Tim Draper's Cycle of VC vs PE "The Draper Wave"

Tim Drapers graph coincides with what we know, that everything goes in a cycle. Aivars Lode

Why Now is a Great Time to Start a Company, be a Venture Capitalist, be an Angel Investor or Invest in a VC Fund – An Interview with Tim Draper, founder & Managing Director, Draper Fisher Jurvetson (DFJ) 

Draper: “After the bubble burst in 2000 we had ten flat years in venture capital. Then in 2008 the world came to an end and I thought  - Oh my gosh! We’re gonna be hit again! I then started to put perspective on it and thought - that just can’t be! It can’t be right, because eventually these things have to come back. So then I went back and started to analyze history and I went back to when my grandfather started venture capital on the West Coast in 1957. I tried to put this all into perspective. I created something I call “The Draper Wave”. Venture capital is not a cyclical business in the sense that it is a sine wave. It is, however, a cyclical business. It goes in waves that go opposite that of the private equity business. The way I describe that is that it comes up like a shark’s tooth (and there’s nothing ironic there) and then it comes down and then the PE business goes up like a shark’s tooth and then comes down while the venture business sort of goes flat.

There’s nothing scientific here, but the data and the emotional strength of the business does follow this. I don’t really know what happened when my grandfather was in the business from 57 to 65, but let’s assume he was trying to solve a big problem where there was a recession. What happens is after a recession people are out of work and looking for something to do. They say - well you know my boss wasn’t that good at what he did. I can do better. Or there’s an opportunity here that the company I worked for didn’t really take advantage of. So entrepreneurial ideas start happening and then venture capitalist come in. Then those entrepreneurs start employing people. Then jobs start to pick up, pick up, pick up and then there’s more and more venture capital. People start to see that these are great companies and they pour it on. Then it comes up to a crescendo and comes crashing down. From 65 to 74 the big companies became conglomerates and they bought other companies up and they fired half the employee force. That’s how they grew. They’d acquire and fire, acquire and fire and they made everything much more efficient. That was the roaring 60’s that went from 65 to 73 and then I think it probably got too frothy and then it came crashing down.

Then we had a recession in 73 / 74. Then people were looking for things to do and then the computer industry started and other interesting things happened. Between 74 and 83 we had a big boom in venture capital again where they employed a lot of people. It peaked in 83 with Arthur Rock being on the cover of Time Magazine and Steve Jobs on the cover of Time Magazine (for the first time) and then it came crashing down in 83. I joined the venture business in 85. The people who were the headliners during that time were the LBO folks. This was a new form of leverage that improved the efficiency of the system very much like the conglomerates did before. And they levered up, levered up, levered up until 1991 when we got the RJR Nabisco deal where they all bought in and then that came crashing down and the banks decided not to lend anymore. They had lent too easily and too crazily. Then it came down in 1991 and we had another recession.

Between 1991 and 2000 people began starting new companies again and that became the big Internet boom and that came down in 2000.  The PE business, which was really just the same thing as the LBO business between 2000 and 2008 came in and made more efficient all the inefficient companies that had been created during the 1991 to 2000 period. Then in August of 2007 that came crashing down with the credit crunch followed by a crash for venture capital in September of 2008 and we had another recession. And so now we are about three years into what I see to be a nine-year cycle. This is the cycle where people start creating new companies and then they start employing people and then there’s more venture capital and there’s even more and more venture capital. So I think it is actually an amazing time to start a business and an amazing time to be a venture capitalist. The angels have it right. They were funding these smaller businesses at just the right times. It’s all going to pay off very well for them. I don’t think we’re going to have another bubble until say 2017 or so. This means that we have plenty of time.” 

Romans: “Tim, right now there is more angel investing activity in the Silicon Valley and globally than ever before in history.  Accelerators are sprouting up everywhere spawning new ventures so the sheer number of companies being started and funded right now is higher than ever before in history.  At the same time, the dollar amount of money going into first round Series A venture capital financings is contracting.  How do you believe these companies will finance their businesses when the balance has shifted so much?” 

Draper: “What I was saying with the long history is that when there’s a need the investors fill in. Once they start making money in an area then they pile on and then it goes to a frenzy and then it comes crashing down. In this case the angels were very necessary between 2008 and 2011. The reason that you’re getting more angels than ever before is that in general the venture capital business is growing globally. You are going to have a lot more angels. You’re going to have a lot more entrepreneurial successes. You’re going to have a lot more businesses that take off because of venture capital. There will be more competitors worldwide and so the competition will be fiercer. But the markets are also bigger. And so I think everyone will benefit from more venture capital and more entrepreneurship. You will see each of these 18-year generations is going to be bigger than the last until it hits a steady state, which I think will be many generations out. Beyond the market growing right here in the Valley I don’t think there are many venture capitalists in East Africa. There are a lot of places in the world that don’t really have a lot of venture capital and entrepreneurship and so there’s still opportunity for growth there. By nature you will see a lot more angels now. I think you are asking where these new accelerator and angel backed companies will get there financing after three years when their angel funding has run out and they are looking for where their next round will come from. The next round will come from either angels that invest at later stages, venture capitalists or private equity or hedge fund guys that say – hey, I have to get into this because there’s an opportunity. I think where there are good companies there will always be funders behind them. Good companies are only limited by people’s imagination.” 

Here’s why everything Malcolm Gladwell writes is so compelling

Agreed, Malcolm Gladwell's writing is very compelling. Aivars Lode

I used to dread going to parties. I stood around struggling with small talk, waiting for an opening to debate about big ideas. That changed 13 years ago, the day I read The Tipping Point.

Suddenly, everyone wanted to talk about Malcolm Gladwell’s ideas, and I felt right at home. He made social science cool in watercooler chatter, spawning an entire genre of books that blend stories and studies to explain how the world works. He carried me through a decade of dinner parties with Blink and Outliers. With last week’s release of David and Goliath, I’ll be set for a while.

Gladwell refers to his books as “conversation starters,” and when people pick up that conversation, they often start criticizing his work. As a social scientist, I think this is a missed opportunity. I’m not saying that Gladwell’s writing is perfect or that his arguments are always true. I just want to make sure that we don’t throw out the baby with the bath water, since we can learn as much from analyzing what he does right as from poking holes in his work. At a recent event, the discussion shifted away from the substance of Gladwell’s arguments, and toward the style: why is he arguably the most spellbinding nonfiction writer of our time?

The most popular explanation was storytelling skills: he’s a master of suspense, to the point that his books read like mystery novels. Some people waxed poetic about how he brings characters to life—who could forget the Six Degrees of Lois Weisberg or the tragic genius of Chris Langan? Others highlighted his ability to present sticky concepts that quickly make their way into the lexicon, like thin slicing, the 10,000 hour rule of expertise, and the magic number of 150 for social groups. And of course, his ability to illustrate social science with examples from popular culture loomed large in the discussion. Who wouldn’t want to read about how Hush Puppies took off, why Phantom of the Opera and Sesame Street hit it big, and what led Bill Gates and the Beatles to greatness? (There’s even a Malcolm Gladwell Book Generator website that plays on this notion by proposing new titles like Clarissa: How One Woman Explained It All; The Cheers Effect: How and Why Everybody Knows Your Name; and Lando: Intergalactic Lessons in Smoothness.)

If you believe that Gladwell’s success is primarily driven by his writing, I think you’ve overlooked the most important factor. What makes him most interesting is not the narratives themselves, but rather the ideas behind them.

In 1971, a sociologist named Murray Davis published a groundbreaking paper (pdf) that opened with these two lines:

It has long been thought that a theorist is considered great because his theories are true, but this is false. A theorist is considered great, not because his theories are true, but because they are interesting.

Davis argued that the difference between the dull and the interesting lies in the element of surprise. When an idea affirms what we already believe, we’re bored—we call it obvious. But when an idea is counterintuitive, we’re intrigued. Our curiosity is piqued, and we’re motivated to ask questions: How could this be? Is it really true? What else might this explain?

Challenging our assumptions is what Malcolm Gladwell does best. To see how he does it, let’s take a look at what Davis called The Index of the Interesting. Davis classified 12 different ways of challenging conventional wisdom, and Gladwell’s key ideas map beautifully onto at least five of them.

1. Bad is Good and Good is Bad

The idea here is to take a negative and unveil its positive side, or vice-versa. This is the theme of David and Goliath, where Gladwell argues that disadvantages can give us advantages. Who would have thought that a disability like dyslexia could actually make people more successful? With reasoning reminiscent of the Daredevil comic books, he illustrates how the absence of one ability—reading—can lead people to develop other abilities in areas like creative problem solving, acting, listening, and rule-bending. He presents data suggesting that losing a parent as a child, one of the worst things that can happen in life, may actually increase your odds of becoming president or prime minister. He also explores the other side of the coin, arguing that power led the British Army and Southern segregationists to underestimate uprisings in Northern Ireland and Alabama.

2. What Looks Like an Individual Phenomenon is Really a Collective Phenomenon

Another way to challenge assumptions is to show that what we think is caused by individuals is in fact caused by broader societal forces. This is the heart of Outliers. Gladwell argues that we think professional hockey and soccer players make it because of talent and hard work, but it’s really about being born a few months earlier than their peers. We assume that planes crash due to mistakes made by individual pilots, but it’s actually about the cultures in which they were raised. We believe Bill Gates and the Beatles achieved greatness because of their talents, but they had to be in the right place at the right time.

Gladwell does the opposite in The Tipping Point, arguing that major collective changes are actually fueled by small numbers of people. Styles and social movements catch on when connectors build bridges between people and ideas, mavens share expertise, and salesmen convince people to come aboard.

3. What Seems to Succeed Fails, and What Seems to Fail Succeeds

It’s interesting when something that appears to work doesn’t, or when something that looks ineffective proves to be effective. In David and Goliath, Gladwell covers evidence that contrary to popular belief, small classes in schools don’t lead children to learn more. In Blink, he adopts the reverse strategy, showing that although we expect reason to outdo intuition, we underestimate the power of intuition. We believe that the best way to spot fake art is through systematic analysis, but an expert can tell in the blink of an eye. Even when critical information is stripped away, and we only have tiny clues, our intuition can be strikingly accurate. A 10-second silent video clip is enough to spot an engaging teacher; an audiotape with the words garbled so that we can only hear the tone still allows us to identify the surgeon who was sued for malpractice; and a 15-minute conversation about taking out the garbage allows us to predict which marriages will fail.

4. What Appears To Be Local is Global

It’s also surprising when seemingly isolated events are in fact driven by common forces. This is another hallmark of The Tipping Point, which shows how the same kinds of dynamics can explain the spread of sexually transmitted diseases, pop culture trends, and crime sprees. We also see it in David and Goliath, where the willingness of underdogs to play by a different set of rules serves as a lens for illuminating events as diverse as the success of the American civil rights movement and an inferior basketball team with an inexperienced coach making the national championship. (The Gladwell Book Generator picks up on this theme too, with the faux title Nothing: What Sandcastles Can Teach Us About North Korean Economic Policy.)

5. What Looks Like Disorder is Actually Order

The ability to find structure in chaos is another quality of interesting theories, and this is a signature strength of The Tipping Point. We think fads come out of nowhere, but if we appreciate Gladwell’s three rules of epidemics—the law of the few, the stickiness factor, and the power of context—we can better understand the systematic factors that cause them to spread. Confusion also turns into clarity in Outliers, where the puzzle of why a man with genius IQ works as a bouncer is traced to his difficult upbringing, and in David and Goliath, where the mystery of the greatest medical breakthroughs in modern history is also informed by a difficult upbringing.

On Becoming Interesting

Of course, execution is important. Before presenting an idea, Davis observed that the author “articulates the taken-for-granted assumptions” of the audience, and only then reveals how the idea challenges these assumptions. This rhetorical strategy is visible in each Gladwell book: articulate what we currently think, and then present examples and evidence to show how our beliefs are incomplete, inadequate, inconsistent, or just plain wrong.

Interesting ideas are counterintuitive, but not all counterintuitive ideas are interesting. Davis warned that if we believe too strongly in an idea, we don’t want to see it questioned:

one must be careful not to go too far. There is a fine but definite line between asserting the surprising and asserting the shocking, between the interesting and the absurd… those who attempt to deny the strongly held assumptions of their audience will have their very sanity called into question. They will be accused of being lunatics; if scientists, they will be called ’crackpots’. If the difference between the inspired and the insane is only in the degree of tenacity of the particular audience assumptions they choose to attack, it is perhaps for this reason that genius has always been considered close to madness.

Gladwell is very careful on this front. In David and Goliath, he intentionally avoided analyzing the Israel-Palestine conflict, knowing that it was a hot-button issue, and instead chose other conflicts that were more likely to intrigue than offend. At the same time, recognizing that his ideas need to have meaningful consequences, he addresses topics that matter to society. Gladwell writes about improving education and fighting crime, making planes safer and curing cancer, electing the right president and championing human rights. He also writes about ideas that matter to us as individuals. As Davis put it:

an audience will find a theory to be interesting only when it denies the significance of some part of their present ’on-going practical activity’… and insists that they should be engaged in some new on-going practical activity instead. If this practical consequence of a theory is not immediately apparent to its audience, they will respond to it by rejecting its value until someone can concretely demonstrate its utility: ’So what?’ ’Who cares?’ ‘Why bother?’ ’What good is it?’”

Gladwell’s books make us care. He challenges us to rethink how we raise our children, how we build our workplaces, and how we live our lives. He gives us hope that if we practice enough, we can become great musicians or athletes. That if an idea is worthwhile, we can make it take off. That if we change the way we evaluate people, we can overcome stereotypes and give disadvantaged people an equal chance. That if we face disadvantages of our own, we can draw strength from them.

The Dangers of Interestingness

Although it’s tempting to use the Index of the Interesting as a guide for developing an idea, Davis advised us not to do that. It works better as a mirror than a map. When we try to generate ideas in this formulaic fashion, it comes at the expense of creativity. Rather, the Index comes in handy once we have an idea: we can use it to explore different assumptions that we might be challenging. But this too proves difficult, Davis observed, because “assumptions about a topic” are often “too diverse or too amorphous” for any idea to be “universally interesting.” Perhaps Gladwell’s true genius lies here, in identifying common assumptions that lie just beneath the surface—beliefs that are so widely accepted, so taken for granted, that we don’t even know we believe in them.

The punch line from Davis is that interestingness is in the eye of the beholder. What’s fascinating to one audience is obvious to another. Over time, assumptions evolve, and reactions depend on the current assumptions of your audience. This means that if you successfully champion an interesting idea, it will eventually cease to be interesting, because everyone will believe it. And that’s why we need Malcolm Gladwell to keep writing new books.