Super LP (www.superLP.com)

Careening with Smeed

So there I was, thinking about how I was going to start this blog post; I'd been meaning to compare investing to Smeed's Law -- a behavioral theory that predicts the rate of traffic fatalities -- for a while.  Determined to come up with something vaguely witty and quasi-relevant to kick off this post, I sat in my car for a moment before going into the 7-Eleven for my morning Double-Gulp when -- WHAM! -- it hit me!

I mean, really, it hit me ... some cat driving an Audi A4 ran into me in the parking lot.  Seriously, dude?!?  Who runs into a parked car?!?  Oh well, as Old Man O'Malley used to say through the fog of cigar smoke encircling his head: "some days youse da dog and odders youse da hydrant."  Today was shaping up to be a hydrant day, for sure . . .

Anyhow, back to traffic.  There was this great retrospective by physicist Freeman Dyson a while back in Tech Review.  In it, he talks a bit about the things he learned from his old friend, RJ Smeed.  Among many other contributions, Smeed had postulated that deaths on the roads had little to do with speed limits, car safety features, quality of the roads, etc.  Instead, motorway mortality was a function of psychology.  Dyson said it best:

"The number of deaths is determined mainly by psychological factors that are independent of material circumstances. People will drive recklessly until the number of deaths reaches the maximum they can tolerate. When the number exceeds that limit, they drive more carefully. Smeed's Law merely defines the number of deaths that we find psychologically tolerable."

And it seems to me that we're running a great test case of Smeed's Law: cell phones in cars.  Now, the nervous Nellies would tell us that gabbing while driving distracts people to a dangerous degree; I've now lived in three states where one can't use a handheld phone (and I've been a good boy ... most of the time ... or at least occasionally).  And indeed, while the number of cell subscriptions has exploded to over 250 million from a base of about zero 15 years ago, the total number of police-reported accidents has fluctuated in a pretty tight band during that time.  The average number of accidents over those 15 years has been about 6.3 million, with a high of about 6.8 million in 1996 and a low of 5.8 million in 2008; the standard deviation is about 4.15% around the mean.  I'd bet dollars to donuts that if you overlaid miles driven on the data, the rate of accidents per mile would be darn near constant.  [Now, I'll be the first to admit that texting/emailing is a whole different story . . . anyone with a Blackberry behind the wheel is a menace to souls and property!]

And that's what makes Smeed an unwitting market philosopher.  Markets are all about calibration of risk, and his insight was that as people feel safer, they get more reckless.  Comfort breeds complacency.  You can fiddle with speed limits, pave roads, install air bags, ticket people for manner of infractions, but folks just end up stretching their envelopes of comfort until they undo the putative progress; they calibrate to the risk.  And the same is true for the markets: just think about the banks that kept stretching (in every way) and the hedge funds that kept getting pushed to add risk because their volatility was too low.  Maybe now that memories of a crack-up are fresh in people's minds, they'll be a little more cautious, but that caution will be thrown to the wind as soon as we all get comfortable again. 

Inevitably, we'll have some regulations and rules thrown at the markets.  But what real effect will that have?  Remember when the "circuit breakers" were established after Black Monday?  Traders joked that trading curbs would give people a couple of hours to write out their trade tickets while the markets were "cooling off."  But no matter the safeguards we put in place, regardless of who we call systemically important, it's darn-near impossible to save us from our reckless selves. 

But maybe it's New Hampshire that has it right: it's the only state in the Union that doesn't have a universal seat belt law.  For those of you who've never seen it, New Hampshire's roadside seat belt signs say: "BUCKLE UP UNDER 18 / COMMON SENSE FOR ALL."  Does it surprise anyone that the Live Free or Die state is number 49 in the among the 50 states in traffic fatalities?  Maybe we all could use a little more common sense and a little less regulation, on the road and in the markets?   

Let's all be careful out there.

   

DC-8s and Tigers and GPs! Oh my!

A few weeks ago, a local TV station aired a news story about a mostly-forgotten plane crash, the May, 1968 unintentional ditching of JAL Flight 2 in San Francisco Bay.  After an uneventful flight from Tokyo, the nearly-new DC-8, nicknamed "Shiga," was on final approach to an overcast SFO.  Captain Kohei Asoh, a veteran pilot, guided Shiga's descent through the low-hanging clouds.  But planning errors, equipment unfamiliarity, and miscalculations conspired against the crew.  Dropping out of the fog, Shiga was lower than expected and about to crash into the foam-flecked bay just below.  By the time the First Officer cried out, "pull up!" and Captain Asoh applied throttle, it was too late.  The landing gear had struck the brackish water and the plane lurched to a halt, the wheels coming to rest in the muck seven feet below -- two and a half miles short of the threshold of Runway 28 left.

Remarkably, no one was hurt and some passengers had no idea that they had landed in the water until the evacuation began.  And even then, the de-planing was so uneventful that most folks didn't even get their feet wet.  But for me, the best part of the story was popularized by management guru, Jerry Harvey (author of the Abilene Paradox): when Captain Asoh was called before the Transportation Safety Board, the inquisitors opened by asking how an experienced pilot flying a sound airplane on a straight line to an unobstructed runway in generally benign conditions could land in the water miles short of the field?  Offering an answer that resounds across the ages in its clarity and honesty, the Captain replied, "as you Americans say, 'Asoh f@#%ed up.' "

Fast forward 40 years and compare Captain Asoh to the bellyaching finger-pointers that were in the cockpit of the Northwest flight that overflew Minneapolis.  And the public nature of Captain Asoh's taking of responsibility stands in stark contrast to the recent (ahem) screw-ups of Tiger Woods.  Look, I'm not a moralizer or a scold -- I grew up in the anti-role model era heralded by Charles Barkley and Ice Cube -- but Tiger, dude, you make your living by having people look at you; you get paid because people watch what you do.  I'm not sure you get to flick that switch off by pleading for privacy.  Even if you ask, "pretty please."

And what does this have to do with investing?  Recently, I was talking to a buddy who's a GP at an LBO shop (this conversation was explicitly cleared for the blog on the condition of vagueness -- I should note that it's not a group in which I'm an investor).  This GP bemoaned the fact that his LPs had seemingly thrown in the towel on his troubled fund; turnout had been sparse at this year's annual meeting and some investors had stopped returning phone calls.  He insisted that they had Great Stories of Progress to tell for each of their troubled portfolio companies and that if they could just convey these stories to LPs, all would be well.  How, he asked, could he communicate the exciting stuff afoot? 

So I asked him to test drive some of the rap on me.  After a few tales larded with lament over difficult (but improving!) end markets, missteps by (recently replaced!) management teams, and (impossible to please!) crabby lenders, I asked him how many times they'd screwed up in the fund?  Now I don't mean to be harsh, but here's what I heard for the next 90 seconds: "excuse excuse excuse blah blah blah excuse excuse excuse blah blah blah."  No wonder his LPs have tuned out his firm's fund, I told him; I'd just been handed a bagful of excuses devoid of any corresponding accountability or responsibility.  It was the first time I'd heard the fund's story and I was already tired of it.

Look, LPs understand that business has been tough and even the tightest investment theses have been severely tested over the last 18 months.  We get that.  And we also know that investors are fallible.  It's OK to make mistakes sometimes.  Really it is.  Sometimes even good decisions have bad outcomes and vice-versa (more on that next week).  Sometimes people are just unlucky or in the right place at the wrong time.  But when things head south, please be honest and straightforward.  (There's no need to take things to an extreme and self-flagellate, like some GPs do.  There's no joy in that for anyone.)  As GPs and LPs, we're in a long term relationship -- one that's longer than many marriages.  An open, honest, transparent dialogue pays dividends in the long term. 

So my GP buddy asked me for some advice once I climbed down off of my soap box.  The best I could come up with was, "just remember, it's not the break-in that brings down the presidency, it's the cover up."  Sometimes, like Captain Asoh, you've just gotta say, "I f@#%ed up."

[Off topic] Road Rants

[Beware; there's absolutely no investment content below.  If you're looking for something thought-provoking, look elsewhere . . .]

So here we are in the thick of the fall annual meeting season, which means I’ve got Seat 22E Palsy - again.  I’ve often said that I accomplish 105% of my annual productivity while on the road, but it’s really hard to bang out an investment memo or board book report (or a blog post) from a middle seat on a tightly packed Southwest Seven-Three-Gee.  The amount of sustained contortion necessary to do anything more than one-finger-peck a laptop would stress out even a seasoned Chinese acrobat; I sometimes wonder if I could expense the massage I invariably need after a long flight in a middle seat . . . it’s either that or some kind of workman’s comp claim (just kidding . . . anyhow, the workman’s comp cats probably would have a hoot about a milquetoast investor like me bellyaching about sore shoulders; the country has bigger problems). 

But seriously, I find that the most effective way to tap-tap away is to scrunch up one’s shoulders, rotate the torso about 25 degrees and go cross-handed, with one hand taking the top half of the keyboard and the other the lower.  Every now and again, you gotta switch it up and go southpaw, or else you can cramp up.  I used to hate connecting flights, but now I relish the computer free climb-outs and descents offered by each stopover that give my aching back a break.  It’s a hard knock life (said sarcastically . . .  there are a million worse things I could be doing with my days and nights).

But if you’ll indulge me for a moment, dear reader, I’ve got a gripe that I need to get off my chest:

I've noticed that security lines now ask travelers to self-select into cohorts by traveling skill; there’s even a ski slope-like rating system.  I fancy myself an expert traveler, so I look for the black diamond.  I bet there’s even a double-black hidden away in a known-only-to-locals corner at Hartsfield-Atlanta or Orchard Field (that’s the old-school name for O’Hare, hence airport code ORD; I got your useless knowledge right here, pal!) 

Anyhow, I really think there should be some sort of sanction if you screw up in an expert traveler line.  Walking through the metal detector with your six-pound, all-steel “Don’t Mess with Texas” belt buckle?  Three months probation.  Left your boarding pass in your duffel bag that just went through the metal detector?  Two hours community service.  Forgot to remove your laptop?  $1000 fine and five days in jail.  Seriously.  You’re in the expert traveler line and you don’t remove a laptop?!? 

And I've noticed that Midway Airport is the worst . . . it’s as if people's brains are addled from having endured another Sisyphean season by their beloved Cubbies.  But in the Southwest terminal, there's a Kafka-esque twist: the expert traveler line snakes around out of sight, so you have to commit to what might e a 30 minute wait while the rookies are breezing through.  Sometimes you realize just as you've turned the corner that the posse from the senior center is taking its annual trip to Reno or the girls of I Tappa Kegga are spring breaking (Like Omigod! Like what do you mean I can’t like bring my like 48 ounce bottle of like aloe acai essence conditioner on the plane with me?!?  Like Oh! My! Gawd!)  Sorry, girls, you gotta remember the 3-1-1 rules.  After all, violators will be prosecuted.  Now, if you'll excuse me, I've got to sign off . . . my shoulders are starting to cramp up again.

The Suburban in the Garage, Or Big Investors and Their Funds

About 15 years ago, I learned a lesson I’ve carried around ever since: when I was a rookie consultant visiting an industrial firm in the Midwest I got in a discussion with our client-side project leader about why people sometimes buy things that don’t make obvious sense.  “For instance,” my client asked rhetorically, “why do you think the Chevy Suburban [the only extra-large SUV at the time] annually tops the owner loyalty and re-purchase rankings when there are so many great cars out there?  You'd think every once in a while some other car would topple the 'Burban, no?  And who wants to drive such a behemoth, anyhow?"  Before I could whip up a smart-sounding, yet hollow textbook answer about key buyer purchase criteria or some such noise, he answered his own question, “what the heck else are they going to buy, though?  If you've got four kids or three dogs or a snowmobile you have to tow, there's just no other choice.  What’s the alternative?  Buy two cars and split up the family when you go out?"  

I’ve thought a lot about that story lately, as it offers an important metaphor for investors.  After all, like large SUVs, big venture and private equity funds have been getting kicked around a lot lately.  (And I think I can credibly say that I’d been an early and consistent (and sometimes unfair?) fist-shaker in the direction of some large funds.  Sure, there are some big funds out there that will be successful -- and to be clear, I don’t root against anyone; that’s bad karma -- but the arithmetic facing sizable funds is daunting.)  Yet, despite my ever-mounting cynicism and some good research and analysis that bolsters the small-fund argument, I’ve actually started to feel some sympathy for big funds and their investors and I’ll (not-so) secretly express a hope that larger investors stay focused on bigger funds.  After all, they’re like the Suburban buyers of the story: if they must go out for a spin, it just makes sense for them to find larger vehicles.

See, if you have a gazillion dollars to put to work, it’s actually pretty hard to execute a smaller fund-oriented program, even though many large investors are currently fetishizing such a strategy.  And to those investors thinking about jumping on the small fund bandwagon, I’ll note that such funds tend to be hard to find, challenging to diligence, difficult to “sell” internally, expensive to monitor (at least in terms of time), and catalytic of insomnia.  Indeed, I love my managers like I love my children -- all equally but differently -- yet the younger ones tend to keep me up more at night.  For sure, the rewards can be great and I’ve got high hopes for all the kiddies, but people never let me forget that I’ve taken a lot of career risk . . .

And then you get to the practical challenge: if an institution is deploying a ba-jillion bucks a year, it’s hard to do it in $10 million chunks.  Even if one could write a bigger check to a smaller (sub-$200M?) fund how much more would you want to do?  Would you want to be 25% of the fund?  40%?  Would the GP want you to be that big?  And if an institution is writing a bunch of $10 million checks, are they writing too many of them and seeding a whole bunch of competitors in a space?  Are they ruining the experiment by participating in it?  Stretching our tiring metaphor, if everyone’s trading in their Suburbans for a pair of roadsters and taking two cars out on family trips instead, all those incremental cars on the road will snarl traffic, no?

So let’s raise a glass to big funds with a toast of sincere best wishes for their success . . . of course, I’ll be explicit about my ulterior motive: keeping the small fund space the preserve of the nimbletons.  If big players continue to focus on big funds, it’ll be more beer for us.

The Gatsby Funds

In my younger and more vulnerable years, I must have read The Great Gatsby a dozen times.  Maybe more.  And I loved and identified with the humble narrator, Nick Carraway.  His thousand mile journey to New Haven from Minnesota was much further than my hundred mile one from Brooklyn, but we shared the same occasional outsider's bewilderment at the antics of the eastern elite.

And yesterday, as I sat out on the deck of the Rosewood Sand Hill gazing up at the thin wafer of the moon rising out of the verdant hills and ascending the sanguine sky I wondered what Nick would've thought of this place.  Because sometimes I wonder if Silicon Valley is the modern version of Fitzgerald's Jazz Age playground.  Call it East Egg 2.0.  

But there are days on which it feels like there's a hush about the place; the raucous energy is muted and the punchbowls seem to have gone missing.  Sure, the future's still under construction here; the quiet is punctuated by the staccato tap-tap of programmers and designers working on the new new thing as cooling fans whir in the distance.  But there's a whiff of introspective stillness like that to be found on crisp autumn evenings after the grand shore places have closed for the season.

And maybe that stillness is the melancholy realization that the receding tide will beach some of the dinghies in the harbor.  Some even suggest that the venture business should shrink by half.  But which half?  There's a pandemic of bellyaching about "the venture asset class" among LPs, but I suspect that most investors will keep coming back . . . remember, most Americans hate Congress, but love their Congressman.  I think the venture business is the same way.  

But I'm always asking myself, "what do I need to believe to believe that a particular fund will be successful?"  There are a lot of good investors out there with compelling stories; in fact, there are probably more than I could invest in if I had three lifetimes.  But there's a whole other swath of the business for whom heroic leaps of faith are necessary; the arithmetic of their funds doesn't quite work, or they need too many outcomes to come out just-so, or the IPO market needs to be bubble-icious once more.  Like Jay Gatsby's, their reality is an idealized and stylized rendition of a sloppy present; it's not necessarily a false rendition . . .  just a hopeful one.  And it occurred to me as I pondered the imponderable future that the last few paragraphs of the book capture the challenge facing these funds, The Gatsby Funds, better than I ever could:

And as I sat there brooding on the old, unknown world, I thought of Gatsby's wonder when he first picked out the green light at the end of Daisy's dock. He had come a long way to this blue lawn, and his dream must have seemed so close that he could hardly fail to grasp it. He did not know that it was already behind him, somewhere back in that vast obscurity beyond the city, where the dark fields of the republic rolled on under the night.

Gatsby believed in the green light, the orgastic future that year by year recedes before us. It eluded us then, but that's no matter - tomorrow we will run faster, stretch out our arms further . . . And one fine morning -- 

So we beat on, boats against the current, borne back ceaselessly into the past.

Founder Visas: A Good Idea

I hate to admit it, but I'm not a fan of Indian food.  And it’s not just Indian food, it’s almost any ethnic cuisine.  You see, my immigrant parents aimed to fully assimilate: I’m named Chris, because that was the most popular boychild name at NY Hospital in 1972, I was encouraged to play baseball because it was the National Pastime, and nobody likes apple pie as much as me.  Nobody.  And since my parents emigrated from different countries - thrown together by fate in Bryant Park on a sunny afternoon in 1970 - there was no "local cuisine" at home.  For better or worse, my tastes were more influenced by the cuisine of Oak Brook, or Northfield, Illinois than by the food of anyplace else.

But there I was, eating lunch at Saravana Bhavan in Sunnyvale (ahh, the things we endure on our spouses' birthdays!) when I started noticing the t-shirts from local start-ups and NASDAQ 100 companies that stood out like a dense chain of barren, monochromatic islands among a colorful, undulating sea of saris.  I wondered how many of these foreign-born tech-sters would still be here in one year's time?  Three years?  Five years?  Because in case you haven't noticed, America is facing a brain drain unlike any in our history. 

America?  With a brain drain?!?  Whoa!  Now, there are a ton of reasons for it, but a key one of them is the byzantine complexity of our immigration laws.  (Check out Manu Kumar's compelling success story to get an idea of the challenges faced by immigrant-entrepreneurs.)  But hey, immigration laws are complex because people bemoan the loss of jobs to immigrants; that's a debate that's been going on since the earliest days of the Republic and it's not one that I'll get into here.

But I will say that I'm a huge fan of Paul Graham's Founder Visa idea.  Why not allocate 10,000 of today's existing visas specifically to people who want to come here to start companies?  I get the whole H-1B controversy, but if someone's here to plant and nurture an entrepreneurial seed in the most fertile soil in the world, let's let them try before they go do it elsewhere and we find ourselves in a Dust Bowl.  Anyhow, if someone is trying to start a business, they won't be competing for jobs; the Founder Visa envisions prohibiting these cats from working for existing companies.

And indeed, the impact of these immigrant-founders on the economy is profound.  If entrepreneurship is as American as apple pie, then it's got a coconut burfi, a fortune cookie, some strudel, and a maybe a cappuccino or Tim Hortons double double on the side.  Some estimate that a quarter of all US start-ups are founded by people born elsewhere while over half of Silicon Valley's are launched by immigrants.  These companies aren't just creators of hundreds of thousands of jobs; they're part of the very idea of America, the America where anything is possible.

And that very idea of limitless possibility animated prior generations of immigrants as they helped forge a mighty nation.  Their memorial was the New Colossus that stands in New York Harbor.  And like those immigrants of yore, this generation of nation-building immigrants deserves a monument.  Wouldn't it be fitting for their symbol to be a virtual one, not a physical one?

So, you Twitter-heads among the readership: send a tweet using the #StartupVisa hashtag and include @2gov (or register on 2gov.org - see Eric Ries's post here for instructions).  Lend your voice to the clamor seeking to preserve one of the pillars of American entrepreneurship.

Keeping the Window Open

Most people seem to have a favorite Saturday Night Live skit.  One of my favorites is, "Ruining It For Everybody," a 1993 masterwork that features John Malkovich and some cast members discussing how they did something to ruin things for everyone else.  The Adam Sandler character, for example, explains why many restaurant bathrooms are now, ahem, "for customers only."

Of course, finance is full of people who ruin things for everybody, too (thanks for the SarbOx, Enron!)  But the most insidious wreckers are those companies that go public and then miss their numbers within a few quarters (what's up, Rosetta Stone?!?)  It's those flubs that have a chilling effect on the market for emerging growth companies. 

And as the IPO backlog builds, I hope the bankers take out only those companies that can keep the momentum going, not just those that will pay enough fees to help them get out of arrears at The Stanwich Club.

I say this because, as institutional investors, we've seen that movie before.  And I worry that the IPO market for IT companies could start to look like the market for biotechs: long stretches of desolation punctuated by sporadic frenzies of activity that end when public investors start to feel snookered. 

There are some good companies in the IPO pipeline right now and I wish them all well.  Their success should lead to more opportunity for other companies.  I just hope that the backers and bankers of some of the hundreds of other companies considering a public offering think long and hard about pushing a marginal or unprepared company into the arena.

Please don't be that guy; don't ruin it for everybody.

Getting Out of the Doghouse

Hey, finance professionals: we've got a problem.  Really we do.  In case you haven't noticed, the Great Recession of 2008/9 has a Villain (with a capital V) and it's you and me.  I know, I know, we did nothing wrong; we're generally decent, hard working, well-intentioned souls who humbly ply our trade in a peculiar, esoteric, and well-paying corner of the economy.  But we don't actually produce anything tangible, which makes us an easy target when a lot of people who do actually manufacture real "stuff" are out of work.

And, indeed, the demagogues swirl like turkey vultures seeking carrion.  Who is blameworthy for the sad state of affairs in this country?  The cry rises from the frenzied mob: Banks!  Private Equity Firms!  Mortgage brokers!  Investment banks!  Venture Capitalists!  Money Managers!  MBAs!  (Barney Frank busies himself handing out torches and pitchforks while Timmy G and the Treasury crew ready the shackles.)

But even our friends are enemies in this battle: over the summer I helped a cousin work through a mortgage refinancing.  Some Excel whiz-bangery did little to clear up a confusion born of too many options marinated in too many layers of uncertainty.  "Forget the spreadsheet; what's the best choice for me?" asked my cousin.  "It depends," I replied, dusting off an all-purpose answer.  "What do you think the future holds?  How long will you live there?  Are rates going up or down?  What will your tax situation be?" etc., etc.  "It's all so confusing," was the reply.  Then, my cousin's tone changed to bewildered frustration: "you finance people have made this stuff so complicated, and each choice seems like another opportunity for people to get ripped off."

And then it hit me: the average person doesn't want life to be an HBS case.  The Socratic method may work well in air-conditioned, wi-fi enabled classrooms with sage professors guiding a meandering discussion, but people live in the real world where decisions have consequences and costs -- sometimes big ones, sometimes immediate ones.  And all of the optionality increases anxiety, not to mention adding complexity to once-simple account statements.  I know some pretty smart people who just don't understand their cell phone bills.  The dis-utility of complexity has exceeded the utility of choice optimization. 

But we can help, finance people!  And burnish our tarnished communal reputation at the same time!  Here's my modest proposal: what if everyone in finance, insurance, and real estate committed to doing a few hours a month of pro bono work?  Maybe we could participate in "office hours" for half a weekend day once a month?  We could use bank branches; after all, the government owns a lot of 'em now.

Sure, you'd have to pass some good Samaritan protections so that lawsuits wouldn't ensnare the well-meaning, but imagine the good (and goodwill) that would arise from an army of savvy people helping oldsters understand their cable bills, helping young couples think about their mortgage options, helping college graduates set up their 401k plans.  Anything that has to do with money and is even remotely intimidating would be fair game.  (Of course, it would have to be a marketing-free zone.)

You could even make it a continuing education requirement for the first five years after attaining professional licensing or designation like a CPA, CFA charter, Series 7, CLU, or CFP, with subsequent participation encouraged.  I suspect the idea of ongoing participation could elicit some chortles on the 5:26 out to New Canaan, but remember, guys: that cat next to you from Ropes & Gray's New York office could be coming back from a day at the NYC Family Court Legal Service Project.

My old buddy, the Prof, suggested making some threshold of pro bono activity a requirement for FDIC insurance.  He even had the idea of creating the equivalent of "patient advocates" for thornier cases.  Maybe we could establish industry-funded fellowships to support laid-off or on-sabbatical professionals.

You could even imagine some kind of clearinghouse for people that incorporated the best of Web 2.0: feedback ratings, maybe even a "bid system" for appointments or specialists.  Think of it as a mashup of Craigslist, eBay, Google Maps, and us.  You could even throw in Twitter for good measure.  We can fix this, we have the technology.

Now the last thing I want is to create more bureaucracy and regulation.  But we have to realize that the regulation train has left the station and is bearing down on us at full steam.  And indeed, there are a lot of folks in the chattering classes who would portray finance professionals as the looters that smashed the storefronts of the economy, cynically plundering from the earnest masses.  Maybe the best thing we can do for ourselves and the economy is to pick up a broom and start sweeping up the mess.  

Pain Points

Along the way, the kids on the block started calling old DiPietro “Boch.”  I didn’t know what it meant, but always guessed it was short for some term of endearment in La Bella Lingua.  And it was a great nickname for the generous old guy: whenever a Spaldeen would crack in two – a pretty frequent occurrence in our stickball marathons – the cry would rise up from the boys to his ever-open apartment window: “Aaayyyyy, Boch!  Yo Boch! Bocheroonie!  You got a spare Spaldeen up there?”  Sometimes it took a minute or two, but eventually, a pink rubber ball would fly out of that window on the third floor and go bounding onto East 2nd Street below.  I swear he bought those things by the case. 

Boch had seen a lot since boarding a ship for America all by himself in Palermo on his fourteenth birthday.  And he loved to tell us stories; his favorite was about how he snuck into a game at Ebbetts Field on the very day he cleared quarantine at Ellis Island.  But the thing Boch liked best was dispensing advice to the growing boys enjoying some post-stickball lemonade on his stoop.  “In life,” he often warned forebodingly, “someone’s always got you by the coglioni.  The only thing you can control is how hard they squeeze.”

It’s advice I ponder frequently, doing the voodoo I do. 

* * *

Lately, I’ve been a bit bummed out, though: “don’t waste a good crisis,” the new mantra goes.  So let me ask this: why aren't we using this epic downturn to fundamentally re-frame the relationship between GPs and LPs?  Instead, people are battling along the same lines across which LPs and GPs have been skirmishing for years.  It's like World War I: fierce battling yields a few acres of pockmarked muddiness.

But what if it doesn't actually matter if the fee offset is two-thirds or three-quarters?  What if it really doesn't make a difference whether the no-fault is triggered by 66% or 80% in interest?  Maybe the the LP-friendly/GP-favorable axis needs to be discarded in favor of some entirely new, orthogonal continuum that re-thinks how interests are aligned?   

Let me put a finer point on it: currently, LPs worry that the carry system grants GPs a free option in times of frothy markets; LPs ask: why pay an incentive to people who simply capture beta?  GPs on the other hand bellyache about how long-dated carry payouts can be; after all, those wacky hedgies get paid every year (watch those high watermarks, boys).  But what if we rethought the way in which carry is paid?  What if we instead paid people on a deal by deal basis, but only when they beat the opportunity cost of an appropriate public index?  And let's acknowledge that the public markets are a fast rabbit, so we should pay people a substantial portion (25%? 50%?) of the excess return above equity-substitute cost of capital.  You would have true-ups every couple of years to ensure that groups didn't get paid more than X% of the net profits on the fund.  

Something like that could be a win-win: LPs get a formalization of private equity's return enhancing essence while GPs pull carry forward (increasing the PV!) and could even get paid on flat (or down!) investments, as long as they exceeded public market comps. 

While we're at it, we could also get everyone on a budgeted fee (now I'm getting Pollyanna -- sorry: I've exceeded my daily Diet Coke allotment).  Pay yourselves well, folks; this is America and there's a market for your services, but let's not be bonusing back millions of dollars in excess fees . . . let's focus on cap gains, not W-2 income.

Of course, there are a million reasons why we'll never see a radical departure from the status quo: the fundraising "haves" don't need to mix it up while the "have nots" may be perceived as desperate for offering something new.  And indeed, LPs find themselves trapped in a prisoner's dilemma.  Most perniciously, the legal and accounting costs of a new structure could be prohibitive.

But, unfortunately, the most difficult hurdle to surmount is that any out-of-box thought would "make people's heads hurt."  It's a common complaint.  The status quo is easy to support and difficult to dislodge.  Maybe old Boch was right?  Maybe by trying to avoid headaches, we're sealing our destiny to keep squeezing each others' coglioni?

But what if we used this juncture in the short history of the private equity business to do something extraordinary?  What if we tried something new to make us all better off?  Almost a half-century ago, President Kennedy exhorted us to go to the moon, not because it was easy, but rather because it was hard and surmounting the difficulties would bring out the best in us.  Maybe trying something new might beat the squeeze-off to which we've otherwise consigned ourselves?

Random Thoughts from Denver Airport

So, I've got a more fulsome post (at long last) coming later this afternoon, but in the interim, I had to get some things off my chest:

[insert rant here]

First: if we're going to have national healthcare, particularly a program that's paid for by a small subset of taxpayers, we need to ban the sale of cigarettes yesterday.  Either that, or tax 'em at like $15 per pack.  Anything less creates a huge principal-agent problem.  While we're at it, let's do something about Mixed Martial Arts.  Do we really want kids watching this stuff on ESPN and then going out behind the trailer and practicing a sport whose usual loser's outcome isn't graceful defeat, but rather a hospital visit?

Second: Why is anyone surprised that the savings rate continues to climb (some say it might soon exceed 10%)?  Sure consumers are de-levering, but savings rate is also a function of people's expectations of future disposable income, no?  And disposable income is a function of income and tax rate.  People may have differing expectations on income, but one thing we can probably all agree on is that taxes are going up, up, and away.  As we used to say in Brooklyn: BOHICA.

Last: no matter how low my expectations get, United Airlines never ceases to underwhelm.  Once, I expected courtesy, then I hoped for indifference, now I just want to get home without interacting with any more of their employees or having them bark at us over the intercom.  How does an airline that treats its customers so cynically stay flying?  Remember the old phrase, "one bad flight attendant can bring down an entire airline?"  When did people stop caring?  It's that pesky principal-agent thing again . . .

[end rant]