Models for Entrepreneurs and Venture Investors

In 2023 we observed the passing of a generation of leaders, including former U.S. Secretary of State Henry Kissinger; U.S. First Lady Rosalynn Carter; Chinese Premier Li Keqiang; Italian Premier Silvio Berlusconi; U.S. Supreme Court Justice Sandra Day O’Connor; and U.S. Senator Diana Feinstein.

?

The investment world mourns the departure of Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway for over sixty years. Over 40,000 shareholders congregate in Omaha, Nebraska to hear from Warren and Charlie at Berkshire Hathaway’s annual meeting, also known as “Woodstock for Capitalists.”

?

Munger’s distinct investment style has drawn much attention. Munger used a “latticework of mental models,” a collection of frameworks, paradigms or concepts drawn from psychology, physics, economics, chemistry and accounting to assist in investment decisions. While there are thousands of models – the fifth edition of Wiley’s The Portable MBA summarizing business frameworks has ballooned to over 700 pages – Munger claims “80 or 90 important models carry about 90 percent of the freight.”

?

Models are representations of the physical world in a specific context. Models are essential in many disciplines to convey a theory or worldview. It is a useful way to package and distribute knowledge. Models are context specific. When used judiciously and in context, models are a source of illumination. Models are indispensable when used well as they may capture the most relevant aspect of reality in a given context. But when used inappropriately, they may confuse or obfuscation a matter. Math gives models clarity and consistency.[i]

?

Munger spoke frequently about models but was reticent on his process and preferred frameworks. Across his talks collected in Poor Charlie’s Almanac, Munger discusses 25 psychological ‘tendencies’ and mentions 25 other concepts in passing, a sample of which are listed in Table 1. When pressed for a fuller elaboration, he responded, “if you figure it out and do the outlining yourself, the ideas will stick better than if you memorize them using somebody else’s cram list.” His response was appropriate as models are context specific. The models that Munger used for investments at Berkshire Hathaway would overlap partially with those appropriate for startups and venture investing. ?

?

Table 1: Mental Models Mentioned by Munger in Poor Charlie’s Almanac

?Yet surely entrepreneurs and investors would benefit by having a repository of models with contextual discussions to guide decisions and increase the likelihood of success. Munger acknowledged his own late epiphany in his self-reflection: “We are too soon old and too late smart.”? Jack London the tradeoff between youth and wisdom poignantly through the lens of a boxing veteran: “The thought came to him that the sum of his wisdom and Sandel’s youth would constitute a world’s champion heavyweight. But that was the trouble. Sandel would never become a world champion. He lacked the wisdom, and the only way for him to get it was to buy it with youth; and when wisdom was his, youth would have been spent in buying it.”[ii]?

?

Though reluctant to elaborate his system, Munger encouraged others to do so and offered to fund a cross disciplinary course called Remedial Worldly Wisdom assimilating useful mental models. A cottage industry has emerged proffering compendia of mental models. James Clear and Shane Parrish have compiled mental models that inform life decisions. Books offering frameworks and guidance to improve decision making include Thinking, Fast and Slow by Daniel Kahneman; Metaphors We Live By with George Lakoff and Mark Johnson; Predictably Irrational by Dan Arielly; Clear Thinking by Shane Parrish; The Art of Thinking Clearly by Rolf Dobelli; and Seeking Wisdom by Peter Bevelin.

?

Munger offered encouragement for those who accept his challenge. Referring to Valiant-for-Trust in Pilgrim’s Progress, Munger offered “My sword I leave to him who can wield it.” He recommended starting with Influence: The Psychology of Persuasion by Robert Cialdini. Beyond this he repeatedly reinforced four points in his various talks.

?

First, “invert, always invert.” By inversion, Munger encourages one to always consider counterfactuals as a reasoning method. One example of inversion is his famous quip: “All I want to know is where I’m going to die so I’ll never go there.” From this quip has emerged premortems, the practice of imagining what could lead to failure to test the merits of a decision and inform strategy if one decides to move forward. Munger followed his own advice well and lived to the age of 99.

?

Second, Munger often quipped “if you would persuade, appeal to interest, not to reason.” Appeals to reason alone rarely suffice as Kahneman and Arielly have established that humans are predictably irrational. Buffett advises us to invest as though one would make only ten lifetime investments, yet traders avoid the asceticism of inaction and trade frenetically. Effective leaders align interests to promote desired performance.

?

Third, Munger used checklists to ensure he had considered each relevant mental models when making decisions. The airline industry significantly improved safety standards after adopting pre-flight checklists in the 1980s. Checklists have improved safety and performance in healthcare, construction, manufacturing, project management and emergency services. Investors would be well advised to include checklists in their investment memos. ??

?

Fourth, beware of the ‘lollapalooza effect.’ Equivalent to the Butterfly Effect in chaos theory, lollapaloozas refer to the magnified impact when two or more forces operate in the same direction. Lollapalooza effects are green investment flags when they align positively and red flags when they signal compounded investment risk. Munger “repeats for emphasis” the value of checklists to help identify these “combinatorial effects that create lollapalooza consequences.” ?

?

Over the last five years at NGP Capital, we have collected and developed a set of frameworks that we consider relevant to entrepreneurs and our investment practice. Munger’s list of tendencies and biases apply well to any investor and most apply to entrepreneurs. Yet many concepts apply specifically to innovation, entrepreneurship and venture investing.

?

In the coming months, I will share a few of these models. We trust entrepreneurs and venture investors will find these frameworks useful. I would welcome your comments on these models plus others that have been useful to you. ?

?

[i] Dani Rodrik, Economic Rules

[ii] Jack London, A Piece of Steak