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You Are Never in the Same Boat

January 20, 2022

Different opinions about a course of action in business decisions are usually caused by one of two factors. The first one is simply a difference in probability estimates of uncertain events. The worldviews are different. One person believes that the probability of succeeding with a plan is high, and one believes it is low, so the optimal course of action according to the two is different. Here I find that there is often a fair chance of agreement and finding a way forward after a bit of discussion. You can always get more information and discuss to try to settle on the right way of proceeding.

The second factor is when preferences, rather than the worldviews, are different. Same worldview but different preferences. I find that this cause for disagreement is no more frequent than the first factor, but when it's there, it can be much harder to make progress. Discussions are rarely centered around why preferences are what they are, and instead the discussion becomes centered around the worldviews even though they should be around the preferences.

Even if we hold the same number of the same class of shares in the same company, have the same worldview, preferences are not the same - even if we both are "rational", if there is such a thing. The preferences are always slightly or very different. This is because many other external factors come into play, and those are always different.

Yet people rarely acknowledge this. Instead, people say that when two different parties hold the same financial instruments, their incentives should magically be aligned and that what is in one's interest is in everyone's interest. "If you think it's a good idea, then I think it's a good idea, because I trust you and we have the same shares, so incentives are aligned and we're in the same boat." But this is an oversimplification. You are never in the same boat.

Here's one example: A startup raises capital from VCs. The VC now wants the cash to be spent quickly, within 18 months, so the company can capture market share, dominate the market, show impressive growth, and the right before the money is gone manage to raise another round to survive and do it all over again. The plan is very front-heavy cash-wise because showing impressive growth usually means making a bunch of recruitments, which takes time, and those people might not be productive for the first six months. So as a founder your job is to recruit people really quickly after the cash is raised, get them up and running, then hope that the growth comes. The risks with the plan are obvious: The growth might not come, or rather, it might not be so extremely good as it needs to be to convince the next VC. Then the company is in a really tough place because all the money was spent upfront. The VC accepts this risk because they have a portfolio and can take a few write-offs as long as some of the companies do well, but imagine that the founders are not. The founders simply don't want to run the company at that level of risk, even though rewards may be huge if they succeed. Instead, a great plan for them might be to build a solid company, make it to break even and eventually profitability. The founders put their life into this and they're not going to see it fail.

No plan is objectively better than the other. The VC and the founders have the same financial instrument in this example, no prefs. They don't have to disagree on the probability of succeeding with any of the two plans. The plans simply are different in terms of risk and reward and align differently with the preferences. The founders and the VCs hold the same type of shares in the same company, they both claim to want what's best for the company, and yet their preferences, and thus the preferred course of action, is different. The seemingly minor fact that the VC holds a portfolio of investments, while the founders do not, makes all the difference. They thought were in the same boat, but you never are.