The Insane World of VCs, Softbank, WeWork, Uber & Lyft (w/ Josh Wolfe and Michael Green)
MICHAEL GREEEN: Mike Green, I'm here in New York with Josh Wolfe-- one of my absolute favorite people. JOSH WOLFE: The feeling is mutual. Love to be with you. MICHAEL GREEN: Thank you very much. You've had several chances to sit down in front of us on camera with Real Vision. And one of the areas that you've spent a lot of time talking on-- and I'm just going to jump right into it-- has been this idea of medical tech innovation. And you had a huge event occur in just the last couple of weeks where Auris Medical, which was one of the investments that you had discussed online, was just purchased by Johnson & Johnson. JOSH WOLFE: Yes. MICHAEL GREEN: Can you tell me a little bit about Auris in particular? And I'd love to understand what helped you identify this, and how you thought about this type of investment, and what you were tapping into that ultimately led to this incredibly successful investment? JOSH WOLFE: So let me give you the dishonest answer, and then the honest answer. MICHAEL GREEN: Perfect, I like both. JOSH WOLFE: The dishonest answer-- well, we did really copious amounts of research, and we analyzed from top to bottom, the state of robotic surgery, and we looked at the past four years of analysis for Intuitive Surgical, and we looked at every single product line-- no, none of that was true. MICHAEL GREEN: Was there a two by two involved? JOSH WOLFE: No, there was nothing. I mean, this was an engineer that we met. MICHAEL GREEN: OK. JOSH WOLFE: So it comes down to the two-legged mammal. We met an engineer. And the engineer said, you know, I'm doing this thing that's pretty cool and it has to do with robotic surgery. And our first thought was, well, you know, there's this monster company-- $30, $40, $50 billion, depending on what the time was in market cap-- which is Intuitive Surgical. And he says, yeah, about that-- actually, the guy who founded Intuitive Surgical, Fred Moll, is actually the founder of this new company. So suddenly, it piqued our interest. OK, you've got an interesting segment, not a lot of venture-backed companies-- in fact, you know, maybe less than 4. And you've got the godfather of the industry that is doing something new. And the new thing that he was doing was taking advantage of some of the most cutting edge stuff that was happening in robotics at a scale that had never occurred before and combining that with software, so that you could start to do things inside the human body akin to what Google has done in mapping roads. Where we've now called this, or I've called this-- Fred hates when I say it-- Moll's law, where you went as a surgeon from-- if you've seen The Knick with Clive Owen-- you know, cutting people open-- turn of the 19th century. And then you went into small-scale arthroscopic surgery, where you make a little small incision. And now with Auris, you make no incision. You go in through an orifice of the body, and you basically navigate with almost GPS-guided capability to the site of where you need to perform the surgery, and you do it from the inside out. And so their first modality was focused on lung. And there's a whole slew of other things that they're focused on. But the basic thesis we had was Intuitive was really focused on two things, which were prostatectomies and selling to the urology department, and then hysterectomies only for women. And we'll expand beyond that, but it was basically one department. Go to the urology department. And we said, OK, wait a second. If you had a multimodal robot where you could sell it into the ER or the OR and just basically swap out one technique for another and put different equipment on top, then you would have this super flexible robot. And that was the founding thesis. We originally vested, I want to say, it was around a $20 million pre-money valuation. MICHAEL GREEN: Wow. Now just to toss numbers on it, it just sold for $4 billion, if I'm correct. JOSH WOLFE: If everything pays off, it'll be just under $6 billion. MICHAEL GREEN: Phenomenal. JOSH WOLFE: We brought Peter Thiel into this Series B-- MICHAEL GREEN: I've heard of that guy. JOSH WOLFE: --and then a slew of crossover hedge funds-- Viking, and Coatue, and Partner Fund, D1-- at successively higher valuations. And as you know, my view on valuations is basically for us, the killing of risk. And so for us, it was the super early identification of OK, here's an entrepreneur and an engineer. You know, all they have is technical risk. Can they actually make it? Can they build it? And then you have market risk. Can you actually get indications from hospitals and players that you're going to be able to actually enter a market where Intuitive is the 800-pound gorilla? And you know, fast forward, this was pretty much in stealth for about five years, which for me is very hard because I like to talk. And my partner Peter was the board member-- Peter Hébert is my co-founder at Lux. And we kept it under wraps. $600 million was raised, FDA approval, and then we came out to the public. And within a year, J&J began negotiations, and then the sale was announced in the early part of Q1 2019. MICHAEL GREEN: So one of the things that I loved about what you skipped over in your description is actually part of the product creation process, right? So as I think about the dynamics of da Vinci, one, you're hitting on the component that it was sold within a particular department, right? And so this was not something that was broadly utilized, and so other departments were available to purchase the Auris system, for example. JOSH WOLFE: Sure. MICHAEL GREEN: There wasn't a sunk cost component where I have to depreciate my MRI machine, therefore I'm not going to buy a new MRI, right? The second was that Fred, or whoever was behind it, did something really ingenious, which was give it a video game controller. JOSH WOLFE: Exactly right. In fact, I had Bill Gates, which I've been on a board with for the past five years, come and visit Fred. And it turns out they didn't know each other, but went to the same high school and they were a few years apart. And it was amazing watching Bill Gates, using a Microsoft Xbox controller, basically navigate through a person. In this case, it was a dummy, right? It was a plastic doll. MICHAEL GREEN: You'd have to be a dummy to let Bill Gates do surgery on you. JOSH WOLFE: But that was the point was take the best genius of the best surgeons, and if a single surgeon performs an operation, the machine and the technology and the computer should be able to learn the technique. And so what you end up doing is you can make great surgeons better, but you can make above average or average surgeons really great. And if you think about this, when a human gets into a car accident, you know, the human learns, right? Maybe there was something to learn. I went too fast, or I should've paid attention, or I shouldn't have been texting, or whatever it might be. When you have an autonomous vehicle that's networked, when one car gets in an accident, a million of them learn. Today if you have an amazing surgeon, it's really hard unless you're watching videos of the surgeon and you're doing multiple repeat techniques for millions of other surgeons to learn. It's a very linear process. But if you wanted it to be massively parallel, then you would want a machine to learn from the haptics of the robotics of a surgeon, and then translate into a technique, which means that some aspects of the surgery will be entirely done by a robot with the human effectively, just like autopilot on a plane, taking off and landing. And the same sort of thing will happen inside the human body. MICHAEL GREEN: So this is very similar to the phenomenon that we see in electronic sports, where there is only one Michael Jordan or LeBron James or Stephen Curry. And neither you nor I care about the sports component, but it's a useful analogy because we see kids that can play basketball on an Xbox and do things that they couldn't possibly imagine. Effectively, the intelligence or the capability of Michael Jordan, LeBron James, Stephen Curry has been built into the machine. You're talking about the exact same dynamic in the Auris Medical system. JOSH WOLFE: Yeah, and the analogy is actually quite interesting because I do think that you will see the skill of the surgeon effectively be replaced by the skill of the machine and the technology. And that is ultimately a function of a team of engineers working with surgeons to embed the very best algorithms, hardware, sensors into the technology. Now, the same thing is true in, you know, what we're calling now esports, where the idea that somebody is actually an athlete because what they're effectively able to do is rapid firing and eye-hand coordination. MICHAEL GREEN: Extraordinary use of opposable thumbs. JOSH WOLFE: Yes, right? I mean, this is the next stage of evolution. But they're able to do it in a world that is not real in the sense that it does not exist in meatspace, but it does exist in bitspace. Those worlds were conjured, like Inception, in somebody's mind, and then 3D designers created them. And we can objectively together share that we are looking at the same space and somebody can quickly navigate through that. In a related company-- and we may have talked about this in the past-- we have a company called Drone Racing League. Drone Racing League is literally a racing league for drones. Now whenever I have this thought, it usually implies that the investment will end up being good, but the thought that I had when I heard about Drone Racing League was this is the stupidest idea I've ever heard. So whenever those words come out, it usually means there's probably something there and I'm in the minority. But here, you have people that were literally racing drones. And that evolved and these drones get faster. And now, you have people who were able to fly these flying projectiles 60, 80, 100 miles an hour in 1/2 a second doing hairpin turns. Now I know, because these guys also work with the military, there are Air Force pilots that can't do these kinds of maneuvers. And this becomes straight out of Ender's Game, where we've talked in the past about the gap between science fiction and science fact, but some of the pilots who are going to be flying mission-critical military missions will have been plucked from the video game world. The pilots that are flying these drones, they're doing them in the real world. But now, they have a simulator and there's no difference. The physics engine that is running the simulation that has the course that's plotted out, wherever they're going through-- a stadium, a museum, whatever the space is-- it's 3D scanned. It's photorealistic to a point that if you were looking at this, you wouldn't be able to tell if you're looking at video or you're looking at the simulacrum. And people are flying through and it's the exact same controls, whether you're controlling reality or simulation. And so that blurring between this sort of meatspace and the bitspace is going to be relevant for autonomous driving where we're training our cars effectively on simulators, in robotic surgery where surgeons will be effectively doing it in simulation and not know the difference, and in drones and beyond. MICHAEL GREEN: Well, and one way to think about this-- and I think this is how the da Vinci system by and large had worked, right-- is that it raises the incomes of those who know how to do it because they can do more surgeries, they can behave remotely. One of the things I love about what Auris has done though by making it a video game controller is just that you've expanded the number of people who could potentially do it, right? That you've lowered the barriers to entry to being a great surgeon as compared to a mediocre surgeon. JOSH WOLFE: Well, I've always said that just like in investing, the most dangerous words are, you know, this time is different, that in venture, the most valuable words are it will rot your brain because every time a parent utters those words, it basically presages the next $10 billion industry. People that bemoan the couch potatoes who were sitting there, you know, playing video games back in the day on Sega Genesis, and then Xbox, and then PS4-- those are the people that today are the drone pilots or the robotic surgeons of the future. And their dexterity and their skill to rapidly learn new games that are coming out is just off the charts. MICHAEL GREEN: Well, it's off the charts. I would point out, just in case anyone's confused and thinking that you're recommending that you educate your children by putting them on the sofa and having them play Xbox, that what you're describing is a situation in which they will be able to do that, and therefore the value of that will collapse. You will effectively be able to have a truck driver-type job be a surgeon. JOSH WOLFE: Yeah. In fact, there's no reason why you wouldn't be able to remotely operate a truck. And so somebody could be sitting in their living room. And maybe they were exceptionally good at Monster Truck 2000 or whatever it is. They could also be in the real-world situation with sensors and Lidar, and complimenting an autonomous system to be able to take remote control. Now, the stack of technology that you need through that-- right, you need the telemetry, you need the connection, you need satellite, you need GPS, you need the simulation, you need real-time control-- every one of those pieces is whitespace opportunity. There's some technology company, just like in the inside of a computer where you had, you know, RAM, and memory, and compute, and control, and GPUs-- every piece of that stack is a company that's waiting to be funded. MICHAEL GREEN: So every piece of that stack is a company that's waiting to be funded, but there are tremendous nonlinear behaviors associated with that, right? JOSH WOLFE: And they're hard to predict-- very hard to predict MICHAEL GREEN: Very hard to predict, I think that's absolutely correct. And so part of the underlying dynamic, we've talked about the TV show connections in the past, right? And there is this element of you can't make cannons until you've invented the casting technology to make bells, right? You're describing something very similar, where you can't have autonomous driving until you've got the systems, the telemetry, the GPS, et cetera that can provide the feedback for somebody to step in when it is absolutely needed and the machine might not be good enough, right? And that person can be functionally in a call center in India or sitting on their sofa in Des Moines, but that system, that backup, that overall system capability has to be there before the thing can switch. JOSH WOLFE: Exactly right. And that's the idea of the adjacent possible, right-- that certain technologies which are intended for one use, then somebody else in this different domain comes and plucks it out and repurposes it. You know, people have taken the Microsoft Kinect 3D depth-sensing camera, which was intended as a video game for just dance or like doing three-dimensional depth perception and playing games and controlling it with your body, and people have taken that to say, OK, we can do 3D scanning of rooms and we can use that for real estate. And so technologies exist and they basically become like an artist tool. It's a palette that people can draw from, and then mix, and remix, and combine. Sometimes, you know, these big new inventions are basically just the combinations of old things. By the way, talking about somebody being able to operate in India, the single best drone pilot in the world today-- any idea? MICHAEL GREEN: Well, I'm guessing India. JOSH WOLFE: 12-year-old girl in Thailand. MICHAEL GREEN: Really? JOSH WOLFE: 12-year-old girl. And she started playing when she was 8. And she is better on every metric. In speed, accuracy, she beats everybody. Her name is Milk. And that's, you know, her call sign. But a 12-year-old girl in Thailand is the best drone pilot in the world. MICHAEL GREEN: So it truly is actually Ender's Game, which is the book by Orson Scott Card where we rely on children to fight the intergalactic battle. Fascinating. That's absolutely amazing. Let's think about the nonlinearity for a second. And one of the topics you wanted to bring up was this idea of liquidity as a nonlinearity. JOSH WOLFE: Yes. MICHAEL GREEN: And so one of the things that we see within venture capitals is that there's been this explosion of liquidity, particularly exceptionally well-funded growth equity. So not the true VC stage one, Series A-type round, although that obviously has benefited from this dynamic, but the Series E pre-public here's $1 billion, here's a $20 billion valuation, here's a $100 billion valuation. Talk to me about how you think about this liquidity switch and the impact that that has on your industry and the impact that has on innovation? JOSH WOLFE: Well, it ultimately is going to define all the returns. And if you go back a little bit and say, well, why are we in this situation, where we've called this in the past, the minnows and the megas? You have lots of these small firms that are starting up that are doing the seed checks, and then you have these large players that are writing these $100 million plus checks. Going back 7 years or so, Andreessen-- who I think is a brilliant investor, a brilliant technologist-- basically said, there's only 10 companies that matter in a given year. And statically, that's probably true. Now knowing which 10 is very hard, but he said, you just basically want to be in those companies. And I that was a meme that really went very wide. And people said, OK, well, it doesn't matter if you invest in Facebook at $1 billion, or $5 billion, or $10 billion because we're going to be hundreds of billions. And so does it really matter if we're negotiating here and quibbling over $1 billion or $2 billion. Well, of course, it does, but that I think induced a lot of growth investors to say, let's just try to speculate on some of these big unicorns. And you've got this phenomenon of companies that were pining to signal that they were going to be that next Facebook by attaining a billion-dollar valuation. And then you got a positive feedback effect where people were funding these things, and to get access, would write an $100 million check at a $900 million pre. And they would own 10% in a billion-dollar valuation. And the problem for the early-stage investors and their limited partners is they were getting these huge markups. And on paper, it looked phenomenal. And then they would go out and raise their next fund and put it into more illiquid companies. But they weren't necessarily getting liquidity on that billion-dollar company. And you have started to see over the past 3 or 4 years, a lot of these unicorns not go from $1 billion to $800 million. They've gone from $1 billion or $2 billion to 0. MICHAEL GREEN: To 0, yeah. JOSH WOLFE: And so there's this liquidity trap that is natural in markets because people are basically taking massive amounts of capital, which in the venture world, there's a capital structure just like in the traditional public markets. And you have common equity, which sits on the bottom of the stack, and then preferred, and then debt on top. When you have preferred equity of a size that is so large, and with it might have the classic Carl Icahn, you know, your price, my terms. So SoftBank would come in, for example-- we could talk a bit about them-- and say, sure, we'll give you $20 million, and we want to own 20% at a billion-dollar valuation, and we want a 2x or 3x liquidation preference. Now, you're talking about a payout where if they actually got sold for $1 billion, SoftBank is not getting 20% of that. They're getting $600 million. And so all the people below the stack, that might be OK because you're really actually getting your percentage of a $400 million distribution in a waterfall, but what if it's only $400 million or $500 million? You're getting nothing. So the presence of SoftBank coming in and basically said, you know what? We're going to do this in a huge way. And combination of Saudi money, and others, and complex debt structure, started basically becoming in a relatively-- not relatively-- in an absolutely inefficient market, the top-tick price setter. And suddenly, they were writing these large checks, owning very large pieces of companies at extraordinary valuations, setting comps that other people would reference, while SoftBank just did that as though they would fund the other. They would publicly come out and do these Solomonic baby splits, right? We're going to go to California and we're going to invest in either Lyft or Uber. Fight it out because we're going to king-make one. It's my view that-- and this is a borderline tinfoil conspiracy theory-- I think that part of what's going on is SoftBank is investing in companies that they know that they will be able to inflate the value of later on. You saw this with We Work. First investing at around $10 billion valuation, then $20-- basically, pricing up the deal themselves. And when you looked at the earnings release, either a quarter or two ago, most of the profits that SoftBank was able to show on paper were from the write-ups of their equity holdings. So I believe that a lot of the activity is done not just because they think they can make money-- although I'm sure that's true-- but because they believe that it will serve as collateral against a massivelyindebted mothership parent company. And so that has absolutely distorted the venture market. And we have warned our companies, unless you and we are getting liquidity in one of these monster rounds, you're basically taking the risk that you're going to be holding zombie shares. And I think that there will be a rude awakening for a lot of people that that's the case. Now, it has attracted other people who are providing capital as alternatives to SoftBank. And so you have crossover funds and you have really smart groups. We get Tiger-- who has absolutely killed it in a really smart way-- Viking, and Coatue, and others that are writing $100 million plus checks. They do have the public market savviness and understand what the comps are. They are generally value-add. In the case of Auris, you know, all those groups that came in were, I think, super helpful. But it's a very dangerous phenomenon where you have huge amounts of money coming in at huge valuations on what are still largely unprofitable binary outcomes. MICHAEL GREEN: Well, so those companies hit on two separate issues, right? One is at minimum in a Minsky-type framework, they're speculative finance, right? They rely on the capital markets remaining open in order to cover their costs and service their existing levels of debt. At worst case scenario, they have Ponzi-like aspects, which is in order to keep going, they need to keep raising more money, right? The second component though that you're describing when you talk about these types of preference rates is you're creating waterfall characteristics similar to a securitized debt stack. JOSH WOLFE: The structure of the payout. MICHAEL GREEN: The structure of the payout is very different depending upon the underlying outcomes. And pricing that is really quite tricky, right? It's very unclear that anyone involved is actually making the type of calculated analysis that says, well, I have an option that suddenly has very different components. JOSH WOLFE: I actually think that there is a very sophisticated step-- there's just three steps. The first step is the finger in the air. The second is to the tongue, and then the third is to put it in the air. MICHAEL GREEN: To put it up, yeah. Yeah, it's a highly efficient temperature gauge. I think that's right. And that would largely argue that most of the participants in the venture space are not by experience equipped to do that type of calculation, right-- understanding the option components. JOSH WOLFE: To be fair, Auris from a $20 million pre to a $5.75 billion exit-- MICHAEL GREEN: Oh, sure, pick on something that worked. JOSH WOLFE: --I didn't look at a single spreadsheet-- not a single one. We didn't model anything. MICHAEL GREEN: Right. JOSH WOLFE: I mean, it was literally, you know, we're backing a team. They're developing a technology. We think it's going to be relevant to this market. And if you would've told me that it would've been sold for $3 billion, or $8 billion, or $4 billion-- like we had no conception of what that range could actually be. MICHAEL GREEN: So that's traditional venture capital, right? And that's obviously meant as a compliment, all right? But when you start making an observation about a historical distribution of payouts, and then change your behavior based on that historical distribution of payouts, what you're actually doing is changing the future distribution of payouts-- i.e. Marc Andreessen's observation was correct as it described the history of venture capital. But by choosing to act on it and act on it as a scale enough agent-- and SoftBank obviously is even larger in this context-- but by acting on it as a scale agent, you've changed the future distribution. You won't know that until you observe the outcomes. JOSH WOLFE: I think you've skewed the probabilities lower, right? I mean, just by definition, the more people that are chasing things, you know, the greater the competition. Now if you have these layers in the public markets where there were pools of capital that were voracious to be buyers of IPOs, then you would see this flood of IPOs, like we saw in the late '90s and early 2000. You don't see that today. Now for a variety of reasons, the narrative is to stay private for longer, control. But I think you're absolutely right that by making the observation that there's a handful of companies that mattered and the price that you paid didn't, it attracted a flood of capital. But that's flood of capital, I believe is going to end up with a lot of donuts. MICHAEL GREEN: I think that's correct. And I think the challenge is that there is a feedback loop as you go through that process. So exactly as you highlight with SoftBank, where they're able to write up their investments and show profits, that in turn is then able to be presented to investors and say, hey, look how stable this process is or how profitable it is. JOSH WOLFE: Which induces more capital. MICHAEL GREEN: Which induces more capital to come in. JOSH WOLFE: It's very dangerous. I mean, it is, in a sense, like a Minsky cycle. MICHAEL GREEN: It's absolutely a Minsky cycle. The challenge on all of this though is that in a world that is dominated by empirical finance, which is the historical returns are the only fact pattern, the future returns are your opinion and my opinion. Particularly in that process of migration where more pools of capital are coming in, raising the valuations, improving the returns, you can look like a fool-- a complete Cassandra-- arguing that this is bad in the future because the immediate history is going to tell you the exact opposite. JOSH WOLFE: And the analogies between the history in public markets, which I try to study a lot-- not anywhere near as well as you. I learn way more from you than I do from any of my venture brethren when it comes to capital markets. And you compare that to the venture world. There are really ends of ones in venture. Like looking at comparables, in 1997, you would have been an idiot-- or '98-- you would have been an idiot for saying, who the hell needs another search engine, only to miss Google. But then once you see the presence of Google, you would've been an idiot to try to fund the next 10 Lycoses or whatever it was. And so it's very hard because you have these aberrant outcomes. They are total anomalies, and then people try to learn from these things. And it's just it's way different. And I would actually argue that the reason it's different is because you do not have the kind of information that is conveyed through price discovery in traditional markets. You do not have the number of really smart people that are looking at a security, analyzing its history, looking at the fundamentals, debating it, being long it, being short it. The absence of that kind of relative efficiency is totally missing in venture. And so you also get, which you don't typically get in the public markets as much, massive dislocations between bids and ask in pricing events. So the step-ups that we see in, you know, seed stage round can be 10x into a Series A. Now the scale of what you're talking, you might be putting a few $100,000, or a few million dollars in it, a few million dollar valuation, and then you might be raising $20 or $30 million at a $50 million valuation, then $100 million at $1 billion. The gaps-- the discontinuities between those is huge. Now, liquidity is one form of that-- this sort of asymmetry of information-- but it starts before conception or inception of a company. And there's information asymmetries all the way. And you could argue that they get reduced over time. But the first information asymmetry-- like the maximum information asymmetry-- is with the invention that a scientist has. And you know, there's this quote from Linus Pauling, a Nobel Laureate, who said, I know something that nobody else in the world knows. And they won't know it until I tell them. That is the ultimate power in the world-- to know a secret that soon, the rest of the world will know, but you're the only one that knows it. So that's maximum information asymmetry. The next is, OK, now, the scientist has teamed with an entrepreneur. Now, the entrepreneur might have asymmetry because not a lot of other people know about it or they've befriended the scientist and they started the company. But then the entrepreneur has an asymmetry of both a false positive and maybe a true positive, which is their estimation of their ability. Almost all entrepreneurs believe that they are more valuable than the market thinks they are. Because if the market thought that they were-- MICHAEL GREEN: Most teenagers as well. JOSH WOLFE: And by the way, the disposition are the same. MICHAEL GREEN: Very similar. JOSH WOLFE: They throw tantrums. MICHAEL GREEN: Absolutely. JOSH WOLFE: They seem like they're drunk. You don't know if you should trust them with money. The entrepreneur, if they felt fairly valued by the market, would go and just join a consulting firm-- a McKinsey. But they say, no, either because they were rejected, and they say, no, I'm going to go do it myself. And so to do something entrepreneurial, in a sense, is to have an overestimation of the thing that you know or think you know that the rest of the world doesn't. Now 90% roughly, let's just say, failure means that 10% of those people are actually right or lucky. And maybe some of them are right and unlucky. So that's the next asymmetry-- the entrepreneur who thinks that they know something or maybe does, in fact, know something the rest of the world doesn't. Then the next stage is the investor. So now, we come along and we meet the engineer or the Fred Moll. And we think, OK, wait a second. We're early here. We've got something that nobody else knows. And so we jump on that. And that's really, it is the same phenomenon as the teenager who is discovering the band that nobody else knows about yet-- the book, or the movie, or the artist that is going to impart on them social currency because they have discovered the thing that everybody else is going to celebrate later. There's no difference. So for us, it isn't an Excel spreadsheet. It's not a model. It's like based on the market, and the understanding we have, and the marketability of this entrepreneur, and their ability to raise money, and recruit people and convince them to part with their jobs and move across the country and join them. Do we think that these guys and girls are going to be really valuable? It's a total qualitative psychological judgment. So now, we're in the first few board meetings. And we know everything that's going on in the company, or let's say, 80% of what's going on in the company. And if you have a good relationship with the CEO, you know a lot more. And if you don't, then they hide things from you. But now, a new investor comes in. And so, let's say, we've invested in this case, like in Auris a $20 million pre, and then Peter Thiel comes in at 80 or whatever it is. Does Peter know more than we do? Now, maybe he knows something about the market that we don't know or maybe he has an unfair access to be able to make introductions that are going to create value by reducing risk. But there's very improbable chance that a new investor knows more about what is happening in the company than an existing investor. So now, we have asymmetry of information. And so it's very different than public markets where you might have different preferences in time, or liquidity, or expected return. The information asymmetry starting from that scientist to the entrepreneur to the first founders to the funders to the later funders is just enormous. Over time, I think it starts to reduce. And then ultimately, you're going to the public markets. And the public markets are saying, well, we demand to be able to look at the books, and understand, and how this compares to comps, and how it's going to be valued, and what our estimation is of how other public market investors are going to value it. And then you start to get more and more scrutiny. And scrutiny, I think ultimately creates liquidity and it creates markets because you have more information. So that information asymmetry is, I think, where most of the returns on venture come from, and being able to identify people early, develop a reputation so that you can attract the next entrepreneur who believes that they might be like your last entrepreneur, and have a reputation for being a good actor with other investors, and not being zero-sum-- knowing that this is a long game. And otherwise, I think it's an asset class that, frustratingly for us as insiders and definitively for outsiders, is really dominated by luck. MICHAEL GREEN: Well, you know, Michael Mauboussin-- who we both are close with-- has the classy expression, is it luck or is it skill? If you can lose money intentionally, then it's skill. JOSH WOLFE: Can you fail on purpose? MICHAEL GREEN: Can you fail on purpose? I would argue empirically, you can do that within venture. So I'm going to take away some of your luckiness and replace it with skill. JOSH WOLFE: Wait, wait. If I tried to bet that a person was a fraud, I might still-- so I'm intentionally trying to fail-- I might have identified very early on that Elizabeth Holmes from Theranos was a total fraud. And I would say, OK, guys, watch this. We're going to lose some money. And I put money with her. I might have gotten very unlucky in the attempt to do that because there were all a lot more suckers that actually believed it was real. MICHAEL GREEN: I think you're being too self-deprecating, but I understand your point. And certainly in this environment, exactly as we're describing, if you're in the process of changing the distribution of outcomes, you can absolutely confuse skill for luck. And there will be people who carry that. I mean, you talk about investing in search. One of the things I think is often underappreciated within search or the emergence of Google is their luck in buying DoubleClick. Had they not had that integrated advertising platform, you would have had people out there trying to sell ads in the exact same way that they did for Yahoo and other display banners. And it's not at all clear that the game would have played out the way it did. JOSH WOLFE: Now post facto, I've constructed a narrative as it relates to Google that has informed some of our other investments, which is thinking in a market sense like about abundance and scarcity. What became abundant as Google was rising? It was the presence of a ton of information being produced online. And you had the rise of blogs and web pages. And it just like the abundance of information was abundant. What was scarce was being able to search through it. So we talked about this in the form of technology, be it from game controllers, or the gamers themselves, or components like 3D cameras. When you can identify a technology, or component, or a market phenomenon where there is abundance, then if you turn your turrets to look at what is scarce, it's not going to definitively lead you, but I think it increases the probability that you're going to find something interesting. So today, we look at this and say, OK, with the abundance of information again, we feel like there is a scarcity of veracity-- of being able to tell what's real or not. And that's not just for fake news. That's is the image that I'm looking at a real image or not? Is the video that I just watched a real video? Is the object that I'm looking at a simulacrum or reality? And I think that there are going to be companies that rise to basically solve that problem for people when they encounter negative events from having made a mistake. MICHAEL GREEN: Well, you see this online on a continuous basis, where information comes out. It's presented in a certain way. The reaction function from a subset of the population is with extraordinary certainty, about what this indicates. And then we discover that it's edited video or that we didn't get the full picture. Some fraction of the population retracts their view. Some fraction of the population insists that this is true in the broader sense, but not true in the specific sense. JOSH WOLFE: And by the way, some portion of the population-- probably the majority-- doesn't even know because the information cascade has taken off, that there is a debate about whether the information is true or false. And so in markets, it's the same thing. MICHAEL GREEN: Well, in markets, I think you actually have-- and you mentioned the dynamic of public versus private markets. Ben Hunt has been on my mind a lot with Epsilon Theory. He's been talking about the dynamic of information as alpha, full stop. I think it's a little bit of a simplification, but I think that there is some truth associated with the broader observation. In the public markets, information by and large has become explicitly illegal. Reg FD made it impossible for management to disclose to even sizable investors, information that hadn't been disclosed to everyone else. JOSH WOLFE: If not regulated away, then competed away. MICHAEL GREEN: And so I think that's actually, to me, that's the most interesting dynamic about what's happening in the public markets is that the information is actually increasingly becoming a disadvantage. This can be seen in things like the volatility of individual securities around fundamental information events. So much of the focus in the public markets is around things like can I predict earnings? Can I access all the credit card data so that I know exactly what's going to happen? And the challenge is that you are a possessor of fundamental information, trading against individuals who, for the most part, you're uncertain about their information. And so there's an element to the game of, do I know what you think you know, sort of thing. And then there's a second component, which is, is the dominant flow players with information or with an entirely different modus operandi? JOSH WOLFE: Now, I know you have views about the structure of the markets, say, today versus 5 years, or 7, or 10 years ago. MICHAEL GREEN: Yes. JOSH WOLFE: And so how does that play into it? More passive players today-- what's the implication for the value of information on an individual security? MICHAEL GREEN: So information, as I think about it, is ultimately an event that creates volatility, all right? The reason we as public investors or you as private investors gather information is not for the beauty and the joy of having information, but because it prepares us to actually provide liquidity. So if an earnings beat occurs or if an earnings miss occurs, it's incumbent upon me to immediately internalize that information and decide, am I going to become a willing provider of liquidity or am I going to become somebody who demands liquidity? Am I going to buy the stock or am I going to sell the stock? JOSH WOLFE: Now, something that Mauboussin has also, I think, noted really well is that gap between fundamentals and expectations. And most of the information change in the volatility isn't really an adjustment of what people's prior assessment of what fundamentals were and their expectations suddenly meeting new facts and information about what fundamentals actually are. MICHAEL GREEN: So I think that there's an additional layer on top of that, which is again, the expectations game can only be played by people who value information and expectations. There is nobody at Vanguard who cares what Apple's earnings were. Literally, nobody in the room. So the single largest holder-- the majority provider of liquidity on a day-to-day basis for Apple in the event of an information event-- Apple reports earnings-- disappears. They don't exist. They cease to exist. They neither provide liquidity or demand liquidity. Potentially based on totally extraneous dynamics-- what is the flow coming into and out of various Vanguard funds, or BlackRock funds, or State Street funds, not to pick on Vanguard-- they could behave in a manner that is completely contrary to the underlying information. As they become larger and larger players, the impact of their lack of concern of information and response strictly to a flow dynamic radically changes the structure of the market and the behavior. And so what we've seen is despite the fact that we've had among the most robust earnings periods in history, stocks have become incredible-- individual securities are becoming dramatically more volatile around the fundamental information events. JOSH WOLFE: So what changes that? MICHAEL GREEN: I mean, the quick answer is I don't know. My concern is that the behavior is being driven by these flow dynamics and that these flow dynamics, because of the regulatory structure in a variety of ways, continues to drive that. I think it's one of the reasons why people are creating a story for themselves around a desire not to IPO. I don't want to be a publicly-traded company. Of course you want to be a publicly-traded company because that provides liquidity for your investors. That's optionality. What you're actually saying is, I'm not sure I can convince Vanguard to buy enough of my shares to support the price that is currently embedded in the private markets. Because within the public markets, particularly when you think about passive investing being driven by things like index inclusion, how do I get into the S&P 500? That's an entirely different investment criteria than is this the most fascinating and wonderful thing ever? JOSH WOLFE: What's interesting too is private market prices in some ways are eclipsing the historic relationship, as I understand it, in public markets. Where in public markets, you would pay a premium, in the private markets, you would demand a discount because of liquidity. In public markets, you were paying really two prices-- the price of what you actually value the fundamental security at based on the future cash flows that were being discounted and the right to sell it. In the private markets, you have no such right to sell it. It's very hard, if not impossible sometimes. MICHAEL GREEN: 100%. I mean, this is what underpins David Swensen's original analysis of the advantage that a long-dated endowment has-- the endowment-type model for investing in vehicles that you can extract a liquidity premium for. JOSH WOLFE: It's interesting. I'm almost imagining an event horizon where people had the longer-term view, and it got shorter and shorter as you had more competition. And then so you're focused on the annual event, and then you're focused on the quarterly, and then you're focused on information to understand what weekly or daily sales are or the hourly sales. And as you come closer, and closer, and closer to the present, information paradoxically becomes less valuable, as you said. MICHAEL GREEN: I think that's actually the world that we inhabit. And again, it's one of these things where this is a forecast. And the process of moving there feels very much like progress. The market gets more efficient. The returns are becoming more stable and more predictable or they're becoming better. And really what's actually happening in my analysis is money is flowing into Vanguard. Vanguard, while we typically think of algorithms as super complex and built around machine learning and all sorts of stuff, actually has the world's simplest algorithm. Did you give me cash. If so, then buy. Did you ask for cash? If so, then sell. JOSH WOLFE: So this may be the answer of what causes the breakdown because on the upside, it doesn't matter. I see good news. I see bad news. I can come up with a story. But if I know that a company is actually doing well, fundamentals are good, but the flows are bad, suddenly people will say, wait a second. There's this breakdown in this relationship. There's no reason that this company should be below the historic values of this and that. Now, the question is what causes the flows to suddenly reverse, and for massive amounts of inflows into equity to reverse and go into debt or something else? But it seems to me like today, flows trump fundamentals. MICHAEL GREEN: I think that's correct. JOSH WOLFE: And when outflows trump fundamentals, then people will suddenly say, wait a second. Active investors make more sense than passive because clearly you can look at this, and observably discern that this is a quality company-- that Apple, let's say, is not going to be worth $100 billion. There's massive outflows and it's just structural. It seems like it will invite an analysis and reinvention of market structure. MICHAEL GREEN: So well, you can actually think about it-- and this is a lot of the work that I'm doing currently. The way my industry is managed is on the term alpha. And alpha is literally just the simplistic solution to a linear equation, y equals mx plus b, where it's the intercept. The issue is if passive penetration is influencing the return-- i.e. if it's a multi-variable equation and you failed to disclose the component of the return that's associated with m2, x2-- you create curvature in space. And inflows would drive a positive curvature to space. The linear solution to a positively-curved space is negative alpha-- a negative intercept. And that's what's actually happening, I think, in our industry-- that we've completely misdiagnosed the dynamic. We think that there is an excess of active managers and that they're overcompeting away the opportunities. I would actually suggest that what we're about to find out is that the penetration of passive drives the solution set for alpha by active managers negative. And when it reverses, as you're describing, that convexity flips. Suddenly, the alpha becomes extraordinary. JOSH WOLFE: I'm visually imagining a bunch of surfers at sea, and they can actually [INAUDIBLE] and move the waves. But suddenly, the wave becomes so big that their individual movements have no impact. MICHAEL GREEN: That's 100% correct. And so we see this if we actually-- I've built simulations of some of this stuff. And I want to focus on you in a second, but this is exactly what's happening. The wave is becoming so big that it's swamping any of the individual actions. JOSH WOLFE: Now, the relevance for me is in the absence of the buyers, who provides liquidity for us? Now in the case, you know, we're talking about Auris, J&J was a motivated buyer. They're motivated to compete with Intuitive Surgical. You've got a news cycle about talcum powder. And so you can identify post facto reasons. What would be the drivers of this? Because I'd love to believe it's just because robotic surgery is amazing and Auris is the most incredible company in the world, but there are other things in work. And if we can identify that, we might be able to skew our odds across many of our private companies. Who is the natural buyer here? But it isn't always obvious to us. MICHAEL GREEN: I think that's actually going to be the crux of the situation. I think you're hitting on possibly the most important question that comes out of venture. And so far in the presence of that wave of liquidity that's coming from SoftBank and others, the answer is, well, why would we need to? JOSH WOLFE: Well, and to be clear, it isn't necessarily a wave of liquidity coming from SoftBank. It's a wave of marginal pricings. MICHAEL GREEN: Yep. JOSH WOLFE: Because unless you're getting liquidity, my view is you're getting zombie shares. You're getting a nice paper mark. And many people will use that paper mark to actually make then irresponsible decisions, which is, in a sense, that illiquidity is almost like leverage. Because if you have a ton of money in your private portfolio as an endowment, and you're like, hey, we're doing pretty well on the private equity side-- I mean, we've got all these great marks-- and then you either allocate more to it or you overallocate to another sector. And then all of a sudden, you know, that billion dollar mark goes down not again to $800 million, but to 0. It's the equivalent of having like a 20% turn in something that is levered 4x or 5x. MICHAEL GREEN: I think that's exactly the right analogy because what you're effectively doing is-- and I misspoke when I used the term liquidity-- if I keep pricing it higher, you're right back to this underlying dynamic of a structured product with a waterfall structure. And you're pushing yourself further and further out the equity spectrum. Some would argue this is central bank-driven. I'm less convinced of that, by the way. But you have created this underlying dynamic where you're being pushed out, right? And what I would suggest to most venture players, public markets are not there for you. So you need to figure out who's the Johnson & Johnson. And perversely, you can't have Johnson & Johnson buy you. You can't have General Motors buy Tesla or Toyota buy Tesla when the valuations get pushed to the levels that they're getting pushed. Can anyone show up and buy Uber? It's highly unlikely. The only buyer is Vanguard and they don't care. It doesn't exist. JOSH WOLFE: That's a great point. MICHAEL GREEN: The company doesn't exist. JOSH WOLFE: That's a great point. MICHAEL GREEN: What changes if this dire forecast emerges? JOSH WOLFE: Well, I think we're going see whether the sophisticated things that you were talking about in the structure of markets and the nature of liquidity in the public markets, which historically have accounted for a significant, if not the majority of venture exits. I think we're just in a natural cycle. I think overinvestment will lead to underinvestment. How does that happen? LPs look at the denominator effect and how much money that they've put out. They say, wait a second. I've got all these paper marks. I don't have realizations. I don't have liquidity. So I would love to invest in your next fund, which by the way, the measure of when you know that the people who know the information asymmetry-- the GPs-- are raising money at faster and faster rates. Why? Because they know that the party is going to end. And this is the same thing as like Chuck Prince-- or was it Chuck Prince back in the day? MICHAEL GREEN: While the music is playing, you got to dance. JOSH WOLFE: Yeah, it's the same thing. There's somebody else who's going to say it in venture and they'll be quoted for it. It's not going to be me. But people are raising funds at ever faster rates before the punchbowl gets taken away. And in some cases, they're raising the money and saying, look, we're actually not going to invest this for the next 6 months or a year because we're still investing out of our last fund. But the FOMO-- the Fear Of Missing Out-- is still there from limited partners and endowments. We go in because we're intellectually honest and we think it enhances our credibility-- when we say, LPs, they say what should we be doing? We say, you should be investing in secondary funds because the shit is going to hit the fan and a lot of people are going to lose money. So sit out the ride because people en masse will go from FOMO-- Fear Of Missing Out-- to shame of being suckered. Now, anybody that was in Theranos and some of these other frauds has shame of being suckered, but it's going to start to trickle into the actual returns. You'll be like, oh, my god, we're overallocated into venture. And I think that the sophisticated LPs will start to pull back from the asset class. And when you see some of the recent visitors-- the tourists that have come in-- corporates are always a countercyclical indicator for where we are in the peak of venture. 5 years ago, there was very little venture activity from corporates. What happens? Somebody is in a board and they say, well, why didn't we see that or our peers are doing that? And all of a sudden, they ramp up a venture program. Now Intel has Intel Capital. They're very active. But every other corporate that you can name starts a little venture unit. And they open up a 3 or 4-person office in Palo Alto, and it's their innovation lab and their innovation unit. And that starts to escalate. Corporates are almost always seen as the dumb money in the cycle. And I think you're seeing peak corporate venture activity. So that's one sign. The second sign are the crossover funds. They're looking for the big growth. And if you're not getting in on the public markets-- and these are guys that historically were really smart on the long and short side-- and you talked to John Griffin and other really smart guys, most of the money that they made was significant market outperformance was from the short side. And it's really hard in an up market where you've got this Vanguard algorithm, or where it's just basically money comes in and buy, to be killing it on the short side. So they start looking and saying, well, wait a second. We can get, you know, 2x, 3x returns, which for us would be paltry. On an individual company, we need to make 10x because a 1/3 of our companies are going to be 0's, a 1/3 we make our money back, a 1/3 we get 10x. We end up with a 3x cash-on-cash fund. For them, 2x is amazing. So they can invest in something at $3 billion and sell it for $6 billion, and that's a killer home run. But I think that they will start to say, well, wait a second. If the corporates retract, and you don't have the public markets to sell to, and there aren't 50 J&Js buying companies, then they're going to start to retrench. And if they retrench, then the growth equity guys say, well, who are we going to sell to? And if the growth equity guys start to retrench, then we start to say, well, who are we going to sell to? And you start to have that same cycle on the downside. Now what the catalyst is and when, my bet would be it would be a colossal poster child failure, whether it was from somebody like SoftBank or somebody like Tesla, where everybody hails them as the inventor of the future, you have, in my view, insane valuations, and there is a liquidity crunch at one or both of those companies that has people scratching their heads and saying, wait, what do you mean? How do they not have money? What happened? And then it just becomes this downward spiral. MICHAEL GREEN: I'm super sympathetic to that articulation. And I think we're likely to find that the irony is, as you're also describing, that pulling-back process raises the probability of that outcome because all of these companies, or almost all of these companies-- a disproportionate fraction thereof-- don't generate their own internal funds. There's a limited number, I believe-- like Airbnb is profitable and a few others that are profitable and capable of self-sustaining because of their business model, as Google was, as Facebook was when they went public. JOSH WOLFE: By and large, they depend on the benevolence of strangers. They depend on capital markets of some form and the provision of capital. And the provision of capital is dependent upon expectations. And as long as they can show growth expectations, then people will provide capital. You're starting to see growth expectations come in from some of the big tech guys-- Facebook, and Google, and others. And I think that that may also be one of the things that starts to set the downward spiral. MICHAEL GREEN: Well, there's a feedback loop as well, right? I mean, most of the numbers that I've seen suggest that somewhere around 50% of Google's search revenue is being generated by venture capital-funded entities. JOSH WOLFE: I almost had a heart attack looking at the amount of aggregate spend from our portfolio on AWS, which for Amazon is an amazing thing. You call this right. I mean, I identified early that Nvidia was going to be this, you know, soul of the new machine for AI and machine learning. And that went from an underappreciated story to a massively overbought story. And fundamentals and expectations were totally detached. And you were one of the few people early that said, you know, one of the key drivers of this is-- MICHAEL GREEN: Crypto. JOSH WOLFE: --the cryptomining. And like, this is going to abate, and then all of a sudden, it's going to hit the fan and it did. And I think it's going to be the same thing here on the growth story on a lot of tech companies, where people say, well, the source of their growth came from these startups, and the source of the startup's capital came from expectations from these new players. And when that disappears, the dominoes fall. MICHAEL GREEN: So let me ask you one other quick question because you and I both spend a tremendous amount of time getting into exclusive nightclubs. My understanding is that when you try to pitch that to investors, we're trying to stay sober. We're not going to use this money. Please don't invest. Do they listen or do they say, no, please take our money? JOSH WOLFE: I think we've been-- well, look. It's scarcity and perception. And I think it was Kierkegaard, one of the philosophers who said, we pursue that which retreats from us. It's true in love. It's true in business. It's true in entrepreneurs. When an entrepreneur turns us down, I mean, my god, I didn't sleep for three nights. My wife, Lauren, you know, she was going crazy because of this company Control Labs doing brain-machine interfaces because the founder-- this PhD genius-- was rebuffing me. To be rejected makes you want something more. And so I think one of the few exceptionally smart people in venture, who I really respect-- and he comes from a capital markets perspective, very close also with Mauboussin-- is Bill Gurley. And Bill says that one of the biggest mistakes that he made 20 years ago during the boom was that they raised like a near billion-dollar fund, and they ended up giving it back. But I think he's got the ethics, and the integrity, and the team structure, which is super rare. Everybody is an equal partner at their partnership. Most places are hierarchies. You're in the fund or you're not. And if you're in the fund, it's all for one and one for all. They've been going to LPs and saying, stop. The more money you put in, the higher the price is. The higher your price is, the lower your expected returns. Stop. If you want this to be a good asset class, just pull back. Well, the smart ones will pull back, but the new ones say, well, we want to get some of that too. And so in aggregate, you have all of these endowments and LPs that are new to asset class coming in. And he has been trying to talk money out using fear. And fear has had the opposite response. It's got social proof. Everybody wants to do it. Sequoia went and raised $8, $10, $12 billion. And you could argue that they're appealing to greed and saying, look, if the money is out there, you know, it's better that it go to us than to go to 10 of our competitors. And so especially if we have to control the fate of our own companies and not let them be beholden to SoftBank, on both ends of this, fear and greed are sort of fighting for the soul of the LP. And right now, greed is winning. MICHAEL GREEN: Yeah, it definitely feels that way. I mean, I'm seeing that. I just had a discussion with somebody about this dynamic within credit markets, where the current pitch to raise funds and credit is things are so bad that we want to be positioned for the other side of this. And inevitably, like if you hear this, your immediate reaction is like, well, wait a second. We've got existing investments in credit, but things are so bad. We should probably pull back, right? And the exact opposite reaction. These guys are so sober. They can see all the problems ahead and we want them to be positioned for it. JOSH WOLFE: Now, we've been lucky over the years. We've gotten more sophisticated investors. The number of LPs has shrunk. It's 10-year locked. You're in this for the long term. And reputationally, it's the game theory. You want to do right by people because you're going to have down years and you're going to have up years. There are things that we did in the past that we won't point to and say, yeah, we're going to do that again. We did Kurion-- nuclear waste. 43 times our early money. I never want to touch nuclear waste again. People send me deals for nuclear waste all the time. We did it. We made our money. You know, I have my battle scars. Robotic surgery-- we got like 20 companies now pitching us because also on our early money, 60 something times. We might not touch robotic surgery again for 2 or 3 years or more. And so I think it requires a lot of intellectual honesty and discipline, which I think itself is a currency that you can gain with limited partners. MICHAEL GREEN: Well, it's one of the many reasons why people love to listen to you so much. And I say this with all sincerity. I mean, you're brilliant and you're intellectually honest about a lot of this stuff. JOSH WOLFE: Mostly because I grew up in an area where I hated being conned and bullshitted, so I can smell it. MICHAEL GREEN: Brighton Beach can do that to you. The vast majority of people inhabit a very different space, which is I've demonstrated expertise in this one area, therefore I'm going to stick to that expertise. I think you and I both have a little bit of a feeling that we get bored very easily with doing the same thing twice. JOSH WOLFE: I would say we're just insatiably curious. Yeah. MICHAEL GREEN: Yeah. With that observation, I love that we're able to bring you back and talk about the success of Auris, having heard you talk about it two years ago when you first came on. Can I get you to come back again and we'll talk about the next big win or how the industry plays out, and maybe how that's creating some challenges in the next 6 to 12 months? JOSH WOLFE: 100%. I would love to. MICHAEL GREEN: Fantastic. JOSH WOLFE: Great to be with you, Mike. MICHAEL GREEN: Josh, thank you.