Weekly Thoughts: Conviction
Here is something that caught our eye this week:
Conviction
Recently we have spent time thinking about conviction. Earlier in our career, the notion of confidence in investing was deeply rooted in the idea that we were playing a multi-stage game with at least semi-defined odds. We could develop a thesis, outline in either quantitative or qualitative terms where we were “wrong,” and place a bet. With relatively low friction costs we felt free, in the classic Keynesian “when the facts change, I change” sense, to act boldly while reserving the right to adjust our view at a moment’s notice. Paul Saffo expanded on this framework in a 2008 blog post:
“Since the mid-1980s, my mantra for this process is ‘strong opinions, weakly held.’ Allow your intuition to guide you to a conclusion, no matter how imperfect — this is the ‘strong opinion’ part. Then –and this is the ‘weakly held’ part– prove yourself wrong. Engage in creative doubt. Look for information that doesn’t fit, or indicators that pointing in an entirely different direction. Eventually your intuition will kick in and a new hypothesis will emerge out of the rubble, ready to be ruthlessly torn apart once again. You will be surprised by how quickly the sequence of faulty forecasts will deliver you to a useful result…This process is equally useful for evaluating an already-final forecast in the face of new information. It sensitizes one to the weak signals of changes coming over the horizon and keeps the hapless forecaster from becoming so attached to their model that reality intrudes too late to make a difference.”
Engaging in creative doubt remains a hugely important part of our process internally. We encourage vigorous debate on a wide variety of issues ranging from investment targets, to financing structures, to personnel matters, to where to get lunch on Tuesday. That said, our decision to focus exclusively on the acquisition and on-going management of small businesses means that the stakes have gone up. If we buy Canadian Dollars because we think the BOC will raise rates, but subsequent economic data makes that seem unlikely, it is easy to get out and, frankly, no one will care. However, the time and expense associated with executing the purchase or sale of a small business means arbitrarily changing our mind is extremely difficult. In addition, by deliberately seeking out companies off the radar of most traditional investors and building the infrastructure to support the end-to-end process we must, ex-ante, embrace the idea that these companies will represent compelling value even when others may not. Most importantly, we recognize that our involvement in these businesses impacts not just ourselves but our employees, customers, and the communities in which we operate, a responsibility we take very seriously. When you are “playing for keeps,” the importance of conviction takes on a whole new meaning as a recent post on the Storm Ventures blog highlighted:
“If I have the conviction and the desire to invest, I dig in. That part is easy. But when it’s time to present and announce to the firm — or even the world — that’s when the pressure begins. Because our investments define us in this industry. But conviction isn’t just about making investment decisions. Conviction is bigger. The most successful VC’s have conviction when others don’t. They see opportunity in markets that others aren’t looking at — and this means they’re out there talking about opportunity and evangelizing about things that others are dismissing. That’s what being thesis-driven means. That’s scary.”
At Chenmark, we acknowledge the natural anxiety associated with making unpopular, largely permanent capital allocation decisions. While we are unlikely to ever achieve complete confidence in a final outcome, we seek to build in a margin of safety in a number of ways. First, we model extremely conservatively, typically assuming company performance well below past experience. Second, we pursue simple and conservative capital structures, ensuring we aren’t overly burdening a company in pursuit of a leverage driven return. And finally, we love what we do. We find the process of identifying and delivering value to small businesses extraordinarily fulfilling and believe that passion, combined with prudent risk-taking, will allow us to maintain conviction as we continue to build our portfolio.
Saffo, Twilio, Howard Lindzon, Storm Ventures, AVC
Have a great week,
Your Chenmark Capital Team
