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September 01, 2009 at 04:00 AM
In last month’s column, I posited that private investments in venture and early-stage companies are ideally characterized by their potential for positive asymmetrical outcomes (PAO), where the risk of losing the entire investment is offset against the potential for high-multiple returns on investment. But PAO refers to more than just the non-linear relationship between risk and return; it also refers to the appeal of investments where multiple liquidity and exit outcomes are possible.
This is often referred to as optionality or current knowledge of the potential for a variety of future outcomes.
According to his book, In an Uncertain World (Random House, 2004), Robert Rubin is said to have developed his appreciation of optionality in his prior days of risk arbitrage at Goldman, where he displayed a penchant for keeping his options open and avoiding a mindset that restricted decision-making to binary and zero-sum outcomes.
It is believed that Larry Summers ultimately coined the phrase “preserving optionality” back when he was deputy secretary of the Treasury under Rubin in the Clinton Administration. It was meant to describe a strategy of keeping options open and fluid, before all of the uncertainties have been resolved in dynamic environments where there is a high likelihood for the emergence of new and material information.
Achieving Optionality
For entrepreneurs, optionality in rapidly evolving scenarios (such as a startup) means leveraging real-time data and experience before making important decisions that are either resource intensive or cannot be easily reversed, such as pursuing a market vertical, developing a new technology or application, embarking on a joint venture, or contemplating multiple exit strategies.
In most instances these options were not conceivable at the outset of the venture because, at best, a startup’s business plan is to an entrepreneur what a treatment is to a script writer: a first draft. It is the actual, real-time development of the story line and its characters that ultimately determines the movie script, or the path to monetization for a new business venture.
Investors and experienced entrepreneurs know this. I have rarely seen a startup that successfully monetized itself based upon the mission, objectives, and milestones envisioned in its original business plan. That’s because time in the market is often more valuable than time to market with respect to improving the quality of the critical decisions that are of material consequence.
