Welcome to The Business Academy.

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In 2015 I met with the CFO of Twitter.

The company was considered a success by then. It had 130 million daily active users. Its public market value was on the order of $25 Billion.

But in a closed room of entrepreneurs, the CFO of Twitter told us the truth.

Twitter was a mess.

For many reading this newsletter, you won't remember the 'fail whale'. The Fail Whale became one of the first ubiquitous internet memes. When Twitter's servers would go down, they showed an image of the fail whale . It happened multiple times a week. It happened so often that everyone laughed about it.

Shortly before their IPO they fired the entire 50-person engineering team. After the IPO they cycled through 4 CFOs in less than two years. The company was an unmitigated disaster.

But despite these challenges, the business was growing nicely. Fast forward to 2023 and the business is a media powerhouse.

This is an important context for us investors.

Because every small and medium business is a barely mitigated disaster.

The natural state of a company is to dissolve into entropy. Without incredible effort to keep things together, everything in a company moves towards chaos.

Knowing that a company's default is chaos or failure empowers us as investors. Because as an investor I’m looking for a business that can resist failure.

That’s the most important criteria for what I do. Never lose money is goal #1. If I can achieve that, everything else will take care of itself.

Charlie Munger taught us to always invert...

So when considering an investment, let's first ask ourselves: how can we easily make this business fail?

I’ll define failure here as a drop of 25% or more in top-line revenue.

For many small businesses, the answer is “fire the CEO”, for at other companies the answer is “fire the top 3 leaders”.

If the answer to the question is either of the comments above, you are entering a risky investment, and you should probably reconsider it.

Consider Twitter as the example again.

The company website was down for hours at a time. The 50-person engineering team was fired in a technology company. And yet the business persisted and kept growing.

A business built on network effects is often a great business. A network effect means that as the number of people who use the service grows, the value of the service grows as well. It's a self-propelling machine.

If we try to think of how to kill the Twitter business, it’s very hard to do. Short of shutting down the website servers for months at a time, Twitter will likely persist and we as investors are less likely to lose our money in it.

What are some other risks that can lead to failure?

Customer Concentration - does one of your customers make up 20%+ of your business?

Supplier Concentration - does only 1 supplier know how to make a special part for your business?

Changing Regulation - think of when flavored nicotine was banned in California, Juul suffered.

Shifting Trends - Is your business a fad like Beanie Babies? It may do well now, but be careful of changing consumer sentiment.

Key Employee Relationships - does one of your employees control key accounts for your business? what happens if they leave?

Ultimately as a small business buyer, you’re going to have to settle for some risks. My uncle used to say “you can break rules, but never break more than 1 rule at a time”.

I think about this concept in the same light. Know the failure risks you are taking on in your business. And avoid taking on more than 1 failure risk. You can control 1 major risk at a time but not more than that.

Reminder ❗ before making an investment write down a comprehensive list of the potential failures. Then when you're done with your research, decide if you're prepared to take on these risks.

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🔑 One good read

​Don't forget the Beanie Baby mania (short video)- Every once in a while I like to look back on times of irrational human behavior.

It's a good reminder: History doesn't repeat itself, but humans remain the same.

Be aware of human nature as a capital allocator, and you will profit.

Have a great week,

Sieva

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Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.

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