The Framework for Business Value Creation | David Friedberg on 20VC Podcast with Harry Stebbings

Key Takeaways

  • Tech competitors are re-inventing the operational model of traditional businesses (for virtually every industry)
    • “It doesn’t mean that technology businesses today are fundamentally flawed, rather it’s a resetting of the time horizon and the value creation cycle.” – David Friedberg
  • The velocity of capital deployment – an interesting dynamic that is playing out right now
    • In 20 years decarbonization is going to happen, the software is going to reinvent the world, life sciences are going to reinvent manufacturing, etc.
    • It makes sense to deploy as much capital as you can to accelerate the process
  • “Every business should raise as much capital as they possibly can, provided it meets their dilution or ownership criteria.”David Friedberg
    • However, you can’t consistently skip the value creation process with just capital
  • The Production Board (TPB’s) structure is unusual; it’s a permanent capital vehicle (PCV)
    • They usually do not start businesses with entrepreneurs, but mostly with scientists, academics, and engineers that work on emerging technologies
  • “This isn’t like a VC where you give founder a bunch of money and you hope he does well with it or pivots away onto something else.” – David Friedberg
    • At TPB, they are very actively managing and working closely with the team to make sure the business succeeds
  • How does TPB capitalize its business?
    • They typically own the majority of equity when they start and reserve the rest for the team
    • Funding is done on a continuous convertible note cycle so they keep putting money and eventually get the money back once the company raises a big outside round
  • The incentive to always raise more capital and make more fees is the biggest flaw of the venture model
  • A lot of people are caught up in the “Joneses cycle”: when people care about their standard of living in relation to their peers
    • It’s a hard thing to break free off, but it’s worth being aware of when framing your life
  • In our “hungry” youths, we forget about being selfless
    • Parenting helps you connect with others and squash your ego

Key Books Mentioned

Intro

  • David Friedberg (@Friedberg) is a billionaire entrepreneur who wants to save the planet!
  • He is the founder & CEO of The Production Board (TPB) and chairman & co-founder at Metromile
    • In this episode of the 20VC podcast, David Friedberg talks about impending rate hikes, frameworks for business value creation, TPB’s structure and approach to building and funding new companies, and how parenting changed his life
  • Host: Harry Stebbings (@HarryStebbings)

Transition to the World of Startups

  • David studied astrophysics at EC Berklee
    • Working in a government lab getting bored to death doing mathematical models
    • Meanwhile, kids in his dorm were making millions of dollars building .com startups
  • For David, the world of tech was the place to be if you want to make the world a better place
    • After graduating in 2001, he got a job in technology investment banking (probably because he was good at poker because he knew nothing about finance and business)
    • Technology IB was an interesting introduction into the world of business before going to the greatest economic engine of all time- Google
    • You learn and then try to build things yourself, and realize there are “… a million roads to success and a million and one road to failure.”David Friedberg
  • He left Google at the end of 2006 to start his own company The Climate Corporation

How Does David Foresee the Impending Rate Hikes?

  • Historically, technology companies sold technology to other businesses
    • Nowadays, technology companies are rewriting how businesses operate
    • Tech competitors are re-inventing the operational model of traditional businesses (for virtually every industry)
  • How far into the future are you willing to look?
    • When interest rates are low, you are forced to look 10-15 years ahead to make a return because you are only making 1% on bonds for the next 10 years
    • When interest rates go up, you can make 4% and invest in bonds for the following 5 years
    • Why look past 5 years to see if you can make a return?
    • This is what caused a lot of the inflation and pricing
  • “It doesn’t mean that technology businesses today are fundamentally flawed, rather it’s a resetting of the time horizon and the value creation cycle.”David Friedberg
    • The result is that valuations come down in public markets first
    • David thinks it’s ironic that valuations came down in early-stage second and later stage third
  • Why later stage third?
    • Because a lot of venture capitalists have greatly marked up their investments and books of private companies over the last couple of years with later stage rounds and they don’t want to take a write-down
    • They are more willing to pump more money into companies they already invested in
    • Keep the valuation up, make sure the books look good and raise their next fund
  • “We’ve seen this over and over again just in the last few months as companies that have tried to go public via SPAC have failed, then they’ve come back to the private market and raised money at the same or higher valuation than the SPAC price from their own investors.”David Friedberg
    • The later stage valuation sticks for a while, and then it tapers off
    • Early-stage valuations are very easy and quick to adjust

Timeline of Deployment Cycles

  • The velocity of capital deployment – an interesting dynamic that is playing out right now
    • David believes Marc Andreessen was among the first pioneers of this aggressive fundraising mentality
    • Take more money than you need, go aggressive, go big, “grab” the market
    • Then SoftBank took it to a whole other level, and now there is an entire line of firms that share the same mentality (e.g. Tiger Global, Altimeter, etc.)
  • Technology businesses will continue to disrupt the traditional business model 
    • In 20 years decarbonization is going to happen, the software is going to reinvent the world, life sciences are going to reinvent manufacturing, etc.
    • It makes sense for many of these companies to deploy as much capital as they can to accelerate the process
    • “For many of these funds, it became about how much money they got out the door instead of how much they own, or the valuation and entry points.”David Friedberg
    • Rather than being selective about playing the market, they make the market

David’s Rubric for Business Value Creation

  • Can too much cash too soon change the plans of otherwise could be good companies?
    • “Every business should raise as much capital as they possibly can, provided it meets their dilution or ownership criteria.”David Friedberg
    • However, you can’t consistently skip the value creation process with just capital
  • David’s fundamental rubric for business value creation:
    • Technical competency: can you make a product?
    • Product/market fit: do customers want your product?
    • Can you make a positive gross margin selling your product?
    • Can you deploy a marketing budget to acquire customers in a positive way?
    • Can you actually increase your unit economics as you scale? (This step often gets distorted)
    • Can you become a platform; multiple products, bringing partners so you get true leverage out of the network you built between customers and suppliers
  • Those steps really do define value creation
    • The problem is thinking that you can get to the next step of value creation with capital and it’s not necessarily true
    • You get stuck between steps and create negative value for the business by putting too much capital too fast
  • At the end of the day, the deployment of that capital within a business should be phased based on a recognition of are you stepping up the value before assuming you are going to get there by scale

How Does David Reflect on His Own Price Sensitivity?

  • David did pass on some companies because of their price
  • If you believe in the team, the market, and the technical competency, there is no reason to pass
  • Let the market set the price, and you determine if the business is good or not
  • “We are not price makers, we are prices takers.”David Friedberg quoting David Sacks

How Does TPB’s Structure Differ From a Traditional Fund?

  • Harry believes TPB’s structure is unusual; it’s a permanent capital vehicle (PCV)
  • David says they are a lot like a company
    • They have a balance sheet, raised some money from investors, have shareholders, etc.
    • Unlike a fund, it’s not just committed capital, they actually take money, put it in a checking account, hold it there and they can do whatever they want
    • They run R&D cycles, start businesses, occasionally make minority investments
    • Their capital is very flexible and is primarily used for building and operating business with them as majority owners
  • Why did David opt for this model?
    • He wanted to be more aligned with his shareholder and own more of the business without making a 20-30% carry
    • He also wanted to be the majority owner of his holding company and the central driving force of value creation
  • The opportunities for building new businesses in areas he is interested in are never-ending
    • Even if they sell a company, or go public, he likes to have an option to cycle that money and make a new business instead of giving it back to his shareholders

How Do David and the Team Approach Building New Companies at TPB? 

  • Food, agriculture, biomanufacturing, human health, and the broader life sciences are their key markets
    • “We are trying to identify scientific engineering breakthroughs that can be applied to the markets in non-obvious ways.”David Friedberg
  • They collaborate with scientists, academics, and engineers that work on emerging technologies
    • They read a lot of scientific papers and journal
    • If there is a scientific discovery relevant to the systems and markets they study, they will go and find the best scientists to figure out how to use the discovery to make a new business model
    • Usually, the scientists are then asked to run an R&D cycle with them and are offered a position like CSO, or CTO if they start the company
    • Sometimes they bring a CEO on day one, other times not even for 3 years. It depends on the build cycle
    • After R&D de-risks technology and the company makes its first product, they go and hire a CEO
    • Depending on the technical challenge of the business, the sequencing changes
  • They usually do not start businesses with entrepreneurs, only with scientists, engineers, researchers, etc. who are mission-oriented, deeply technical, and have a very strong interest in helping the world
    • The goal of TBS is to provide them with help and support

How Does TPB Approach Continuous Funding for the Companies They Create?

  • Proof of concept/prototype cycle
    • For each company, during the RND phase, they try to demonstrate a prototype (is this technically feasible?)
    • In technically difficult businesses (life sciences, synthetic biology, etc.) you need to prove that the science or the engineering works
    • During that phase, they are just funding it
  • Once they prove the science, they build a milestone and a budget plan
    • What’s it’s going to take to achieve certain goals, over what time, and how much money is it going to cost?
    • Their decisions are based on achieving certain stages
    • “This isn’t like a VC where you give founder a bunch of money and you hope he does well with it or pivots away onto something else.” – David Friedberg
    • They are very actively managing and working closely with the team to make sure the business succeeds
  • The way they capitalize businesses
    • They typically own the majority of equity when they start and reserve the rest for the team
    • Funding is done on a continuous convertible note cycle so they keep putting money and eventually get the money back once the company raises a big outside round
    • That way the team feels the pressure of additional capital coming in
    • “You don’t want a Google X situation where everyone makes $600,000 a year, eats in fancy cafeterias, drives their Tesla’s to work and chill out, and if the business doesn’t work they just hop onto the next project.” David Friedberg
  • David thinks it’s important that the team feels like it’s a business and if it works they are going to be successful
    • And if it doesn’t work, and as you take on more capital there is going to be more pain (debt)
  • They didn’t want to get into a situation where they indefinitely fund businesses for no additional equity and also deluding the team

How Does David Approach Liquidity With Regards to Exits for the Companies They Create? 

  • Exits are not their objective, it’s business value creation
    • At any point, if the business value creation rate diminishes they turn it into cash and reinvest it into another project
    • “As long as a business continues to compound value for you as a holder why would I want to liquidate the shares?” David Friedberg
    • If they are still compounding value with the business, they keep owning it and helping
    • As soon as the business stops and they have no good path to the outcome for growth they reinvest the capital

Core Flaws of the Venture Model Not a Lot of People Talk About 

  • “The capital under management incentive, the asset under management incentive is true for all asset management.” David Friedberg
    • It’s a natural incentive to want to raise more money and get juicy fees every year
    • As you raise more fees and expand the board, the quality of investments goes down significantly, as well as the quality of support
    • The way your time gets spent is diluted because you can’t sit on all those boards
  • The incentive to always raise more capital and make more fees is the biggest flaw he sees

How Does David Reflect on His Relationship with Money Today?

  • Desire – the fundamental driver of human psychology
    • Human happiness is defined by the relative change in one’s condition
    • The Happiness Hypothesis by Jonathan Haidt
      • Great analysis for those who wish to understand happiness
  • The notion of desire drives us to go and colonize the world, and eat and kill everything
  • Understanding where our species is headed, understanding science engineering, and the principles of the universe is his primary motivator
    • This is where David gets his great rewards, not from money
  • A lot of people are caught up in the “Joneses cycle”: when people care about their standard of living in relation to their peers
    • People are unhappy because others have done better than them
    • It’s a hard thing to break free off, but it’s worth being aware of when framing your life
  • “You are never going to find the reward just by constantly trying to climb the ladder.” David Friedberg

What’s Worrying David?

  • David doesn’t worry, he is very techno optimistic
    • He sees a myriad of solutions for most of the problems we face as a species today
    • We have the opportunity to resolve energy, carbon, human health, etc.
    • Many of these challenges are resolvable but the next few decades are going to be crucial
    • There are more social than technological issues to resolve (e.g. the right governing structure, what is the money going to be?)

How Did Having Children Change His Operating Mentality? 

  • In our “hungry” youths, we forget about being selfless
    • Parenting helps you connect with others and squash your ego
  • This mindset shift makes you less concerned with personal gain
    • You think more about contributing to other people and your planet
20VC with Harry Stebbings : , , , ,
Notes By Dario

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