Building the Empire

There are mechanisms and ways of thinking to how large fortunes are put together. We are going to kick the tires on Warren Buffett, Elon Musk, Mike Novogratz, and a few others. At certain levels of scale, a number of strategies just stop working. For example, financial literacy and responsible budgeting is going to get you out of debt and into a reasonable personal situation. This will work for millions and billions of people. But if you want to generate empire-building cashflow, there is not enough coffee in the world you can choose to not buy (e.g., $4.00 times 365 is $1,460). Next up is the advice of the venture capitalist. Remember, a venture investor is taking portfolio bets on highly concentrated positions, of which 90% will fail and 10% will return billions of dollars. In such a world, the investor wants each bet to have the highest expected return. A 5% chance of $1 billion is worth $50 million. A 25% chance of $100 million is worth $25 million. The lower probability event will be preferable, because you just structure the portfolio with moon shots. If an entrepreneur is lowering their personal risk, or spreading out their own bets, for many investors that is simply not “focused” enough. And so the advice is to build that one single business with that one single mission. That’s sort of right. But it’s the wrong place to stop, and it will lead one to internalize an incorrect lesson about being the good portfolio company. You don’t want to build the good portfolio company. You want to be the strategic portfolio itself. Here’s Elon Musk as Wario. Musk is one of a few mega-entrepreneurs that runs several high profile companies (Tesla, SpaceX), while founding several other large ones simultaneously (Neuralink, The Boring Company, OpenAI). Jack Dorsey runs Twitter and Square. Sundar Pichai runs Alphabet, which is composed of Google and multiple other operating companies across industries. Warren Buffett’s Berkshire Hathaway is well known to be a conglomerate, which wholly owns about a dozen companies. Notice the pattern? The goal, and the training to accomplish the goal, is not to hit one particularly amazing home run. Selling YouTube to Google ($1.6 billion) or Instagram to Facebook ($1 billion) would be an example of the thing you do not want to do, despite it being good for your venture investor. This is why at any level of price, it is possible to exit too early. Rather, the goal is (1) to maximally leverage your impact using third party capital, and (2) deploy that capital according to your internal judgment, re-investing the gains into your multi-variate vision of the world. No alt text provided for this image The first point is simple and well known. In order to make outsize returns, you have to take on risk — which comes with a chance to make nothing and embarrass yourself. Or perhaps even to annihilate the self and ruin your life, which can happen too. Choosing exposure to risk is a half step; the other half step is getting other people’s money. Financing a small business, or a start-up, or an investment portfolio all require financial leverage from others. In this way, your judgment is amplified in both directions of wrong and right. The second point is straight from Buffett’s playbook. Marc Rubinstein pens a great narrative about the capital strategy that led Buffett out of the fund structure, and into an insurance company structure here. Unlike a fund, where performance fees max out at to 20-30% of the upside, you can keep 100% of the performance less your expenses and underwriting risk in an insurance company. It is the great arbitrage. No alt text provided for this image We can see Elon Musk doing a modern version of this with crypto assets. No alt text provided for this image Yes, Musk has lots of companies. But even in Tesla itself, there are some fun empire-building things going on. Instead of just making and selling cars — which is very quaint and not particularly popular on the Internet — we also see a regulatory credits and crypto currency trading business. A more traditional CEO would *not* be thinking about electric cars as a portfolio of (1) the vehicle and its consumer use, and (2) a liquid government-supported financial derivative. They would not be thinking of their treasury, funded by public equity investors turned social media meme lords, as a Bitcoin buy/sell operation. They would be afraid of these sentiment driven assets. But for Musk these are natural allies, as the operating business is merely a key that opens the lock for opportunities adjacent to a futuristic vision of the future. His social media nativeness, combined with a broad and uncorrelated view of the world, generates serendipity. The idea of serendipity, and the algorithm for such outcomes, is best explored in the book Why Greatness Cannot Be Planned. The short of it is that the path to amazing outcomes, like the pictures generated through selection in the below video, is through surprise and unlikely roads, rather than through clear aiming at goals. This is the algorithm of guided novelty search. So what we have described so far is maximal levered exposure to your internal judgment about the future of the world — i.e., what is novel and valuable — using other people’s money, and a mechanism by which one re-invests into that judgment. That re-investment is counter to the traditional corporate finance advice that benchmarks all return to some risk free rate using the capital asset pricing model. A company should always have a stronger point of view on where to spend through acquisitions and building, rather than just allocating savings into market-tracking asset allocations. If you don’t have a view, you are not taking a risk. And the risk you are taking likely doesn’t show up in return averages, but in the shape of the probability distribution of those returns. Nothing, until everything. To close out this section, let’s highlight a couple more examples of cash flow, capital leverage, and lateral strategy. Galaxy just bought BitGo in a $1.2 billion deal, of which over $200 million is in cash. The custodian adds a strong prime brokerage and technology line to the crypto investment bank. We interviewed the CEO last year here, double clicking on what types of other business lines custody can unlock. No alt text provided for this image Galaxy now looks like a full-service institutional player, with asset management, capital markets, and investment banking. It is well positioned to compete with Coinbase and Gemini around institutional funds, as well as with Fidelity on third party wealth management, as well as Grayscale on asset management. This entire business exists because of Mike Novogratz’ bet on crypto assets, and it grows up and out of that bet like a vine. Another empire to watch is being built by Sam Bankman-Fried. SBF used the cashflow (i.e., leverage from other people’s money) from Alameda Research, a quant trading and market-making shop, to start a crypto derivatives exchange, which in turn created another cash cow. Then, he bought Blockfolio for $150 million, the Ren protocol for an undisclosed amount, launched a $500MM+ DEX token on the Solana blockchain, and made another 37 investments.