aware you are of all those peripheral paths, the more difficult the choice can become. “Sure, I could become a vet, a teacher, or a sales rep, but what about an architect, an entrepreneur, or a stay at home dad?” If you choose to become a vet and a vet is the only option, the weight of the path not taken is light. But if satisficing by choosing the route of a teacher while being acutely aware of the other six (or six-hundred) options, the weight of choice might be great.

And perhaps even more problematic is when we become addicted to the formless possibility of “what could be” instead of pursuing a concrete particularity. While this can happen early in life — being unable to choose a given path– so too it comes later on in life when we irrationally pine for a time of limitless possibilities. In his treatise on middle age, the philosopher Kieran Setiya suggests that when confronted with a path selected, it becomes all too easy to grieve and then idealize the path not pursued. In a review of the book at the New Yorker, Joshua Rothman summarizes the point, “Because the lives of middle-aged people have settled into more or less permanent shapes, for instance, people in midlife often become nostalgic for the feeling of choosing.” To be a permanent shape is to be beset with Kundera’s challenge of being unable “compare it with our previous lives nor perfect it in our lives to come.”

While generating options is a great short-run tactic, this mindset can become our master when unchecked. Our ability to choose and to optimize for a particular path chosen requires wisdom born in an acknowledgment of our finitude. The challenge for each of us is to discern when generating options is life-giving, and where optionality prevents us from flourishing in the here and now of the permanent shapes we embody. 

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Time, Finitude, and Focus

March 2021.

That is the last time I wrote one of these “Towers to Bridges” newsletters.

While only five months time, this gap feels personally significant. Writing this newsletter has been a bi-weekly or, at worst, monthly discipline for the last six years or more. To prepare for the newsletter, I would read throughout the week, jot down notes, and eventually distill it into an essay of sorts on a Sunday afternoon. The writing process helped me clarify my thinking, and I loved sharing those thoughts with friends, clients, students, and colleagues. Metaphorical rain or shine, this was my rhythm.

But then, we had a baby. And shortly after, my role at WashU changed to require spending time and energy building WashU’s Center for Family Enterprise. In other words, time became scarce, and March became April became May became– well, you get the idea.

Psychological Dysfunctions of Scarcity

Scarcity of any resource – time or otherwise– messes with our psychology. One of my favorite treatises on this idea comes from Harvard economist Sendhil Mullainathan and Princeton psychologist Eldar Shafir in their book, Scarcity. Specific to time scarcity, the thrust of their argument is captured in the following review from The Guardian:

Their most arresting claim is that the same effects kick in – albeit not always with such grave implications – in any conditions of scarcity, not just lack of money. Chronically busy people, suffering from a scarcity of time, also demonstrate impaired abilities and make self-defeating choices, such as unproductive multi-tasking or neglecting family for work. Lonely people, suffering from a scarcity of social contact, become hyper-focused on their loneliness, prompting behaviors that render it worse. In one sense, Mullainathan and Shafir concede, scarcity is so ubiquitous as to be almost meaningless.

When time grows scarce – a baby in one arm, a phone in another – I find myself counter-productively pulled in too many directions.

From Finitude to Focus?

Over the last few months, while NOT writing my newsletter, I have grown quite fond of the writing of Oliver Burkeman. His newest book, 4,000 weeks, which comes out today, is a philosophical treatise on the nature of productivity. For Burkeman, the start of a healthy approach to productivity is in the realization of our finitude. We can’t do it all. We can’t be all things to all people.

This framing is interesting in contrast to the work of Mullainathan and Shafir on scarcity. To use Burkeman’s book title, if I only have 4,000 weeks (or personally about 2,100 left), time is by definition scarce. But if finitude and scarcity are somewhat kissing cousins, how do we ensure this realization drives the latter’s wisdom without the dysfunctions of the former?

It seems that the key is moving beyond scarcity as a description of resources to finitude as an existential category. My good friends (and wise scholars) Sara Showalter Van Tongeren and Daryl Van Tongeren put it this way in their recent book The Courage to Suffer:

Priorities clarify in the midst of reminders of death and finitude.

One personal hope is that I am better able to discern true priorities from those projected onto me. I like how Paul Graham puts it in his essay on doing what one loves:

Prestige is like a powerful magnet that warps even your beliefs about what you enjoy. It causes you to work not on what you like, but what you’d like to like.How much of our lives are oriented around what we would like to like? For me, that answer is often far too much of it.Putting it all together, my hope for finitude is to find clarity in how to focus deeper on the things that matter – valuable aspirations over rootless ambition. Burkeman’s book brings extra value to the table in how he translates these ideas into very tactical suggestions. He encourages us to construct days that reflect such finitude, keep focused on a manageable set of to-do items, and reminds us that achieving but two to three hours of truly creative work might be more than enough. I look forward to seeing the argument in full in the book.

The funny thing about all of this is that when I first started telling people about the book, I thought the title was 40,000 weeks. In one of my more depressing Googles of the summer, a quick search made me drop a 0 and feel like I had lost 36,000 weeks of living. But perhaps this error makes even more acute such finitude. More importantly, I hope that we all find a healthy response is not rushing around in trying to accomplish all, but to plant where we find ourselves, invest in those relationships we are in, and pursue worthwhile projects that sit right on our front door.

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Grand Ambitions by Narrowed Decisions

Every holiday — this Thanksgiving, notwithstanding– I return home with confidence and clarity of how I will do things differently. Indeed, taking time away from daily rhythms and then marinating it on an endless drive through cornfield-walled highways helps you to see your life anew, albeit often with greater confidence than warranted.

On this particular drive, I found myself reflecting on a short video of writing advice from the poet Dana Gioia. The clip includes a bunch of really helpful, if obvious, advice. Find time to write sixty to ninety-minute a day. Give yourself something meaningful to accomplish each session. A paragraph a day becomes an essay in a month and a book over a year.

Writing more regularly is on my aspirational post-holiday list. I like Gioia’s advice because it provides a clear template, a path to follow. Indeed, this video is the motivation behind my early wake-up to head downstairs to a room lit dimly by a Christmas tree and the fluorescent glow of a computer, pecking away in search of one great paragraph.

But beyond all the helpful tips in Gioia’s video, it was his opening epitaph that most stood out:

‘Your life is time. That is all it is. And if you are not in control of the time in your life, you are not in control of your life. If you are wasting time in your life, you are wasting your life. You will never get a single one of those moments back.’

Despite being a relatively productive person, I have not been in control of my time for long-term creative goals such as writing. While some of my time-wasting is about lacking the right productivity hack, more often, it is the existential challenge of choosing what to work on that keeps me from the page. It is far too easy to believe that I have five great books in me than to sit down and focus my work on one simple idea. For those of us addicted to optionality, we are made vulnerable by having to choose.

But such tension is precisely why I should return to the daily craft of limiting choice– a discipline whose impact is likely to extend far beyond the written paragraph. Faced with the overwhelming possibilities of all we can be, we must move into the particular. You and I can never be a writer (or entrepreneur, or investor, or whatever your ambition might be) “in general.” We only step into aspirational identities with particular choices. We write… this paragraph. We marry… this spouse. We lead… this group. But it is through the daily decisions, some significant and many relatively minor, that we become talented writers, supportive spouses, or gifted leaders. Counterintuitively, by narrowing the potential space to engage in the world, we are opened up to live into broader identities.

And so, I return to writing. 

What is your starting step into a world that teases you with the false allure of infinite possibilities?

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Strategies for Direct Investment for Family Office

Session 1 - Direct Investment for Family Offices

December 1, 2021
Koch Center for Family Business
Olin Business School at Washington University in St. Louis

Guests & Moderator

Scott Wilson, CIO, Washington University Investment Management Company
Brent Beshore, CEO and Founder, Permanent Equity

Peter Boumgarden, Koch Professor of Practice for Family Enterprise, Washington University in St. Louis

In Goldman Sachs’ 2021 report assessing the investment behavior of large family offices across the globe, the authors note a growing exposure of these groups to venture capital and private equity investment. Specifically, 90% and 100% of these offices had exposure to venture and PE-like investments, respectively, with investments made both directly and through specific funds. 

Despite the growing frequency of family offices pursuing direct investment and investing in PE and VC as an asset class, there is less known on the performance of this strategy and specific tactics for doing it effectively. 

On December 1st, 2021, the Koch Center at Washington University in St. Louis convened a session focused on family office direct investment strategies, exploring everything from seed to venture growth to private equity and mature companies. Given that much of this investment in the private market occurs through venture capital and private equity funds, we also discussed the performance of this asset class. 

The first of a broader series on Family Investment and Impact, this session was moderated by Koch Professor of Practice for Family Enterprise, Peter Boumgarden. The panelists included Scott Wilson, the Chief Investment Officer of the Washington University Investment Management Companies, and Brent Beshore, the Founder and CEO of Permanent Equity. While neither runs a family office, each was able to speak of their work and its implications on the family office and investment space more broadly.

Below we outline a few critical takeaways from this session, the first of three in the 2021-22 Olin Family Investment and Impact Series.

1. The Differential Expertise, Resources, and Goals for Direct Investment

In the 2021 Goldman Sachs report, the two most common family offices goals were capital appreciation and wealth preservation. So, it stands to reason, which of the two is most likely to drive the increasing direct investment footprint? 

While some growth of direct investment could be in service of wealth preservation by investing exposure to asset classes less correlated with the rest of the portfolio, many families seem to search for returns seemingly not possible in a more diversified index-like approach. However, achieving desired returns requires having the capability to make such investments effectively. After all, a series of non-successful direct investments can quickly dilute capital that took a long-time to appreciate. 

Both Scott Wilson and Brent Beshore highlighted the challenges of doing this work well. In particular, Scott referenced that their team might make one-tenth of one percent of the potential investments that come across their plate, thus approximating a 1 to 1,000 ratio of investment opportunities to closed deals. Therefore, much of his team’s work is spent assessing investment opportunities that never come to pass, a process that is quite time intensive. Brent highlighted a similar selection process for his team to make 2-3 deals in a given year. 

Many families, especially under the $1B threshold, attempt to make these decisions with a limited staff allocation– at best, a fractal CIO, and often no surrounding team. This resourcing results in a deck that is easily stacked against the office achieving its goal of capital growth and even undermining the other important objective of wealth preservation.

2. Acknowledging (and Addressing) the Negative Selection Bias

Beyond the challenges of picking winners, both Beshore and Wilson highlighted a challenge with many family offices and university endowments– that of negative selection bias.

Put another way, if a university endowment or family office is less likely to be seen as providing the same kind of value-add support as other potential investors, it stands fair to reason that many family offices do not hear about a potential deal until after it has been passed over by “smarter” money. Recalling the advice of a previous mentor, Brent framed this as you never want to take an oil deal coming out of Texas, given how many other investors have already passed on the opportunity.

Building upon the previous mathematics, if a private equity investment fund with a strong reputation is likely to see 1,000 deals before making one investment, a family office with a similar quantity of opportunities is unlikely to have the same high-quality deal flow. As such, you might expect a need to see even more potential deals than the hypothetical 1,000 to identify a high-quality investment opportunity. This adverse selection bias only further exacerbates the direct investment challenge.

3. The Direct Investment Risk of Recent VC and PE Growth

While some family offices invest directly in an early stage or turn-around company as a part of their approach, many instead invest indirectly through a VC or PE fund. If the challenge of direct investment is picking a winning company, the related challenge with venture or private equity is understanding the evolving performance of this broader asset class. 

One challenge for these two asset classes is specific to the increasing multiples paid at the acquisition point. A recent Bain & Company report found that nearly 2/3rds of PE deals are paying multiples of 11x EBITDA in 2020/21, a number that was less than 10% as recent as the mid-2000s. Another study by Pitchbook found a similar growth in valuations of early-stage ventures.

Opining on such trends, Brent expressed skepticism that such valuations were warranted. While one could make a case that the growth of venture valuations is justified if and when technology enables a categorically different kind of scale and resulting downstream exit, Brent argued that this is a more challenging case to make in sectors that lack such enabling technology.

 

Furthermore, Brent saw some portion of the growth in multiples due to investors applying a logic that works in one part of the market to another where it doesn’t fit. This mismatch between mentality and market leads to significant capital chasing opportunities in sectors where investors lack relevant expertise. For example, Brent and his team have seen several investors come into the middle market and pay multiples far beyond what his team has done historically and perhaps beyond what is prudent for the investment space. For Brent’s team, the challenge is diligence in maintaining rigor in not letting the market get away from their investment approach.

 

In response to these trends, Scott expressed some concern about the current valuations within this space and suggested his team has moved a good bit of their portfolio out of traditional private equity. In addition to Brent’s broader point, Scott identified a concern that much of the stated investment in venture or PE could be found on paper but perhaps not actualized gains.

4. Assessing the the Investor & Portfolio Design

When deciding to invest in either venture capital or private equity, Scott argued that teams should rigorously assess the portfolio of any given investor, asking whether they agree with the operationalized investment approach. Similar to the work required to engage in direct investment successfully, this strategy requires a good deal of time and resources.

Recent work by Paul Gompers, Steve Kaplan, and others has explored the investment approaches of private equity and venture capital investors, research covered during the session and shown below. At a high level, the authors found venture investors spend more time assessing the team, and PE investors invest more based on the company’s financial fundamentals and look to add value to the revenue side. While not necessarily indicating which strategy is optimal, such a framework provides ways of assessing the investor’s underlying mental model of valuation creation. It also provides a method of determining whether an investor aligns with the investor thesis of others in the portfolio.

Another broader strategy highlighted by Scott Wilson was his team’s approach toward greater concentration. While on the face of it, increased concentration might appear to be a movement away from diversification. That said, Scott was quick to highlight how diversifying across a set of partners can result in a portfolio that functions much like an index fund would, but with the unfortunate fee structure of an active management model.

In contrast, by diversifying across a smaller set of managers, the team can better assess the investment risk to reward ratio of underlying investments under the manager and pay attention to how any given investment impacts the risk balance of the portfolio. Furthermore, in being more concentrated, the group can build a lower fee structure across all managers in the collective. For family offices more broadly, the critical item is to ensure the underlying diversification strategy does not merely end up canceling its return potential.

5. Constructing, Leveraging, and Learning from a Network of Partners

Both Scott and Brent highlighted the importance of a robust network of co-investors and partners for effective direct investment. Specific to this symposium, Brent and Scott themselves represented an example of a deep partnership, with the WashU endowment being the largest investor in the recent Permanent Equity fund. For Brent, having a trusted partner in their investor allowed them to explain their distinctive investment approach, buying and holding companies for cash contribution the shorter-term hold of many PE funds.

In this interview and others (see below), Brent has argued how a network of partners provides access to significant learning and co-investment opportunities. Embedded long-term relationships both across investors and between inventors and managers can provide sources of new ideas, insights, opportunities for shared diligence, and broader education. As such, as one attendee of the virtual event, Koch Center Executive in Residence Spencer Burke, noted, this “makes your organization bigger by multiples at no cost—but requires long-termism and loyalty, something few have.”

For a family fund, one potential benefit of long-term partners is the possible expanded expertise that these other family offices or funds bring to the table. In the case of investing in a PE or VC fund and then doing a side deal with a company in their portfolio, such partnerships reduce the evaluation expertise required. This strategy puts the focal evaluation on the point of PE or VC managers while retaining the secondary ability to allocate the fund in different proportions if the family thinks there is a unique opportunity in play.

For Scott and his team, their network within a university helps extend the expertise they can bring to bear on a given investment opportunity. These partners can be funds they learn from or scientists whose research dovetails with an investment opportunity. This capability is one that few family offices have built-in naturally, but perhaps provides a way of articulating an aspirational model built over time in a family fund.

6. Building Capability Over Time by Building on Strengths

A number of the trends identified above suggest that family offices should be wary of direct investment. In particular, the negative selection bias at the point of deal flow would mean that the potential pool of private investments for many family offices likely lags that of the professional firm, thus making it even more challenging to pick winners. Furthermore, effectively evaluating opportunities requires time and expertise that many family offices lack, even those that are quite large in size.

That said, if one does go in this direction, one particular recommendation highlighted by Brent is the importance of starting small in this work. In some ways, given how Permanent Equity is in some ways akin to a family office organized around direct investment that eventually professionalized by taking on external capital, it would be disingenuous for Brent to suggest one should never pursue this work. Brent’s recommendation, however, was to focus on the expertise they have embedded in the family as a resource to build a strategy around.

For example, this might be market experience within a particular vertical, for instance, or a network based on previous work that provides unique and valuable deal flow. Scott also highlighted hesitation for smaller family offices but was more open when an individual or family had a distinct market advantage that was not present for other professional models. The critical thing for families attempting to do this work is to be highly discerning when it comes to the inward look of determining if the skill is, in fact, there as they hope.

Relevant Research
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