Governance Models That Don’t Scale: The World According to Charles T. Munger and Jean Jacques Rousseau

JJRMungerCan you name five benign dictators who have ruled successfully for any meaningful period of time (non-fiction)? Can you name five successful, long serving CEO’s (excluding Warren Buffett) whose governance histories are free of the “high-beta” associated with outliers such as Larry Ellison and Steve Jobs?

It’s not easy. Why? Because enlightened dictators and their corporate CEO equivalents are very, very rare; maintaining immunity to the intoxicating effects of power challenges basic human nature.

It is in this context that I found “Corporate Governance According to Charles T. Munger”, a brief article from the Stanford Closer Look Series, thought provoking if not practical. The article was written by David Larker, Director of the Corporate Governance Research Program at the Stanford Graduate School of business, and Brian Tayan, a researcher with Stanford’s Corporate Governance Research Program.

The authors summarize and explain Berkshire Hathaway Vice Chairman Charles T. Munger’s unorthodox view of a model for corporate governance.    According to the article, Munger believes that corporations and their boards should empower their CEO’s more, not less. Munger’s effective CEO, modeled, of course, on Warren Buffet, should be unencumbered by rigid process and freed of unnecessary, excessive checks and balances. Why? So that the CEO can lead effectively. How? In Munger’s construct, CEO’s police themselves, holding themselves accountable to their loosely overseeing directors by binding themselves to a trust based system. And corporate directors should reward these CEO’s for creating shareholder value, while deliberately underpaying them in terms of their annual salary-based cash compensation. According to Munger, and as quoted in the article:

“Good character is very efficient. If you can trust people, your system can be way simpler. There’s enormous efficiency in good character and dis-efficiency in bad character … We want very good leaders who have a lot of power, and we want to delegate a lot of power to those leaders…The highest form that civilization can reach is a seamless web of deserved trust—not much procedure, just totally reliable people correctly trusting one another.”

I agree with Mr. Munger completely, while asking the same questions raised by the authors at the end of this article:

“The trust-based systems that Munger refers to tend to be founder-led organizations. How much of their success is attributed to the managerial and leadership ability of the founder, and how much to the culture that he or she has created? Can these be separated? How can such a company ensure that the culture will continue after the founder’s eventual succession?”

Unfortunately, and founders notwithstanding, the collective global capitalist experience since private property rights were invented and enforced has shown that there aren’t enough of those people on this planet.

kozlowskimug1For a specific cautionary example, I am reminded of Tyco International and its former CEO, Dennis Kozlowski. Kozlowski was recently paroled, almost twelve years after his indictment, ultimate conviction, and after serving over eight years in Attica, for a $134 million corporate fraud (this amount represents a small fraction of the losses suffered by public shareholders). The disgraced former directors of Tyco International (vintage 1999), seemingly highly trustworthy and accomplished men and women, also come to mind. This group, along with the enterprise builders at Enron, Worldcom, and Adelphia, to name just a few, are at the top of my list of examples of poor corporate stewardship and help explain why Mr. Munger’s model for corporate governance is still-born.

But I did say the article was thought provoking, as Charles Munger’s corporate governance philosophy, in my view, evokes Jean Jacques Rousseau’s concept of the Lawgiver.  Author Alex Scott summarizes Rousseau’s core thesis from the Social contract succinctly in this excerpt from his book, The Conditions of Knowledge: Reviews of 100 Great Works of Philosophy :

“The general will always desires the common good, says Rousseau, but it may not always choose correctly between what is advantageous or disadvantageous for promoting social harmony and cooperation, because it may be influenced by particular groups of individuals who are concerned with promoting their own private interests. Thus, the general will may need to be guided by the judgment of an individual who is concerned only with the public interest and who can explain to the body politic how to promote justice and equal citizenship. This individual is the “lawgiver” (le législateur). The lawgiver is guided by sublime reason and by a concern for the common good, and he is an individual whose enlightened judgment can determine the principles of justice and utility which are best suited to society.”

I agree! Let’s find that individual and give him (or her) the keys to the public policy car! Munger’s corporate lawgiver, the enlightened CEO, is also an admirable model worth aspiring to emulate.

As with Rousseau’s 1762 treatise, history has sadly shown us that we lack sufficient incorruptible raw material across the entire history of mankind to render the “lawgiver” experiment successfully scalable, be it in public government or corporate governance.

The unbridled exercise of power is the ultimate intoxicant, and very few humans can responsibly limit the flow of that drug, especially not when they have are given the opportunity to administer it to themselves.

 

 

Early 2014 Harvest for Napa Valley—Hard Data Provides Perspective on the Impact of Global Warming

As we walked through the Levensohn Vineyard last week with our viticulturist, Zach Berkowitz, and our vineyard manager, Stan Zervas, of Silverado Farming, Zach cut into a green berry from one of our vines. He explained that we are now 50% of the way through the growing season for the 2014 vintage because the seeds in the grapes are now turning crunchy and hardening.Grapes Levensohn 6 22 14

We expect harvest to occur three weeks earlier than our 2013 crop, which was picked on October 3. Since we replanted the vineyard in 2000, this may be the earliest Levensohn harvest yet (our latest was just before Halloween in 2005).  A key factor impacting the rate of grape maturity is the air temperature during the growing season. In the wine industry, the number of Growing Degree Days (GDD) measures this.

According to Washington State University, “The progression of in-season grapevine development is strongly influenced by air temperature. As such, average heat accumulation is often used to compare regions and vine growing condition. This average heat accumulation is often refereed to as Growing Degree Days (GDD). The summation of daily GDD units can be used for a variety of things: comparing one region to another, comparing one season to another, and predicting important stages in vine development (bloom, veraison, and maturity). … GDD are calculated by subtracting 50 from the average daily temperature (°F). If the resulting value is less than 0, then it is set to 0. Thus, daily GDD units are always positive.”

Silverado Farming recently published the following report on GDD for 2014:

Clusters in early season varieties are starting to grow tight. This continues to be an early season, as bloom and fruit development are earlier than usual. Growing degree days are still a little behind last year, but we are catching up. A month ago, 2013 had the most GDD over the last 21 years. Today, 1997 is the leader. The coolest season was 2003, but now 1998 takes that category. We are at 972 GDD, which is 17 GDD, or about one day, behind 2013.

We are eight days ahead of the average, meaning 972 GDD was achieved 21 June in the average year. Finally, 2014 is has the fourth highest GDD accumulation, trailing only 2013, 1997, and 1996. The chart below shows accumulated GDD for four key years since 1994. These include this year, the year with the most accumulated GDD (1997), the year with the least accumulated GDD (1998), and the 21-year average. 2014 is clearly warmer than the average, but about six days behind 1997. The NWS Climate Prediction Center continues to show high probability for a hotter than normal summer, so above average GDD may well continue this season.

It’s possible, but unlikely in my view, that 2014 may have lower GDD than 2013. But we also have to consider the exceptionally mild winter we had and the unprecedented severity of the California drought in any assessment of how things are changing in the Napa Valley for grape growers and winemakers.We do expect an excellent harvest again this year, with high fruit quality for cabernet sauvignon. All signs are encouraging at this mid-point in the growing season. But it would not be surprising to see 2014 overtake 2013 as having the most GDD since 1994 and continuing the trend of well above average GDD. We don’t see this trend reversing.

GDD

 

 

Father’s Day Special: Reflections on Baby Clothes

3 D Baby clothesFathers Day 2I am blessed with three wonderful children. The oldest two are now over twenty, and my youngest is 7 months old. As an older father, I’ve experienced a sense of déja vu and even surprise when I can do something really well on the first attempt, such as swaddling or changing a diaper, even though I had totally forgotten that I knew how to do it.

But one thing I still absolutely can’t understand, twenty years later, is baby fashion. Seriously, who makes all these ugly baby clothes?

Fathers Day1My wife sent me clothes shopping the other day, and it was a tough mission.

In my view, most baby clothes are plain ugly. They feature staggering color combinations that make disco lights look dull. From baby-shirts to pants, blouses to bibs, everything is plastered with weird looking creatures. A dreadful pink bear with a scary smile, an oversized violet dog with a square snout and brown stripes, a red elephant with blue polka dots and a yellow palm tree. How would YOU like to wear this to anything other than a Halloween party?

It gets worse when it comes to gender management. Store shelves, and most salespeople, dictate two iron rules for infants: 1: Girls are condemned to wear pink in all its forms and variations: light pink, dark pink, pink with pink dots, pink with light pink stripes, pink with pink animals and lots of pink bows. And if you have a boy, of course, there is the inevitable, inescapable blue. Blue pants with dark blue ladders, blue with blue little cars, light blue shirts with very light blue hippos…

 

Fathers Day 4

My daughter has piercing blue eyes, and we love to dress her in matching blue (if we can find anything without a printed tractor, a car, or a sailboat, which is tough). Of course, every person we meet in the street or in the park admires our “cute little boy”.

And I can’t understand baby clothes sizes! In the US, baby clothes are indicated with “NB – 3 months”, “3-6 months”, or “12-18 months” etc. This sizing can only make sense to people who don’t have children. I wonder who came up with this bizarre matrix that ignores the fact there are small babies, big babies, thin babies, and plump babies – and all of them may be of the same age.

My daughter fits nicely into baby suits for 18-month olds, a sleeping bag for newborns, and pants for 4 month old babies — all at the same time. I don’t know what to buy! Do I have to bring my baby into the shop to try everything out? Adult clothes aren’t sized by age… Why can’t we have real baby sizes?

Let’s address the actual design of those clothes and their functionality. In my view, three things are essential to a great design for babywear:

(1) It must be easy to put on (even for Dads) without hearing squeals of discontent from your little one;
(2) It must be easy to remove (especially for Dads), and especially under the following use case: baby just spat up a small sea of milk on you, herself, and innocent bystanders; and
(3) It must be easy to open on the bottom in order to change diapers whenever and wherever that task must occur.

Sounds straightforward, right? Nope…  Small sweaters with tiny openings for her head, requiring an experienced pair of hands to pull through her unwilling, wiggling baby head; Tiny buttons that need to be opened and closed each time you attempt to dress your child (do that when she is crying, hungry, or with a colic, and you will understand what I mean). And there are those heavily adorned suits with cool pockets, zippers, and other bells and whistles, but no buttons on the bottom. Which means you have to take off the entire suit just to change a diaper.

Fathers day 6And there’s plenty of fancy, tight pants with an even tighter waistband that don’t allow for important things like breathing, and that’s without a diaper (did I mention these tights pants are for a baby?).
The 2-piece outfits with a bright-colored shirt and matching pants crown my “pointless” list. Babies move constantly, and the shirt always gets pulled up around their neck, leaving them with bare bellies – unless you also dress them in a body suit. But if your baby isn’t eating yet with a fork and knife, and if your baby has a habit of spitting up, you will spend most of your day with her on the changing table.

And those “cute” little nightgowns and dresses that her flying legs kick up and over her waist as soon as you put them on, they leave three-thirds of her body naked.

I ask again, who designs this ugly and impractical baby clothes? We didn’t have the Web when I first became a father. I am hopeful that help is on the way! I can’t wait until I can have my own 3D printer to design and print my own baby clothes at home, maybe a designer will see that there is a bigger 3-D clothing market for babies than for Victoria’s Secret models.

 

 

What’s Wrong With This Picture? Precipitous Decline in US Share of Global Equity Listings Continues Unabated

David Weild and Ed Kim originally exposed and reported extensively on the long-term decline in U.S. equity capital market share of public listings relative to other emerging and developed global markets.  Sadly, this graphic update confirms that the trend has gotten worse.  The implications for American innovation are negative.  New capital formation and new public equity listings are critical for economic growth.  New public equity listings provide  strong components of the lifeblood that nourishes economic growth at multiple levels.   Clearly, the root causes behind this trend have not been addressed in the financial and regulatory reforms implemented since A Wake Up Call for America was first published in 2009.

US Listings Decline

 

The 2009 Grant Thornton report proved without a doubt that the U.S. capital markets for listed equities have been in systemic decline since 1997.  This condition is clearly not the result of the technology bubble or Sarbanes Oxley. Most importantly, the absence of U.S. IPOs negatively impacts American entrepreneurs most of all, regardless of whether they have venture capital or private equity backing.

As of 2012, things have not changed much.  For an updated historical perspective on US IPO’s see the chart below:US-IPO-Activity-2002-2012 (1)

In 2012, of the 128 IPO’s completed in the US, the median deal size of $124 million marked a drop of 2% from 2011.  Excluding Facebook, total proceeds from US IPO’s declined by 27% in 2012 from 2011.  According to the Renaissance Capital report ,all the ten top performing companies’ stock prices and the worst performing companies’ stock prices were from IPO deal sizes exceed $50 million.  This data confirms the continuing absence of IPO’s whose proceeds are below $50 million—and this fact remains a major problem for promising US startups. Our country will continue to suffer the consequences of this trend as long as positive economics for supporting small cap companies in the market are absent.

What can we do about it? One possible solution to this trend would be to establish an issuer and investor opt-in capital market that would make use of full SEC oversight and disclosure, and could be run as a separate segment of NYSE or NASDAQ, or as a new market entrant.  It would offer:

  • Opt-in/Freedom of Choice – Issuers would have the freedom to choose whether to list in the alternative marketplace or in the traditional marketplace.
  • Public – Unlike the 144A market, this market would be open to all investors.
  • Regulated – The market would be subject to the same SEC corporate disclosure, oversight and enforcement as existing markets.
  • Quote driven – The market would be a telephone market supported by market makers or specialists, much like the markets of a decade ago.
  • Minimum quote increments (spreads) at 10 cents and 20 cents and minimum commissions – 10-cent increments for stocks under $5.00 per share, and 20 cents for stocks $5.00 per share and greater, as opposed to today’s penny spread market.  These measures would bring sales support back to stocks and provide economics to support equity research independent of investment banking.
  • Broker intermediated – Investors could not execute direct electronic trades in this market; buying stock would require a call or electronic indication to a brokerage firm, thereby discouraging day-traders from this market.

Research requirement – Firms making markets in these securities would be required to provide equity research coverage that meets minimum standards.

This idea has been presented to our legislators before but has not gotten any traction.  In my view, these new statistics reinforce the need to take another look at constructive, market-based solutions to a severe problem that continues to stifle US economic growth.

Pascal Levensohn in New York November 8: Speech at Museum of American Finance on Risks to Angel Investors

MoAF_GREEN_GREY300I first visited the Museum of American Finance a couple of years ago, and it is not only a great space,it is a useful resource for visitors interested in a wide range of current exhibits on current capital markets topics, as well as documents and artifacts related to capital markets, money and banking. The collection includes stocks, bonds, currency, checks, prints, engravings, photographs, objects and books. The Museum has an extensive collection of stock and bond certificates from the Gilded Age, from companies that include US Steel, Standard Oil and the New York Central Railroad.

But I am coming to the Museum to talk about the leading of edge of startup financing in the digital age and about real time investment risk management in the new Wild West– crowd-funded Silicon Valley post the lifting of the ban on General Solicitation. While new entities and forums are sprouting daily to facilitate aspiring venture investors to fund new ventures with as little as $2,500, the investing risks are no different than they were during the time of the iconic entrepreneur Andrew Carnegie.  And, to be clear, the risks of failure then and now remain very, very high.

My talk on November 8 is about some of the immutable laws of risk in startups. While you can package optimism in many different wrappers, in my view it is essential, especially for unsophisticated accredited investors, to understand critical concepts such as equity dilution from follow on rounds. And most important, they need to have some due diligence process in place before they writ the first check, as well as a similar re-evaluation process whenever they are called upon to fund a follow-on round.

I look forward to a lively discussion on November 8 at 12:30 PM.

New Video: Key Startup Investing Risks for Friends, Family, and Angel Investors

Establishing a mutual understanding between investors and entrepreneurs as to what each expects from the other is essential to a harmonious beginning for a new venture.

The future is likely to be challenging;  if entrepreneurs expect to be able to count on additional support from their friends, family, and Angel investors, several key risks that must be addressed in advance.  This video focuses on four of those fundamental risks:

(1) A startup’s high probability of failure;

(2) The mathematics of dilution;

(3) The tendency to misunderstand a company’s stage of development and, therefore, its capital needs;

(4) Understanding the risks associated with investing good money after bad and knowing when to call it quits.

Some important statistics:

In 2012, the average amount of seed or angel capital raised per company was $880,000 (Source: Pitchbook)

61% of seed-funded companies will not be able to obtain follow-on funding (Source: CB Insights)

Those seedlings that won’t find capital will be the victims of the so-called Series A Crunch

While seed investments increased by 64% in 2012, Series A investments declined by 2%. This defines a supply/demand imbalance exists between institutional VC capital and the ‘Seed Crowd’ .

It is a tribute to America’s innovation culture that, while most startups fail, we are currently experiencing such a boom in seed financing in the United States. Institutional venture capital is not increasing; on the contrary, the industry continues to consolidate by firm and is declining in total.

Being aware of the risks inherent to startup investing and having a clear understanding of the basic parameters of dilution mathematics should be helpful to investors and entrepreneurs alike.  If you are an entrepreneur, this video may be very helpful to you so that you can explain these risks to your investors.  If you are an investor in very early stage companies, this video provides useful perspective on risk and portfolio management.

This video is Chapter 2 of the Entrepreneur Essentials Video Series.

How to Break the Familiar Pattern of Board Dysfunction in a Startup

After watching Board Dysfunction: Root Causes and Solutions, an experienced CEO told me that the video succinctly identifies and summarizes issues that are intuitively clear but often overlooked in practice. Experienced investors know that successful investing often employs pattern recognition. But when it comes to boards of directors, the unfortunate recurring pattern that is familiar to many experienced directors raises red flags about dysfunction. This is particularly acute for startups because most startups have inexperienced board members, and usually the least experienced directors come from the management team. This problem is compounded in the earlier stages of a company’s development because inexperienced co-founders often make common mistakes that could be avoided. Left unchecked, such errors in board management, board configuration, and in board process can cripple a company’s future growth path.

If you are an entrepreneur involved with your first startup, a venture capitalist who wants to educate management on acceptable and unacceptable board behavior, or an independent director new to small company board dynamics, this video should be helpful to you. The video combines PowerPoint slides with specific anecdotes to illustrate frequent errors made by inexperienced boards. The content also highlights typs of behavior that are unacceptable and that should raise concerns among all directors.

It’s easy to say that directors need to communicate more frequently and openly.  But how do you accomplish that? How do you hold directors accountable to each other? The video outlines process tools that are readily available to boards and that can help solve problems. Ironically, viewers may watch this and feel that a number of the points raised are intuitively clear. That is actually the point of this work– most of the time, the people in the room know what’s wrong, they feel it, but they either don’t feel comfortable articulating the problem or can’t easily implement the solution. By watching this video with your peer directors, you can now raise issues that are already in your mind but have not been comfortably stated out in the open.

Please consider this video to be a management tool. It is for investors and entrepreneurs alike, with a focus on the perspective of the entrepreneur.

How to Sell High Quality Video Content to Your Fans Using Social Media: Introducing LittleCast

LittleCast LogoDigital content providers from traditional print media franchises to traditional television have finally figured out that giving away your valuable content on the Web will only accelerate your ability to go out of business.  We are still in the early days of video monetization, and one of the great gaps in the landscape has just been closed by a new startup, LittleCast, that I co-founded with Amra Tareen and Stephen Ackroyd.  What is the gap that LittleCast now fills?  The discovery problem that plagues most video content on the Web.

If nobody knows who you are, it doesn’t matter how great your content is, because you will remain unknown until you get lucky or become a one-hit wonder.  And the economics of advertising driven models for earning money are not very attractive for the content producer.

But on Facebook, LinkedIn, and Twitter, you are part of a community of people who opt-in to following you.  LittleCast lets any videographer sell video on social networks. The videographer sets the price and LittleCast does the rest: the solution publishes the video, of any length up to 3 hours, in standard definition or high definition, to social networks, iPhone, iPad and Android devices.

In addition, LittleCast provides detailed analytics and engagement tools to the videographer to manage the distribution, customer engagement and revenue.

LittleCast is extremely easy to use:  the process is entirely automated and self-serve.  It costs you nothing to try LittleCast—you upload content and start earning money as soon as your Facebook friends and fans buy your videos.  The economics are totally transparent and detailed on the LittleCast website, which is where you go to upload content: www.littlecast.com .

LittleCast has created a real–time mobile and social store for video; the platform is similar to eBay in that the content producer can set the price and change the price.  The viral nature of social networks will also maximize the reach of video sales among friends.  Try it, you’ll like it!

Introducing the Entrepreneur Essentials Video Series

71181_157147241145082_1630163656_n

I’ve written about board governance challenges for startups since 1999, publishing one book, a series of three white papers, and many articles and blog posts on this topic. Because I am both a venture capitalist and a technology entrepreneur, I understand the different perspectives of entrepreneurs and investors from both sides of the boardroom table.

With this new video series, I updated and expanded fourteen years of collaborative work and have structured the content to focus on the entrepreneur’s perspective. The first video will be released on September 5.

Stay tuned for

Chapter 1      Board Dysfunction: Root Causes and Solutions

Chapter 2      Managing Risks in A Startup: Four Key Issues

Chapter 3      10 Things You Need to Know About VC’s (Before You Meet Them)

I intend to help management teams get much more of the flavor of the issues they will undoubtedly face as directors of startups.

Chapter 1, Board Dysfunction: Root Causes and Solutions, updates the material I have developed with other experienced investors and entrepreneurs, emphasizing the challenges that entrepreneurs face.

In these videos, I don’t just ask difficult questions, I answer them.

To learn more, go to my Facebook fan page Entrepreneur Essentials

Field Report From Israel: Things Are Changing, Watch Events at the Western Wall

It’s different this time.  Why?  Because in Israel the reality of demographics is catching up with those who previously believed that wishful thinking makes for sound public policy.

AO5A3900It’s hard to distill into a sound bite what’s going on in Israel and the West Bank.  Knowledgeable pundits are fond of prefacing their answers to meaningful questions about the region with, “It’s complicated…”  And it’s true.  In Israel, especially in Jerusalem, everything is complicated, because politics permeate every crevice, from issues of local real estate to childhood education.

I’ve just returned from a week in Israel, including visits to Tel Aviv, Herzliya, East Jerusalem, and the fascinating work-in-progress at the ambitious construction project of Rawabi City, as well as other sites in the West Bank.

While I have been to Israel many times since my first trip in 2002, I was fortunate join an outstanding program sponsored by the Philanthropy Workshop West for this trip.  Among the highlights of our trip, we visited a wide range of community outreach programs for ethnic groups at risk (Israeli Arabs, the Ethiopian Jews, the Bedouins) sponsored by groups including the Portland Trust, the New Israel Fund, and the American Jewish Joint Distribution Committee.

What struck me most about this visit was that Israel finally appears to be acting more introspectively to address its painful social and political contradictions, acknowledging that these can no longer be left to fester from salutary neglect.

Chief among these contradictions is the discrimination of Jews against other Jews, particularly by the ultra orthodox against Jewish women who seek the right to pray at the Western Wall, and by the State of Israel against Reform and Conservative Judaism (which define Judaism in the United States) by denying these branches of Judaism official recognition and fiscal support in Israel.

AO5A3809

I was not expecting to hear from multiple individuals what I have felt since I first visited Israel 11 years ago: that the country cannot allow the ultra orthodox to be exempt from military service and from carrying their economic share of public services.  And there is a sense of urgency that also surprised me, a sense that this must be addressed by the legislature now.  To wit, the newly formed government majority in the Knesset, for the first time in the history of the State of Israel, excludes the ultra orthodox block, effectively taking the keys to the religious car away from these intolerant and uncompromising constituencies.

The release of the Women of the Wall from arrest, without consequence, on April 11 brings this new political reality home.  The courts overruled the police and squarely placed the blame for public disturbance on the haredim at the scene.  This is a big deal! As reported by the New York Times:

“The judge said the people disturbing public order on Thursday were a group of ultra-Orthodox protesters who were demonstrating against the women. The police said an ultra-Orthodox man was also arrested after he grabbed a book from one of the women and burned it.”

IMG_0854

 

 

 

 

 

 

 

 

Job training centers for the ultra orthodox are springing up, supported by U.S. NGO’s and the Israeli government, and there are waiting lists because of excess demand from haredim who wish to change their lives to consist of more than Torah study.  I view continued progress or renewed failure to achieve change in this area as a canary in the coal mine in terms of handicapping Israel’s prospective trajectory toward broader achievements with the Palestinians.

AO5A3909