Mike Maples Jr. on Inflection Theory and Breaking Patterns in European Venture

Well, hey, thanks for all the kind words and hopefully I'll have something to offer. I know it's a very European sort of audience here. Where did pattern breakers come from? It kind of came from an unsettling realization. So I was 10 years into doing seed investing and one day I noticed that something like 80 to 85% of my exit profits had come from pivots. I talk about this a little bit in the book pattern breakers but it's even worse than the book describes. So with Twitch, I had invested in Justin TV and about five years in they say, 'Great news, we've pivoted. We're two companies now. We're Social Cam and we're Twitch.' And I thought, okay, the reason they did that is nobody's going to want to watch people play video games, so Social Cam is the real company. And at the time, Viddy was a hot startup. So then Social Cam gets bought for 65 million. And I just forgot about Twitch. I wasn't a user. So one day I noticed that Amazon is thinking about buying Twitch for close to a billion dollars. And I'm like, man, is that Justin TV? And I reached out to Emmett Shear and said, 'Hey, just doing some clerical accounting work, just want to verify how many shares I've got. What do your numbers say?' So I didn't even have Twitch on my books. So you can imagine I'm talking to my LPs. I'm like, 'Okay, I got some good news, bad news. The good news is we just made 90 times our money on this investment in Twitch. The bad news is I haven't put it in any of my financial reports and I'm embarrassed and that's not how I like to do things. So if you need me to restate my financials, I can. We'll work something out.' And every single LP was like, 'Nope, we're good. Just send us the money. This is awesome.' People sent me champagne and stuff. But I came away from that thinking, just what business am I even in? Because that same week I'm helping a founder shut down a company that had done all the right stuff. They had defined their culture. They had used the business model canvas. They would have been a Harvard Business School case study except for the fact that they'd failed. And this may resonate with you and some of your listeners who invest in seed rounds, but this wasn't a one-off for me. I saw this happen all the time. And I saw most likely to succeed startups fail miserably or just go nowhere. And I saw the Twitter guys couldn't decide who the CEO was, couldn't keep the servers working, but it didn't matter because people wanted to tweet. There weren't any best practices that I could discern in the early days. So that was the genesis of the pattern breakers thinking. It was, okay, what's going on here? Or should I just retire because it's random and I'm going to get exposed? Or is there something happening below the surface that, yes, there's some chance for sure, but it's not all an accident? That led me on this kind of rabbit hole, multi-year quest to figure out what's going on here. And the ideas of pattern breakers are my attempt to answer those questions.

I think so. Here's how I would internalize it, Andreas. Startup capitalism is a fundamentally different kind of capitalism. Most people when they talk about capitalism, they talk about defensible moats and compounding advantages and all the Michael Porter's five forces, Hamilton Helmer's seven powers. And you realize that a startup has none of that stuff. They only have the founders and their ideas. So a startup doesn't win by doing any of those things. A startup wins by changing the subject. So a startup capitalist wins when they refuse the premise of the rules and impose a new heretical set of different rules and then get the world to agree with their idea, their heresy, and then move the future into a different direction. That's what it reminds me of in evolution. You look at the fossil record, the fossils look the same for a long time, then you have punctuated equilibrium, like a flood or an asteroid or something. The startup capitalist's job is to create punctuated equilibrium. It's to challenge the current frame and propose a new frame. So the ideas in pattern breakers then are how do you do that? How do you change the subject? How do you deny the premise of the rules? You start with inflections. An inflection is a change event that creates a new form of empowerment. The startup needs the inflection because we want to wage asymmetric warfare on the present. We're not interested in having a fair fight. We want to have an unfair fight that's to our advantage. And then the insight is, okay, so how does this inflection let me do something that's non-consensus and right? One company we invested in was back in the day. The inflection was the iPhone 4S had a GPS chip in it. You could have had the idea for ride sharing before that. It wouldn't have mattered because you couldn't have implemented ride sharing. But now all of a sudden there was a window of opportunity where for the first time you could implement ride sharing, but you had to have an insight. You couldn't just be aware of the fact that that chip was in the phone. You had to say, 'Hey, this thing in my pocket, there's a new form of empowerment that could be unlocked in special ways.' Ride sharing would be an embodiment of how to unlock that empowerment. DoorDash was another type, Instacart was another type, but none of those things could have existed before you had smart chips that could locate people in real time. The inflection is the thing that happens outside of the startup and the insight is the thing that happens in the mind of the founder. It's the creative source of inspirational breakthrough that causes them to propose a heretical different future. What I started to realize is that better doesn't matter with startups. You have to be radically different to make a difference. The reason that some of the people who did all the right things didn't succeed is they bought into a context. They bought into the rules as they were defined by the incumbents. So they were limited to playing in the incumbent sandbox. When you play in the incumbent sandbox, there's only a small part of the territory of that sandbox that's going to be offered to you. You're going to always have an incrementally upside opportunity. What you want to do is escape competition entirely by harnessing these inflections and having a non-consensus and right insight. You want a product that forces a choice and not a comparison. You want to escape the comparison trap entirely because comparison is death for a startup. You want to be something that can't be reconciled with anything that's come before.

Yeah. What I've realized is that the best use of it was sanity checking a current idea. When I talk to founders, they don't lack for ideas. What they really are interested in is should I pursue this idea? Does it have enough upside? And my response to that usually has been, how should I know? I'm not a customer. I'm not the genius that you are. I haven't invented the thing that you've invented. But what I realized was that there are some diagnostic questions that you can ask. One diagnostic question is what inflection are you harnessing? What is the new type of empowerment that only recently has become available? And how are you harnessing it in a way that creates massive empowerment that people will be desperate for? If somebody says to me, 'I can't think of an inflection,' I'm like, okay, you still may have one and you just haven't thought of it that way yet. Or maybe you just don't have one. Maybe you have a plausibly good sounding idea that's not that good. The most dangerous ideas, back in the day, Sarah Lary, who's a good friend of mine, started a company with Nirav Tolia called Fanbase before they started Nextdoor, a social network for sports fans. That's one of the most dangerous ideas you could do because everybody's going to tell you it makes sense. Everybody knows sports, everybody knows social networks. So you go talk to 10 people and they'll say, 'Hey, that sounds like a great idea. I think you should do that idea.' The problem is there were no desperate people for a social network for sports fans, or at least the way they defined it. A market that sounds plausibly good with zero desperate people is a failed startup. The inflection allows you to sanity check and say, the only way I'm going to succeed is if I offer a radical new form of empowerment that forces a choice and not a comparison. And the only way I can offer such empowerment is to harness something powerful. The inflection allows you to ask what is the empowering thing that's bigger than me or any startup or any company for that matter? Because otherwise, you have no weapon to wage an unfair battle against the present.

Yeah. One of the challenging things about researching success is that even the successful people themselves can misremember how it really happened. When something works out, you remember knowing things that weren't so at the time. You have to be very thoughtful about the questions that you ask. So let's say that you're talking to Mark Pincus at Zynga. You can't say, 'Why do you think Zynga was successful?' because he has a story in his mind about why it was successful and it may be 100% true, it might not be true. What you want to do is say, 'Hey, can you show me the seed pitch deck for Zynga? I notice that in this seed pitch deck, FarmVille isn't in it. So what's up with that? What happened with FarmVille? What caused you to decide to do that?' You want to get it out of the realm of value judgment and just get the facts. You want to say, what was the difference between what you thought it was and what it turned out to be? What surprises did you notice along the way that caused you to shift in whatever direction you shifted in? You're trying to objectively as possible figure this out. What I also realize about the inflections is it's the best answer I've ever found for the 'why now' question. The inflection is kind of like a Goldilocks moment. If you try to implement an empowering insight before the inflection happens, you lack sufficient empowerment to deliver that. If you wait for too long, it becomes obvious to people and now you're going to be playing the comparison game. So there's this window of time where you seize upon the inflection with your insight because timing is such a critical ephemeral factor. The inflection theory was powerful in that regard. It was a powerful heuristic to judge a startup idea either as an investor or a founder.

We're definitely focused on what is the real insight here. Most people, if you ask them what is their insight, they'll answer in some form of 'the world needs my product.' That's my insight. So it becomes a tautology. The question then becomes how do you know if it is a real insight and if they come by it honestly? My favorite cheat code for that is to ask, 'What future are you living in?' I don't think that great startup ideas come from trying to think of a startup. I think that great startup ideas come from living in the future before others do. When you live in the future, you experience the inflections firsthand. Vision is not about your thought process for what the change is. Vision ought to be a verb. Vision is really more about getting your hands dirty with it. It's about your lived experience with what's new. By having a lived experience with what's new, you learn what's new about it. You learn how the inflections create new empowering conditions that will change how people think, feel, and act because you yourself are experiencing it. But then you also start to realize what you're bumping up against. What are the limits of how it works? That's where I think the best insights come from. Getting out of the present and living in a valid future and then building what's missing in that future. That's what I really look for in a first meeting. The other part of it is more do they have the stuff to convince the world. You have to not just think different but you have to act different. Brian Chesky, who I unfortunately did not invest in, was selling cereal boxes to fund the company. Looking back on it, that was much more of a feature than a bug. Justin Kan was doing a live reality show of his life. The prior company he'd started, he sold on eBay. You look at stuff like that and you say, 'Wow, these people are going to run plays that aren't in anybody's playbook.' Because they have the same type of creativity and generative philosophy in terms of their actions as they do in terms of their ideas. It's hard to get people to move to a different future. It takes great persuasion skills. It takes great resilience and grit. It takes a long-term perspective. So that's the other part of it. They can't just have a superior logic about the future. They have to have the ability to emotionally move us to a vision of a different world to get us to want to move somewhere different directionally.

Yeah. The way I think about it is most venture firms, even the best ones, if you looked at the return on dollars from the first check they write and the return on dollars from their follow-on checks, most firms are scandalously bad. If venture firms were required to report that in their audited financials, some of the LPs would be surrounding firms with pitchforks demanding change because it's just so outrageous. So I'm like, okay, that's interesting. Most people have terrible follow-on returns relative to their first checks. Not everybody, but most. So then you say to yourself, should I ever write a follow-on check if that's true? I think the answer is yes. Occasionally you should because pro rata rights are a right. They're worth something. They're not worth zero. The question is when do you pursue your pro rata rights? The trick in succeeding in investing in anything else is to understand where you have a comparative advantage. It's to understand when you have options to make money that other people don't have. In seed investing, the option to make money that other people don't have is to have better insight. It's to see things that other people don't see. To be a good seed investor, I would assert you have to be good at that. Otherwise, you shouldn't even be doing it in the first place. So on the follow-on side, the question becomes when are pro rata rights an opportunity to play offense with your money? If Benchmark decides to fund Twitter, do you exercise your pro rata rights? Over time I started to realize you probably do if you think that Peter Fenton is a discerning, smart investor and you think Twitter is a good company because nobody else gets to do that but you and the other early investors. So that's point one. Point two about returns is, and I learned this from Dave Swensen, your allocation model matters a lot. If you're an endowment, how much you put in private equity, how much you put in public stocks, how much you put in cash, how much you put in bonds, and whatever else your mix is, that defines your return profile as much as any single decision that you make. I started to realize that your decision about 70/30, 60/40, 50/50 is the VC equivalent of your allocation strategy. I'll give you an example. In Fund One, we were 70% upfront, 30% follow-on. Fund Two, we were 50/50. Fund One had a lower return on first checks than Fund Two, but so far Fund One has a higher absolute return. You think about that, you could have made no other different decisions. You didn't add value differently to any of the companies. You didn't pick the companies any differently. Just that one decision of 70/30 versus 50/50, Fund Two would have had another 2x multiple on top of what it already did. I think right now Fund Two is something like 7 or 8x. It would have gotten probably to 10x had we done 70/30. That's real money. You didn't have to work harder. You just had to decide better. You just had to see better. So that's the other logic here. There's an amount of follow-on dollars that you want to have to play offense with your money, but you want to have that minimum viable amount, not the maximum viable amount. You don't want to cover up the sins of your bad investments by doubling down on the losing companies.

If you buy the premise that follow-on versus upfront is an allocation model question, then you have to ask yourself, what are the governance implications of that answer? Our view was that we should have a partner that's dedicated to making follow-on investment decisions. So we have Iris Choi who's now been at Floodgate for close to 15 years. Iris is like, okay, I'm going to be held accountable for these returns. So I need to have absolute decision rights about whether we make this investment or not. That's how it works. Iris decides our follow-on checks. Now if I want to put in another 50 to 100k to help the company bridge, do whatever's needed, I'm free to do that, but that comes out of my first check budget and there's an opportunity cost for me. If I put 100k into a company that's not working to keep it alive and keep the plate spinning, that's 100k I don't have to invest in the next Applied Intuition or the next great company coming down the pike. What you want is clarity around who decides and under what circumstances. Iris decides to play offense with our money. That's her job. If she doesn't think that we could play offense with our money, she won't advocate investment. But there are times, by the way, she'll say, like Applied Intuition I just mentioned, after we did the Series A, she said, 'I think this is a great company. I think Kaser Ununas is a great CEO. I would own as much of this company as I can any way that I can.' So she started buying super pro rata in the early rounds because she's like, my job is to play offense with our money. I need to take advantage of the fact that we're in some good companies whenever I can. There's not that many companies that move the needle in a fund. So whenever there is one that I think has that potential, I got to go unbelievably all in.

The reason I think that I wouldn't is you have to... Pro rata rights only exist if you made the upfront investment. So it's to keep the right inside the firm and not have that discussion about it going to the opportunity fund. We used to debate this early on. We're like, should we create an opportunity fund? And I realized we already have an opportunity fund. It's called Floodgate Fund 7. What we should be doing is allocating the dollars in Fund 7 to the best use of those dollars. If you do an opportunity fund, it creates its own center of gravity pressure to invest it. I was like, we don't want that. What we should instead be asking is, for Fund 8, which we'll probably raise next year, do we want it to stay 70/30 or should be 80/20 or 50/50 or 60/40 or whatever? It should be a function of the circumstances and our belief of the dynamics of the market and the valuations and power law outcomes and that kind of stuff.

Yeah. The way I look at it, Andreas, is your fund size is your strategy. If I want to know what a firm's strategy is, there's only one question I need to ask. How big is your fund? People could say whatever they want to say, but your fund size is your strategy because it dictates everything that matters. It dictates what is your canonical investment size. It dictates what type of return are you expecting in the winning companies. It almost reminds me of the Olympics when they try to qualify for the decathlon and they put a bar up and you got to pole vault over the bar. If you're not careful, you can no-height. You can be disqualified before you even get into the Olympics because you put the bar too high too soon and don't clear it. Your fund size is a promise that you're making to your LPs about how much exit profits you're going to have in your best fund investment. Let's say I want to have a 5x fund. I have to have one investment that likely returns two and a half times the fund by itself. So if my fund is under $50 million, what that looks like is really different than if it's a billion dollars or $5 billion. That's the first thought. The second thought, Andreas, is a little more subtle. One way I look at it is what does it mean to be a good venture capitalist? If you're investing in public stocks, you'd say I want to outperform the market by some percent. I think in startups there's what I call 20 baggers and 100 baggers. A 20 bagger is an investment where you make 20 times your money on the first check. That's 20 times price per share, all dilution factored in. A 100 bagger is where you make 100x or more on your first check. If you want to be great, you want to get 20 baggers about 15% of the time. If you want to be superlative, you want to get 100 baggers about 5% of the time. My business is hard, but not complicated. It's in the 15% case that I'm right. Am I 20 bagger right or 100 bagger right enough of the time that it matters? It's interesting because if you look at the best funds, and I've asked our LPs to help us out with this, the batting average is not that different between the very best funds and the mediocre or the bad funds. Horrible funds are just horrible at everything. But even good funds versus great funds, the difference is less a function of the percentage of losses and much more a function of how big was the upside when they were right. So that's how I look at it. Why does that matter? It focuses the mind. People say, does valuation matter or not matter? I'm like, well, it matters to the extent that you want to make 20 times on the first check. If the valuation's higher, it takes a higher exit for you to achieve that. What people don't understand about valuation is valuation and risk are one to one correlated because if you pay twice the price, you only get paid half as much for the risk you took. Investing is getting paid for the risk you take. That's why I like this 100 bagger, 20 bagger construct. I have a database of 100 bagger startups and I try to understand what was true about them that wasn't true about most companies. You could drift into survivorship bias, but I still think it's valuable to study those companies and develop your mental models around them and stress test them and see if you're making sense when you think about those companies.

Yeah, generally speaking I don't. If Benchmark or Sequoia say, 'Hey, do you want to invest?' I'd look at that pretty seriously. Or Hummingbird Ventures in Europe, Founders Fund. But there's a lot of small funds where I try to be helpful, but I try to be credibly neutral. You run into this problem over time where if you invest in too many of these, you kind of got to be in all of them or you got to be in none of them because if you're in just a small number, people think that you have a bias or that you're preferred.

Yeah. So for the most part, I'm like, look, I've got enough exposure to early stage crazy risky stuff already at Floodgate. Every extra nickel I get, I should be putting in index funds or something super low risk.

Yeah. I mean, it's interesting. I sort of have this view that it's really important to pick your LPs to the extent that you can because you want to have the kind of relationship where you can tell them the truth with no tricks. There have been times where I thought we're not doing as good of a job as we could. I wanted to be able to go to Dave Swensen at Yale and say, 'Look, I don't think we've done as well as we could in these circumstances. Here's what I think we need to fix. Am I making sense?' I don't want to be worried about, 'Oh, what's Dave Swensen going to think? Is he going to give up on me?' They may decide they want to work with us in the future. They may not decide to work with us in the future. But I want it to be based on valid logic. I want it to be because they had the facts and they made a good choice and we made a good choice. I don't want to hold things back. It reminds me of when a startup works with lighthouse customers. I like to say, you should tell them the truth with no tricks. That's what we try to do. We're perfectly happy. In fact, I was hanging out with the Medley guys at a social event a few months ago and we had an exit and it was kind of an unexpected upside that quickly happened. I'm like, 'What do you guys think about how much we should distribute? What do you guys think about should we recycle and all that?' Maybe we'll do exactly what they want us to do, maybe we won't, but I just want to be able to have the discussion and not worry about how I'm going to position it to them. I'd much rather just say, 'Hey, look, you're seeing the sausage be made with me here.' But that's what it means to be partners. That's what we're in it for. My model doesn't work for everybody. I don't think it would work if you raised multiple billions of dollars. I think that our model only works if your entire LP base can be in one room when you have your annual meeting. Our room's not that big. So that's just how we look at it. Phil Horsley back in the day at Horsley Bridge showed me this thing he had called the Grand Slam study and he told me how many grand slams there were as a function of all the investments that had happened. All these LPs have shared with me data about vintages and exit sizes and timing and all these kinds of things. It's really helped me understand the physics of what a great startup looks like and to what degree does it change over time. To what degree is it constant over time? I'm very grateful that I never have to ask myself, what am I going to say to the LPs about this? I just say, 'Hey, here it is. Let it rip and let the chips fall.' I think that's the best approach. At least you want some of your LP base like that. No matter whether you're massively successful or not, you got to have some that can give you that perspective and you can have that trust with.

My answer may be unsatisfying and satisfying at the same time. One of the things that my dad taught me was the notion of keep your tribalist instinct small. By that he meant when you overaffiliate with any tribe, whether it's Republican, Democrat, EU versus US, whatever the case may be, you start to force yourself into the position of adopting stupid ideas of the tribe. You force yourself to defend ideas that you wouldn't defend if your tribal footprint was small. I'll give you an example. Let's suppose that you say to me, 'What's wrong with the crummy US food supply? It seems like whenever people go to the US, they gain weight and they can't even understand. It must be because they got chemicals in the food and it's all screwed up.' If you say that to me, I have a choice. I can be offended. I could say, 'Oh, yeah, well, screw you and Europe does this and blah blah that.' Or I could say, 'You know what? It's not Andreas's problem if our food supply is screwed up. It's my problem. So I can either decide that I care about that and that it's worth considering and do something about it. I should thank you for bringing it up because it's in my interest to not have a crummy food supply.' But when you get your tribalism caught up in it, you get into this tit for tat kind of thing. 'Oh yeah, well tariffs this and policies that and immigration this and whatever.' I try really hard to just say, okay, what is the specific topic that we're talking about here? First of all, do I even care? Does it affect me at all? And then if it does, what should I do about it? So that's kind of how I see it. There may be questions you have about what's going on in US politics. I just don't have answers for because I don't care that much. I'm just not thinking about it.

Yeah. This, keep in mind, is keeping tribalism small. If you said to me, 'I think European entrepreneurs and VCs have a lot to learn from US VCs and entrepreneurs,' I would tend to push back against that. I would tend to say there's great entrepreneurs throughout the world. I think that Daniel Ek at Spotify is a freaking stud. When I study the art of nailing an early niche effectively and precisely, Spotify is the best example case I can come up with. When I met him and interviewed him for the podcast, I was super excited because I'm like, this guy is a kindred spirit. I don't care where he's from. If I'm in any tribe at all, it's I'm in his tribe, whatever that is energetically, not location-wise. So I can learn from Daniel Ek. I can learn from Danny Rimer who's in the UK. There are great people throughout this world that we can learn from. That's what I try to do. If I'm trying to learn from US VCs, I don't think of them as a group. I think of Mike Moritz, Bruce Dunlevie, Peter Fenton, Hans Tung, Roger Ehrenberg, people that I think are talented that I can learn from specifically. To me, it's not so much learning from Americans or whatever. For me, it's like Europe is the crucible of civilization. Pattern breakers, a lot of people from Europe were the original pattern breakers. Part of what makes me sad, for example, some of the speech stuff that I'm seeing in the UK is not to diss on the UK. It's just I'm like, what would John Locke say? What would John Stuart Mill say about this? It was your ideas that you're going against. It was pattern breaking in art. Picasso with cubism. You look at some of the most groundbreaking consequential ideas in human history, they came from Europe. That's not a tribal statement. That's just a fact. That is an objective truth. So I'm like, okay, my hope for people in Europe is not for their tribe to succeed versus mine. My hope is that we're kindred spirit sovereign individuals and that Europeans, just like Americans, stand up for their sovereign individuality in whatever way they can to make the future better. If that means engaging in politics in the right places, so be it. But I don't know. I think that there's so much that Europe has contributed to humanity and civilization that there's a part of me that thinks there's an inner knowing that Europeans have that they need to rediscover. I look at all my lattice of mental models and the majority of them come from people that were Europeans. So I'm like, there's a lot of good potential there. I want people in Europe to remember who they are, not to try to be more like us in any way.

Right. This is another thing that I really believe about startups. Specificity is a superpower. If a founder pitches me and they say, 'Okay, here's my ICP,' I'm like, there's no such person in the world named ICP. There's no such person in the world named persona. So can you give me one specific person, could be anybody you want, that got specific value from your product in a specific way and tell me exactly what happened? So if somebody says, 'What's European ambition?' I say, okay, is Daniel Ek ambitious? Because last time I checked, he's pretty ambitious. I tend to push back on questions that overgeneralize. I tend to say we're all people of free will and we all get to decide what we want to do with the gift of our time. Choose wisely. If there's things blocking us from living the best life we can, we should try to unblock those things. But I try to get out of the generalities and the tribalism stuff because it clouds my judgment.

Well, thanks. I ended up renaming it to the Pattern Breakers podcast. I can't get out of that. Sorry. But that was what I realized was that there's not a lot of people talking about mental models for startup and zero to one. You could look at Charlie Munger's models and I was like, why hasn't anybody applied that amount of rigor to startup capitalism? That was my real goal. I also saw there's just so many blogs and so many podcasts, so much noise that I wanted to just put my own stamp of opinion of what are some of the timeless counterintuitive lessons that ambitious founders can learn. I try to interview people like Daniel Ek and try to tease out from him some of the things we can really learn, some of the durable lessons, not just Spotify, but beyond. Hopefully it's useful to people. I'm not making any money on it, that's for sure. I just get out episodes when I can. It's kind of a side hustle, I suppose. A side hustle with no money, just like my book pretty much.

Well, thanks for having me. It means a lot that anybody in Europe would have any interest whatsoever in what I have to say. So hopefully I haven't taken any steps backward in that regard.

All right. Thanks.