#48 - Fictions (pt. 1)

We live in a world of fictions

After a long break, I’m finally back to writing! I’m still trying to figure out what I want to do with this newsletter/blog thing, but moving forward, I’ll try to write 1-2 posts per month, still usually about tech but sometimes about other random things I’m thinking about (like this post). Thanks for reading. —Chris

I.

Four years ago, when I was graduating college, I remember being in the pews of a large chapel, elbow-to-elbow with some of my classmates. Parents and friends were sitting in the balcony with tears in their eyes, watching newly-minted graduates sift into our seats. We were wearing black robes and black square hats with long, limp strings dangling from the side, as per usual for a graduation, and we were sweating underneath it all as spring in New England was cresting into summer. Once everyone got seated, an organ started playing, we began singing our college song, and all of a sudden, I felt out of place. I felt strange. For a brief moment or two, I couldn’t bring myself to sing.

It was a strange, visceral sensation. I can perhaps best describe it as an “out-of-body” experience: I felt like I wasn’t experiencing the world in first-person as an active participant, but in third-person as a spectator. The world zoomed out. I looked around me, and I just felt strange… What are we doing?

I’ve experienced this strange feeling with increasing frequency through the years. Just the other day, I was on a walk with a friend; we encountered a random person walking her dog, and the out-of-body feeling suddenly washed over me: We purchase these small four-legged creatures for hundreds / thousands of dollars, put collars and leashes on them, watch them poop, and talk to them in slightly higher-pitched voices as though they understand us. I had to stop and remark to my friend how weird this all was, at which point she just laughed it off.

Perhaps I’m crazy. In these moments, I engage in a thought experiment: If intelligent aliens from lightyears away visited the Earth today and watched what we were doing, how much would they understand? Graduation ceremonies would definitely be quite mysterious. So too would dog-rearing, probably. We live in a world of fictions. Much of our society—our world?—is stitched together by these fictions, things that have little to no intrinsic or universal meaning but have meaning only because we have agreed to give them meaning.

II.

Maybe it’s easiest to explain with more examples.

  • Marriage. First and foremost, marriage is a legal fiction, a fiction backed and mediated by the law. The day before you get married vs. the day after you get married, you’re still the same person—nothing about you has intrinsically changed. But the law now recognizes you as a different person! You can now file joint income tax returns with the IRS and state tax authorities. You can now obtain insurance benefits through your spouse’s employer. You are now entitled to inherit a share of your spouse’s estate.

    Marriage is also a social fiction, one that is backed and mediated by societal traditions. There is no inherent reason why diamond engagement rings are a thing (they became popular in the West only starting in the 1940s, and other cultures have historically and obviously used other types of gifts), nor is there a transcendental reason why engagement rings should be 1/6 of your yearly salary or whatever (this notion is promulgated by De Beers, which owns a monopoly on the diamond industry). Wedding vows, wedding venues, flower girls, bouquet-throwing, open bars, groomsmen and bridesmaids, etc. — we do many things in weddings because this is part of our current social fiction. To sharpen the point: If all cultures could rebuild the “custom of marriage” from the ground-up, there’s no way we would all organically converge on the practices we do today. There is no transcendental, canonical conception of a marriage or a wedding.

  • Money. Again, a legal fiction. A dollar bill is merely a piece of paper with barely any intrinsic value, but it magically gets value from the fact that the state says you can use it to purchase goods. Gold, similarly, has little intrinsic value. Sure, it is a catalyst in chemistry and a crown in dentistry, but outside of niche uses, gold largely derives its value from the state declaring it as a store of value. Money could also be a sort of social fiction. I’m thinking here about certain speculative trading assets (see the meteoric rise of Dogecoin over the past month or two) whose monetary values are fundamentally untethered from any underlying value thanks to meme pumping and dumping.

  • Facebook. At the outset, I note that Facebook, like all other corporations, is obviously still a legal fiction: Facebook is recognized by the state as a legal entity, a corporation that is incorporated in Delaware, has a board of directors and shareholders, can be sued, must be taxed, blah blah. Even if I replaced Zuck as the CEO, even if 100% of its engineers were fired and replaced with monkeys, Facebook would still exist as a legal fiction fabricated by the state.

    You might fairly push back, though, and say that Facebook isn’t a fiction because it has intrinsic value. It has a tangible product and a market cap of $900 bn, right? Yes, I concede that Facebook the entity has value and creates value for people. But, perhaps it’s more accurate to say that the relationships / ideas that bind Facebook (indeed, all companies) together and give rise to its product or market cap are fictions.

    For example, Facebook has an internal system of rules that employees abide by. Facebook has an internal company culture that guides employee decision-making. Facebook has a mission statement that guides the future of its product development and investment of resources. All of these things were “made up” in the sense that they are not immutable truths. The executive team, or higher-level managers, create these rules and can modify them at any point. Facebook’s future (or product or market cap) is hardly set in stone—it will depend on the fabrication of these fictions and the level to which employees buy into them. Executive management promulgates these corporate fictions, and all other employees likewise buy into them. Is there a canonical Facebook in the sense that there is an objectively right or best way to run the company?

III.

In The Matrix, the protagonist Neo initially exists in a high-fidelity virtual simulation (the eponymous “Matrix”) until he is awakened and pulled into the real world. For the first time, Neo realizes that for the past god-knows-how-many-years, his consciousness was plugged into a computer program, a fake world with fake rules that merely mimicked the immutable rules of the real world.

In one scene, after Neo is already pulled into the real world, his consciousness is plugged into a kung fu simulation so he can test the boundaries of the virtual world via a sparring match with his mentor Morpheus. Before they spar, Morpheus tells Neo that the programmed rules of these sorts of simulations can be bent and broken. But Neo initially seems not to get it. In the ensuing match, Neo huffs and puffs while Morpheus easily disposes of him without breaking a sweat. Then, with Neo face-down, belly on the floor, and complaining that Morpheus is too fast, Morpheus asks Neo, “Do you believe that my being stronger or faster has anything to do with my muscles in this place? You think that’s air you’re breathing now?”

Unlike Neo, we don’t live in a virtual simulation, but many parts of our world are fictional in the sense that they aren’t immutable truths. To be a contrarian is to reject the fiction. To be an entrepreneur (or legislator or changemaker or whatever) is to rewrite the fiction. The challenge is being able to see that the walls around us perhaps aren’t even walls in the first place.

I’ll conclude with one of my favorite Steve Jobs quotes:

When you grow up you tend to get told the world is the way it is and your life is just to live your life inside the world. Try not to bash into the walls too much. Try to have a nice family life, have fun, save a little money.

That’s a very limited life. Life can be much broader once you discover one simple fact, and that is – everything around you that you call life, was made up by people that were no smarter than you. And you can change it, you can influence it, you can build your own things that other people can use.

The minute that you understand that you can poke life and actually something will, you know if you push in, something will pop out the other side, that you can change it, you can mold it: That’s maybe the most important thing. It’s to shake off this erroneous notion that life is there and you’re just gonna live in it, versus embrace it, change it, improve it, make your mark upon it.


📚 What I’m reading

Most of these links are from a few months ago, but they’re great reads nonetheless!

  1. Why is everything liberal? (Richard Hanania)

  2. On seriousness. (Katherine Boyle)

  3. How global tech executives view U.S.-China tech competition. (Brookings)

  4. Goldman analysts work too hard. (Matt Levine)

  5. Infrastructure, governance, and trust. (Francis Fukuyama)

#47 - The iconoclastic VC

Does she exist?

Administrative note: I’m going to be taking a break from writing for a bit.

I.

Last week, I analogized entrepreneurship to a magic act: The entrepreneur is the magician, and the venture capitalists are the audience members, inspecting the entrepreneur’s act to find the trick but nevertheless hoping to be dazzled.

I also framed this in terms of The Pledge, The Turn, and The Prestige (from the famous movie The Prestige):

The Pledge is the entrepreneur’s visionary pitch to the investor . . .

The Turn is when the entrepeneur’s pitch is so dazzling that, in spite of the investor’s due diligence, she still excitedly cuts a check . . .

But the investor doesn’t stand up to clap yet, nor does the entrepreneur, because the hardest part has yet to happen: The Prestige . . . The Prestige requires the entrepreneur to grow the company, meet and exceed financial projections, and eventually not only return money to the venture capitalist, but also change the world in the way the entrepreneur had envisioned during The Pledge.

I framed (1) The Pledge, (2) The Turn, and (3) The Prestige from the point of view of the entrepreneur, but it turns out that we can assess these three functions from the point of view of the investor as well. VC firms need to do these three things well in order to be successful:

(1) Deal flow: VC firms need to have a constant stream of companies at the top of the funnel. Using the magic analogy, they need to be hustling to get tickets to as many shows as possible.

(2) Picking: VCs need to know what companies to pick and what companies to walk away from.

(3) Support: After picking a company, VCs need to provide support to help the company grow and accomplish The Prestige. For example, does the VC firm have a wide network that the company can plug into? Does the firm have some sort of expertise in a particular area (e.g., regulatory issues, hardware expertise, etc.)?

[Note: The fourth function the VC needs to do well is winning the deal, which happens in between picking and support. I’ll try to discuss this in another post sometime.]

II.

The stereotypical VC is the singular visionary who excels at the picking function. She thinks futuristically, pondering what the world will look like ten years from now and how a startup could bring that future to fruition. She has strong convictions but at the same time is willing to suspend disbelief of outlandish ideas. The paragon VC can identify diamonds in the rough that everyone else, even other VCs, pass over. In short, she is an iconoclast.

However, I wonder if the picking function is getting easier, if the iconoclastic VC is in shorter and shorter supply (or even non-existent). Venture capital has been around for quite a while now, and a lot of ink has been spilled on how to identify superstar companies. For example, consumer apps with product-market fit are supposed to see their user numbers skyrocket, at something like > 100% growth per year for the first few years. Strong SaaS companies are supposed to triple their annual revenue, then triple, double, double, and double it again (called “T2D3”). Because the strength of a SaaS company is relatively easy to ascertain, VC firm Tribe Capital has even quasi-automated the picking function for SaaS companies with its Magic 8-Ball software.

To be fair, I’m not super confident in saying that picking has become drastically easier. Different companies are different, and there is no strict mold for success—if a SaaS company grow revenues by 150% instead of 200%, a venture firm probably isn’t going to immediately write it off... Moreover, people might ask why, if picking really were that much easier, do venture returns still adhere to power laws? Why don’t we see a higher proportion of winners among an investment portfolio?

My point is not that picking has become easy on an absolute basis. Investing in startups, especially at the early-stage, is still really risky (ahem, startups still have to complete The Prestige). Rather, my point is merely that there are ballpark markers for future success (e.g., user growth, revenue growth, employee growth, founder quality, etc.) that will de-risk an investment to a certain point, and many VC firms know to diligence these markers when thinking about an investment opportunity. Perhaps you can get the investment risk down to an asymptotic value, but the continuing existence of high amounts of risk and VC power laws doesn’t automatically mean that picking hasn’t gotten at least relatively easier.

Figure 1. Risk of investment into Company X. Note that this is an over-simplification of risk assessment. A VC firm can further de-risk an investment opportunity (to a point below the asymptote) based on how well the VC firm supports the startup post-investment.

If my hypothesis is correct, that picking has gotten a bit easier, then perhaps what we’d really expect to see is more VCs getting on unicorn deals (rather than only the “best” VCs being uniquely able to identify the unicorns). And indeed, this seems to be what we’re seeing. According to a 2014 report by Cambridge Associates, from 2000 through 2012, 70 VC firms registered at least one “top 10” deal (based on return), and no firm accounted for more than 7.7% of the top 10 deals across the period. In contrast, during the pre-2000 period, only 25 firms had at least one top 10 deal, and five firms accounted for at least 8% of all the top 10 deals in the period. Moreover, as shown in the Figure below, more and more of the value in the “top 100” investments (based on return) is being captured by new and emerging venture funds. This all lends some credence to the idea that picking is, indeed, getting a bit easier.

III.

I’ve spoken to a few of my friends who’ve founded companies. Many don’t have positive conceptions of VCs, in no small part because they think VCs aren’t the iconoclastic visionaries they’re made out to be. And this makes sense—with so much capital in the ecosystem today, and with so many VCs having studied the home-run VC exits, you have a proliferation of VC firms that don’t need to be iconoclasts in order to earn strong returns.

But I don’t think this means the iconoclast VC investor is a myth. Some VCs proactively craft theses / roadmaps about particular markets and doggedly chase startups that match their vision of the future. It’s all very forward-thinking. Bessemer, for instance, tends to do this quite well. Other VCs like Lux Capital make a conscious decision to invest in industries or technologies that most other VCs tend to shy away from. For example, while B2B SaaS is flush with capital, deep tech hardware attracts very few VCs because, as discussed last week, deep tech is way riskier. Because there is less of a uniform playbook for deep tech investing, many VC firms are scared away, thinking the risk is too high, no matter how much due diligence they conduct (see Figure below). Iconoclastic VC firms, though, often come up with their own playbooks for the future of deep tech and have sufficient levels of conviction to make an investment, notwithstanding the risk.

Figure 3. Deep tech vs. traditional software investing. Many average VC firms love software startups but will shy away from deep tech. No matter how much diligence they do on deep tech company X, they simply won’t make an investment due to their lack of conviction. Iconoclast VC firms may be more willing to invest in deep tech because they have stronger convictions about the technology and the future. Is a VC firm’s level of conviction concomitant with the level of risk for a particular company? Note that this graph is an over-simplification because different VC firms likely have different risk tolerance vs. conviction graphs (in green).

📚 What I’m reading

  1. Late-stage pandemic is messing with your brain. (The Atlantic)

  2. The robots are coming for Phil in accounting. (New York Times)

  3. U.S. to impose sweeping rule aimed at China technology threats.
    The Biden administration plans to let the Trump-era rule on technology purchases and deals take effect, despite U.S. business objections about its scope. (Wall Street Journal)

  4. How Dapper Labs scored NBA crypto millions. (Protocol)

  5. A year of secrets. COVID-era confessions, from ski trips to lovers to second jobs. (The Cut)

  6. Scientists developed a clever way to detect deepfakes by analyzing light reflections in the eyes. 🤯 (The Next Web)

  7. Moore’s Law for everything. (Sam Altman)

  8. The end of Silicon Valley as we know it? (Tim O’Reilly)

  9. What we learned about Clearview AI and its secretive ‘co-founder.’ (New York Times)

  10. MOOCs failed, short courses won. A brief look at Coursera’s upcoming IPO. (Inside Higher Ed)

#46 - SPACs, VC, and The Prestige

Deep tech magic

Every great magic trick consists of three parts or acts. The first part is called “The Pledge.” The magician shows you something ordinary: a deck of cards, a bird or a man. He shows you this object. Perhaps he asks you to inspect it to see if it is indeed real, unaltered, normal. But of course... it probably isn't. The second act is called “The Turn.” The magician takes the ordinary something and makes it do something extraordinary. Now you're looking for the secret... but you won't find it, because of course you're not really looking. You don't really want to know. You want to be fooled. But you wouldn't clap yet. Because making something disappear isn't enough; you have to bring it back. That's why every magic trick has a third act, the hardest part, the part we call “The Prestige.”

The Prestige

[Note: If you haven’t watched The Prestige yet, I highly recommend it — or, at the very least, watch the trailer!]

I.

When it comes to magic, we want to be fooled. We know there’s a trick somewhere, and search desperately as we may for the trick, the more we are fooled, the better. By shining a light on the trick, the magic is ruined.

I’d argue that something similar exists in the world of venture capital. Here’s Matt Levine:

What you want, when you invest in a startup, is a founder who combines (1) an insanely ambitious vision with (2) a clear-eyed plan to make it come true and (3) the ability to make people believe in the vision now. “We’ll tinker with hydrogen for a while and maybe in a decade or so a fuel-cell-powered truck will come out of it”: True, yes, but a bad pitch. The pitch is, like, you put your arm around the shoulder of an investor, you gesture sweepingly into the distance, you close your eyes, she closes her eyes, and you say in mellifluous tones: “Can’t you see the trucks rolling off the assembly line right now? Aren’t they beautiful? So clean and efficient, look at how nicely they drive, look at all those components, all built in-house, aren’t they amazing? Here, hold out your hand, you can touch the truck right now. Let’s go for a drive.” That’s not true, but it’s a nice metaphor; the goal is to get the investor to see the future, so she’ll give you money today, so that you can build the future tomorrow. [ . . . ]

Startup investors understand that this is the game they are playing; they want to be sold an enthusiastic vision of the future by someone who believes it so purely and tangibly that he thinks it has already happened. Sometimes it works out great, the founder achieves his vision, the future is as predicted and the investors get rich. Other times—most times—it doesn’t work out, the vision fails, the future is different and the investors lose their money. It’s fine. That is the game they are in, betting on wild visions of the future sold to them by wild visionaries; only some of them have to come true for the investors to get rich.

To make the analogy more concrete, the entrepreneur is the magician, and the venture capitalists are the audience members, inspecting the entrepreneur’s act to find the trick but nevertheless hoping to be dazzled.

II.

Let’s frame venture capital explicitly in terms of the three steps of magic mentioned in The Prestige.

The Pledge is the entrepreneur’s visionary pitch to the investor. As an initial matter, is this market big enough to make venture capital returns? What are the existing solutions to the problems? And what is the entrepreneur’s specific solution to the problem? What is his vision for the future?

The Turn is when the entrepeneur’s pitch is so dazzling that, in spite of the investor’s due diligence, she still excitedly cuts a check. The entrepreneur shows off everything his company has accomplished to the current moment, a bunch evidence that the he has already done something extraordinary and magical in the problem space. The investor is asking for the entrepreneur’s references and doing financial modeling on where the entrepreneur’s company is heading. She’s looking for the trick, for all of the reasons why this company might fail, but if she concludes that this is unicorn magic, she cuts a check. Most startups, however, don’t make it from The Pledge to The Turn. Famed VC firm a16z, for instance, apparently hears 3,000 company pitches per year but only invests in 20 of those companies.

But the investor doesn’t stand up to clap yet, nor does the entrepreneur, because the hardest part has yet to happen: The Prestige. If The Turn is about showing off everything that happened before the check was cut, The Prestige is about everything that happens afterwards. The Prestige requires the entrepreneur to grow the company, meet and exceed financial projections, and eventually not only return money to the venture capitalist, but also change the world in the way the entrepreneur had envisioned during The Pledge. And this is where the magic analogy begins to break down: When a company successfully performs The Prestige, the magic is no longer magic—it’s been turned into a reality. There’s no more “trick” that everyone’s radically skeptical about, no more veil that people are trying to pierce. Many companies don’t make it from The Turn to The Prestige. Famously (infamously?), venture capital investments adhere to a power law. A teeny-tiny minority of companies generate the vast majority of returns. It wouldn’t be surprising, for instance, to see a return profile like the following for ten investments: five return 0x, two return 1x, two return 2-3x, and one returns 10x.

III.

One interesting way to think about a private company going public is that it lets retail investors behind the curtain to get in on the magic of a startup… Except not exactly. Traditionally, by the time a company goes public, The Prestige has already happened. The venture capitalists are already giving the standing ovation. The startup has already found a way to generate sustainable revenues (and perhaps even profits). The startup already has a product with strong traction. The runway for the startup has already been sufficiently de-risked to allow participation from the public. Indeed, going public is the imprimatur of sustainable success. The opaque magic act in the world of early-stage venture capital can now give way to the highly institutionalized, transparent, and scrutinized world of public markets.

A couple of years ago, the trend was for high-growth unicorn tech companies to stay longer and longer in the private markets. Rather than going public, they would raise increasingly large “growth equity” or late-stage VC rounds. And this made sense to me! Visionary founders don’t want to have their businesses put under a microscope. They don’t want to bend to the will of public markets. There’s still magic yet to perform. Wait for The Prestige before you applaud.

Interestingly, we’re now seeing SPACs reverse this dynamic. Rather than raising later and larger VC rounds, high-tech growth companies are entering the public markets sooner through a SPAC acquisition. The public can actually get in on the magic sooner. Of course, there are some great benefits to going public sooner. A public company has easier access to future capital. Rather than raising successive rounds from venture capitalists (which can be very cumbersome!), a late-stage private company can just raise all that money at once through a SPAC. By going public a company also provides liquidity for its investors and employees. And going public is also a form of advertising, giving the company more prestige among shareholders, customers, and analysts. This is especially true if the company is going public via SPAC where the SPAC sponsor is a celebrity like Chamath Palihapitiya or Bill Ackman.

But what if companies are getting SPAC’d before The Prestige has yet to happen?

IV.

“Any sufficiently advanced technology is indistinguishable from magic.”

Arthur Clark

The tech closest to actual magic is what’s called “deep tech.” Deep tech involves risky (and often literally) moonshot ideas, super high capital expenditures, lengthy sales cycles, and highly proprietary technology. Examples of deep tech ideas include manufacturing organs in space, delivering people around in drones, and genetically engineering blue fin tuna. Unlike traditional software investing, deep tech investing hardly has any sort of uniform playbook, timeline, or metric for success. It’s much more difficult to evaluate deep tech companies because much of their worth is tied up in future revenue generation opportunities rather than existing revenue.

Recently, we’ve seen an increasing trend towards more deep tech companies getting SPAC’d. This in and of itself is not inherently a bad thing, but what I find slightly concerning is that a few of these companies haven’t made a single cent in revenue. Nikola, an electric truck company that got SPAC’d in June 2020, soared to a $34bn valuation despite making $0 in revenue. It has also recently been embroiled in allegations of financial fraud. Virgin Galactic, a company that promises to take civilians on space tourism trips, got SPAC’d in October 2019 without having sent a single tourist to space yet. Virgin Galactic’s lackluster 2020 Q4 earnings call revealed that it’s continuing to push back plans for its test flights. And Joby Aviation, a passenger drone company, recently got SPAC’d in late February but won’t be ready to start shuttling people around until 2024. Don’t get me wrong, companies like Joby are extremely cool, but there’s still a lot of magic that needs to happen in the intervening years.

So why are SPACs targeting these sorts of companies to go public?

  • S-1s prohibit companies from including financial forecasts. SPACs, on the other hand, don’t need to file S-1s and in fact are governed pretty much exclusively under merger & acquisition law. SPACs use a private due diligence process which allows companies to present financial forecasts and promote themselves heavily before the SPAC transaction. This presents a unique opportunity for SPACs to merge with more vision-driven or high-growth earlier stage companies, where the trailing financial profile is not representative of the company’s trajectory.

  • Over the past year or two, we’ve seen an increasing public fascination with growth stocks. Many SPAC’d companies like Joby Aviation are exciting, high-growth businesses. This fits the social-financial milieu, appealing heavily to the unshackled public of retail WSB / Robinhood investors.

  • Venture capital investors who disagree with me will argue that many of these companies have already performed The Prestige, so what’s all the fuss about? Companies with differentiated technologies, strong management teams, and full order books may still be good businesses, even if these companies are years away from generating revenue.

V.

Should the public be allowed to invest in pre-revenue deep tech SPAC’d companies?

My guess is that your view on this question will depend on whether you think the Gamestop frenzy was a good thing or not. I’ve previously written my Gamestop take here.

On one hand, I’m in favor of democratizing finance from the hands of a few institutional incumbents to the People. SPACs do exactly this, whether or not companies still have to perform The Prestige. Specifically, SPACs democratize finance from the hands of late-stage venture capitalists and investment bankers to retail investors. To clutch my pearls and say that it’s unsafe for retail investors to trade stocks seems a bit paternalistic (“you’ll hurt yourself, kid!!!”), and a small libertarian voice in my head tells me that retail investors should be allowed to live and die by their own sword.

The obvious pushback here is that many securities laws are designed to protect retail investors. In fact, a bunch of laws are designed to protect us from ourselves (seat belts, cigarettes, etc.), and even if you call these laws paternalistic, that doesn’t necessarily make them bad, at least from a utilitarian perspective.

I think these are fair points. I’d obviously prefer for every company that gets SPAC’d to be a great company. I’d also prefer that retail investors aren’t goaded into SPAC’d companies yet left unknowingly holding the bag if these companies turn out to be trash. And if there’s a way to do these things without imposing super heavy regulations on SPACs, I’m all for it. I dunno’, you can imagine something like a big red box on Robinhood every time you want to buy shares of a SPAC saying “This company just got SPAC’d and has never made a single cent in revenue, you should be careful.” And if the retail investor still goes through with it, then so be it. That seems to be a pretty lightweight requirement. However, I’m worried that heavy-handed regulations (like deal-structuring or disclosure requirements) might reduce not only the number of bad companies to get SPAC’d but inadvertently also the potential number of good ones too. Indeed, heavy regulations might defeat one of the purposes of SPACs, which is that they’re far less cumbersome than the traditional IPO process.

VI.

Some people claim we’re in a SPAC bubble. In the month of January, nearly 100 SPACs raised nearly $26 billion. We’re living through a time where capital is chasing startups, rather than the other way around. I bet a lot of this capital will find great companies that are “ready” to be taken public, but I also bet that some of this desperate capital may find its way to companies that are years away from completing The Prestige. Would you consider this a bubble? Or a sustainable trend? The answer to these questions will depend on how well the public market adapts to these types of companies that are based entirely on future projections and growth rather than current revenues and profitability. While public markets traditionally have not been patient, maybe we’re living through a fundamental shift in the behavior of public markets thanks to the flood of WallStreetBets investors. I honestly have no idea. Traditional history suggests that we’re witnessing a frothy bubble, but as I’ve written previously, much of tech is fundamentally different from what came before.


📚 What I’m reading

  1. Private schools have become truly obscene. (The Atlantic)

  2. How Neopets predicted the future of the social Internet. (The Ringer)

  3. Ten breakthrough technologies 2021. (MIT Technology Review)

  4. Consumer technology trends 2021. (Heartcore)

  5. Technology, freedom of speech, and Rush Limbaugh. (Francis Fukuyama in American Purpose)

  6. As remote work becomes the norm, vast new possibilities open for autistic people. (Wall Street Journal)

  7. Interview with Martin Gurri. (Matt Taibbi)

  8. Criticizing public figures, including influential journalists, is not harassment or abuse. (Glenn Greenwald)

  9. Trapped priors as a basic problem of rationality. (Astral Codex Ten)

And finally, given this week’s focus on magic, here’s Eric Chien’s amazing “Imagination Coins” routine again (it’s just so clean):

#45 - BigLaw in the 21st century

Disrupting the billable hour

I.

Even those [law firm associates] who seem to succeed often confess they have been lured into a Faustian bargain and that for all their material success, they have lost their souls.”

Towards the end of an interview I had with a corporate law firm, when it was my turn to ask the questions, I popped the following: “What does it take to be successful as an associate at your firm?” The answer was a classic: “Well, you need to be humble. You need to understand that the work you’re doing will very often be unglamorous, and you’ll be doing a lot of it, so if you think the work is beneath you, then you won’t last long.”

It’s not a secret that many corporate lawyers are profoundly unhappy. The reason stems from a key aspect of the law firm business model: The billable hour. For example, let’s take a hypothetical and ambitious first-year associate at a top corporate law firm. Like most other first-year associates, our associate makes roughly $200,000 per year all-in. She also needs to keep track of her hours assiduously in order for her firm to correspondingly bill the client for her work. Junior associates are expected to bill around 2,000 hours per year, but let’s say our hypothetical associate is so ambitious that she wants to bill 2,200 hours for the year. The amount of time she spends on the job also doesn’t map 1:1 onto the amount of time she can bill. According to Yale Law School, our associate will probably need to be at work for over 3,000 hours (about 60 hours per week with no weeks off) in order to bill 2,200 hours. If the law firm bills the client for those 2,200 hours at $500 / hour, the law firm generates $1,100,000 in revenue. The more our associate bills, the better for the firm, and the more she can climb the ranks. However, our associate captures very little of the economic value she creates ($200k vs. $1.1m), and while the firm is billing the client $500 / hour for our associate’s time, our associate herself makes a comparatively measly ~$65 / hour.

II.

I have not met a single law student who praises the billable hour. Everyone knows that it sucks, yet it still exists. Why?

My theory is that the billable hour model is just one piece of a huge, ossified flywheel that continues not only to generate outsized revenues for law firms, but also to attract young prestige-hungry lawyers and to produce high-quality work for clients:

While each piece of this flywheel are important, I think a couple are particularly interesting:

  • Prestige: One might think that at some point, young lawyers have had enough. “I’m stick of this billable hour BS, and I’m putting my foot down! Pay me more or work me less, or I’m out.” But no. Many fresh law school graduates continue flocking to top law firms that work them to the bone, and my theory is that it’s in no small part because of prestige. I’ve written previously that the legal profession is highly stratified. You’d hope that the rankings end at law school, but in fact, even corporate law firms are ranked, and many law students choose to work at firms based on those rankings. Law firms desperately cling onto their ranks and try their hardest to crawl their way up into the “V50” or “V20” or “V10” or whatever rung of the ladder is up next for them because they know that the ranking boost will increase their talent flow. Prestige is a form of lock-in.

  • Top clients: One might also think that at some point, clients have had enough. “I’m sick of these law firms milking my cash. Charge me less, or I’m taking my business to another firm!” But again, no. The legal world is so complex nowadays, the potential penalties are so large, and the costs of losing a corporate lawsuit are so tremendous, that the bigwig business executives will sleep easier at night knowing that their legal work is in the hands of a V5 law firm with the best talent. So the clients grumble all the way to the bank as they cut their multi-million-dollar checks to the suit-people at Skadden, Arps, Slate, Meagher & Flom (the name of a firm!).

III.

Of course, I write this all tongue-in-cheek. I like corporate lawyers, they’re very smart people. But I do wonder where the tech ~disruption~ is. Will it ever come?

I’ve seen two startups make ambitious attempts to disrupt the BigLaw billable model (both attempts ultimately failed): Clearspire and Atrium. Each is instructive in thinking about the future of BigLaw in the 21st century.

Clearspire, founded in 2009, built a “two-company” model: (1) A law firm staffed with professional lawyers who actually completed all the legal work for clients, and (2) a services company that provided software and other support for the law firm. With Clearspire’s integrated technology platform, Clearspire’s lawyers could work together from anywhere around the world, enabling Clearspire to reduce office requirements, increase efficiency, and reduce costs. Clearspire also billed clients using a “statement-of-work” (SOW) process whereby each client matter had a fixed cost rather than a billable hour variable cost, enabling greater price predictability, accountability, and transparency. Unfortunately, Clearspire ultimately failed because clients were unfamiliar with the Clearspire SOW model. Clients wanted to stick with the billable hour. Clearspire apparently hypothesized that large corporate clients would be attracted to its model because of the clients’ significant volume of work and the substantial savings, but this was also wrong. The more established the corporate client, the more it preferred an established, traditional law firm.

Atrium, founded in 2017, also built a two-company model. Its law-firm arm offered a suite of legal services specifically for startup companies and charged clients on a subscription, rather than hourly, basis. Atrium’s software arm developed legal software in-house to accelerate its lawyers’ work. Near its height, Atrium grew to about 150 employees and was even apparently able to poach a bunch of top-notch lawyers from renowned Bay Area law firm Wilson Sonsini. However, in January 2020, Atrium decided to lay off all of its lawyers, focusing instead the legal software portion of its business. A couple months later, Atrium shut down entirely, citing an inability to figure out how to make a dent in operational efficiency. In other words, they were burning far more money than they could make. According to Atrium’s founder Justin Kan in a tweet storm explaining Atrium’s shutdown:

I encourage you to read the entire thread (it’s very insightful!), but the Tweet above stood out to me in particular. Is Justin saying that … he should have built something more similar to the billable? 😳

Okay, to be fair, a “flat rate hourly model” isn’t necessarily the same as the BigLaw “billable model” as it currently stands. But what I think Justin was getting at (again, read the entire Tweet thread) was that the subscription revenue model was not operationally efficient. With so many Atrium lawyers needing to be paid and so little revenue coming in, Atrium was drastically in the red. In an attempt to increase operational efficiency, Atrium pivoted to software-only, since software margins at scale are amazing. However, the company had so much inertia that it couldn’t really change course. Part of this inertia came from the fact that the provision of legal services is not a quick, one-time thing like checking your News Feed might be. Transactional legal services often require days, if not weeks, of negotiations and contract-drafting, and to the extent you’re involved in litigation, it can take years. It’s hard to iterate, and Justin just couldn’t see a viable path to the green.

IV.

Unlike Clearspire and Atrium, most of the legal tech startups aren’t disruptive to the BigLaw model. Instead, they are what Clay Christensen might call “sustaining” innovations because they prop up the existing BigLaw value chain. These companies sell / license legal software to BigLaw firms to help their attorneys produce higher quantities of higher quality work, feeding the aforementioned flywheel. For instance, here’s a chart from Tracxn on the top legal tech startup business models by funding:

With the exception of “Legal Forms,” which is serving a different legal market than big corporate law firms, the remainder are essentially designed to fit within the existing BigLaw value chain.

So, again, I ask: Where is the BigLaw billable going in the 21st century?

V.

A starry-eyed 20-year-old me was absolutely sure the professions would be disrupted “soon” thanks to artificial intelligence (robot lawyers, robot doctors, etc.). Now, I’m a bit more skeptical, for precisely the reason that many of the tech innovations in the professions are sustaining rather than disruptive.

However, let me end with one final idea for the future of the professions. From The Innovator’s Dilemma (emphasis mine):

The second element of the failure framework, the observation that technologies can progress faster than market demand . . . means that in their efforts to provide better products than their competitors and earn higher prices and margins, suppliers often “overshoot” their market: They give customers more than they need or ultimately are willing to pay for. And more importantly, it means that disruptive technologies that may underperform today, relative to what users in the market demand, may be fully performance-competitive in that same market tomorrow.

But is it possible for the professions to really “overshoot” in terms of performance? After years of complex corporate litigation, the winning party usually doesn’t think, “You know? My lawyers were just too damn good, I wish they were a bit worse so I could pay less!” No, the winning party is wiping the sweat of their brow as they go grab a drink and heave a sigh of relief. Similarly, if I’m going in for brain surgery next week, I’m going to try my absolute hardest to find the best possible brain surgeon out there. When the stakes are high, good simply isn’t good enough. At the high end of the professions, it’s impossible to be too good. It’s impossible to overshoot.

This doesn’t mean that the professions will never get disrupted. It just means that the high-end of the professions will be the very last to get disrupted. While new tech and business models might “underperform today, relative to what users in the market demand,” they may be “fully performance-competitive” at some point in the future. Indeed, if you graph tech performance over time, this is how disruption works:

Today, “low quality uses” in the law, where existing legal solutions “overshoot,” are in small things like parking ticket disputes. However, these uses are not in the purview of BigLaw, which is the “most demanding use.” Companies like DoNotPay are using software to disrupt the low-end of the market, so I guess only time will tell whether and when these companies move up-market to disrupt the legal monastics sitting atop the law firm rankings.


📚 What I’m reading

  1. Power to the Person. (Not Boring)

  2. NFTs and CBGBs: How’s that for a clickbait title. (Alex Danco)

  3. The hidden reality of U.S. foreign policy. (Glenn Greenwald)

  4. A better way to think about conspiracies. (New York Times)

  5. To take or not to take (COVID stimulus checks). (New Ideal)

  6. When SPAC-Man Chamath Palihapitiya speaks, Reddit and Wall Street listen. (Wall Street Journal)

  7. The short-term, middle-term, and long-term future of the coronavirus. (STAT)

  8. As the insurrection narrative crumbles, Democrats cling to it more desperately than ever. (Glenn Greenwald)

#44 - Twitter's Birdwatch, decentralized truth, and kangaroo courts

🦘

I.

One sign of a well-functioning democratic process is that the losers accept the outcomes. If the People think that the process is rigged, then the outcome is fraudulent, and you don’t really have a Democracy.

It’s useful to think about large institutions or systems like “Democracy” in terms of processes vs. outcomes. At a certain size, when a bunch of people who don’t know/trust each other are involved in making decisions that affect the whole, you need rules to guide behavior and decision-making. As long as we agree to these processes and abide by them, we theoretically should accept the outcome, no matter how “bad” it turns out to be.

This principle plays out in various organizational contexts. For example, consider start-ups. All successful startups eventually face a scaling challenge: What happens when the start-up grows to a size where the CEO can no longer make all the important decisions? There’s a conundrum. If you’ve gotten to that size already, then obviously you’ve already done something right. But will you still be able to reproduce that “something” across all the employees, each of whom has vastly different backgrounds and priors? This is an existential question. Find a way to reproduce and scale success, or die.

The solution for the startup is to establish a uniform culture, a standardized process that guides organizational decision-making. As the company grows, the particular behaviors that resulted in success during the company’s infancy must be distilled into principles (e.g., Facebook’s famous “move fast and break things”) and promulgated throughout the entirety of the organization. Employees buy in to the culture and use it as a framework for making decisions. Even when employees are presented with problems they’ve never seen before, culture guides them to a course of action that their managers and executives would likely make if they were in the same shoes.

Consider also how our legal system works. When two private parties are negotiating a contract, they can pretty much impose any kinds of rules they want on themselves or use any heuristic for judgment to reach a resolution. But the minute those parties end up in court, courts impose a host of uniform rules of procedure that lawyers and judges have to adhere to. Why? It’s because courts adjudicate all matters of proceedings across the hundreds of millions of Americans, and in order to produce consistent decisions from judge to judge, from party to party, you need some level of standardized process in place.

Now imagine that courts don’t have any rules. The lawyers are shouting over one another. A member of the jury is the defendant’s best man. A witness is called to the stand and allowed to present hearsay evidence (“I heard her say the she saw the defendant committing the crime!”). The judge is wearing a party hat.

Without some semblance of uniformity in the rules, the nationwide court system would break down. Rulings would be unpredictable. People would lose their trust in the venerable judiciary branch of government. Would there be any sense or hope of justice left at all if our courts are completely defunct?

In short, processes matter when large systems make decisions. If you don’t have enough rules, or if people don’t agree on the rules, or if too many people disobey the rules, then the system breaks down. People and decisions begin splintering in every direction. Eventually, the institution loses its legitimacy. Trust crumbles. And if the institution somehow is still standing, it stands merely as a hollow shell, an outward representation of fake legitimacy that ultimately is devoid of any value on the inside. Once you’re at that point, then welcome, my friend, to kangaroo court.

II.

One popular misconception back when I was in middle school was that Wikipedia was a kangaroo court. My teachers told me that Wikipedia was a wildly unreliable source of truth or information—“never cite it for your papers.” The sentiment boiled down to: Wikipedia was so decentralized that any random person could edit any random page, and there were no rules in place for editing. Hence, kangaroo court.

Perhaps another misconception about Wikipedia is that the more polarized a topic is, the more the Wikipedia page for that topic is a kangaroo court. After all, this might make intuitive sense: If people are super polarized on a topic, then any attempts to arrive at truth on that topic could devolve into shouting matches or edit wars where one side makes a change to the Wikipedia page and the other side immediately undoes it.

It turns out, though, that Wikipedia is far from a kangaroo court, and in fact, the more polarized a topic is, the more accurate that topic’s Wikipedia page is. Wikipedia has somehow managed to create a set of rules and processes to arrive at decentralized truth—incredible!

Here’s how (emphasis mine):

Justin Knapp, a prolific Wikipedia editor with more than 2 million contributions, agrees that Wikipedia’s robust bureaucracy is crucial to cultivating a space for meaningful disagreement . . . Knapp says that even when political disagreements are fierce, or seemingly unresolvable, the clear set of editing principles — to cite facts properly, to present information in a neutral voice — allows editors to resolve disputes without devolving into toxic arguments . . . “Wikipedia has a serious collective goal and that is to create an encyclopedia,” Knapp says. “Because of the shared mission, Wikipedia editors generally have an overlap in their set of values. And these values generally override a disagreement on a particular issue.”

Put simply, Wikipedia has a strict but uniting set of rules that editors agree to and abide by. As stated elsewhere in the article, “[e]diting on contested topics is like arguing in a court of law,” not a kangaroo court.

III.

At last, here’s Twitter, in an announcement last month:

[T]oday we’re introducing Birdwatch, a pilot in the US of a new community-driven approach to help address misleading information on Twitter . . . Birdwatch allows people to identify information in Tweets they believe is misleading and write notes that provide informative context. We believe this approach has the potential to respond quickly when misleading information spreads, adding context that people trust and find valuable. Eventually we aim to make notes visible directly on Tweets for the global Twitter audience, when there is consensus from a broad and diverse set of contributors.

So… will this be a kangaroo court?

Here’s Mike Solana, glibly:

At first blush, without knowing anything more, I’m inclined to agree. If you open the floodgates all at once in an attempt to decentralize truth, you’re going to be in kangaroo court. Everyone will have weapons, and fact-checking will devolve into who is louder and who can mobilize more people in the moment.

But the product and policy people at Twitter aren’t stupid. Birdwatch is only open right now to a small test group. Twitter has already laid out values that it is asking Birdwatch contributors to abide by. Twitter has also specified a few challenges Birdwatch will need to overcome.

Even still, is this enough? In its list of Birdwatch challenges, Twitter seems to be missing what I think is its biggest challenges: In order to keep Birdwatch from turning into a kangaroo court, Twitter needs to impose and enforce strict rules (like neutrality, citations, etc.) for all Birdwatch contributors, and more importantly, contributors need to buy into those rules.

However, I’m not exactly optimistic that Twitter will be able to solve this challenge because there may be a cultural mis-match between how Twitter users use Twitter and how Twitter users will use Birdwatch. That is, if Birdwatch users habitually treat “note-taking” on Birdwatch anything like tweeting on Twitter, then we’re going to have kangaroo court. Indeed, Wikipedia has no cultural problem because it was designed from the ground up as an encyclopedia, a canonical source of truth that people can contribute to, but Twitter was designed from the ground up as a network of random 140-character (now 280) ideas that people share.

So, I’m kinda skeptical. For instance, check out some of these “notes” on Birdwatch:

Haha, this is just… not really useful? These “notes” seem like normal Tweets that I would find on my Twitter feed, not a serious attempt at providing value or reaching decentralized truth.

Anyways, when it comes to new products, businesses, whatever, it’s always easier to be a bear than a bull, a skeptic than an optimist. Birdwatch obviously only just launched, so we should suspend disbelief until we have a few more data points. At the very least, I’m happy that Twitter is willing to try a bottoms-up approach to fact-checking rather than imposing its will from the top down. But I guess only time will tell whether Twitter can keep Birdwatch from turning into kangaroo court.


📚 What I’m reading

  1. The moments that could have accidentally ended humanity. (BBC Future)

  2. “Mark changed the rules”: How Facebook went easy on Alex Jones and other right-wing figures. (BuzzFeed)

  3. Shopify. (Benedict Evans)

  4. The AI research paper was real. The ‘coauthor’ wasn’t. (WIRED)

  5. A modest proposal for Republicans: Use the word “class.” (Astral Codex Ten)

  6. The profound, unintended consequence of Apple’s new privacy policy. (Mobile Dev Memo)

  7. Yuval Noah Harari: Lessons from a year of Covid. (Financial Times)

  8. Iceberger. Okay, this isn’t really something I’m “reading,” but it’s fun and cool. (Josh Tauberer)

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