Why Startups and Hedge Funds are the Same Thing

At Harvard, there’s this bifurcation between the investment students and the startup students. The bifurcation becomes more pronounced at higher grade levels, as students often feel compelled to choose sides. They are either an investment student, concerned about rates, ebitda, and unemployment, or they are a startup student, concerned about yc, monthly users, and revenue targets. Incidentally, there’s even some conflict between each side. While I’m unaware of what the finance students say about startups, I’ve heard several startup people make remarks that what they are doing is superior to finance, since they are actually contributing value to the world. I always thought such statements were a little silly, especially since, in my view, investors and startup founders are really doing the same thing.

First things first, many startup founders purport to be interested in creating something valuable for the world, when deep down the true motivation is to make money. There isn’t anything inherently wrong with that – that’s the whole point of business. However, I think it’s a bit of a misrepresentation to suggest that the sole reason some startups and big tech companies make so much money is that they are providing something very valuable to the world. There is an argument to be made that many profitable companies do harm to society along with the value they provide. Some may even say that certain companies do more harm than good. I’m not here to call out specific companies. I simply want to acknowledge that the reason certain companies are so successful isn’t because they provide so much value to the world. Rather, it’s that they make a lot of money. Making money and providing value are two different things, which sometimes go together and sometimes don’t. Numerous ventures provide a very valuable service but don’t make enough money to survive. Moreover, if we think about specific companies, the founders of such companies reap a tremendous amount of the gain. Is it because they did most of the work, because they provided most of the value? No. It has nothing to do with that. Making money and providing value are two different things. The chief reason the founder makes most of their money is because of the risk they took. Ah, I see a connection to finance already. Even though startup founders act as if investors just put their money into other businesses and let other people do all the work creating value for society and profit for the investor, that is not so different from what startup founders do. The second they start employing other people (or paying for llms to do work), they are suddenly doing the same thing – giving their money to someone/something else to deliver them a profit. Sure they might be giving guidance (investors can do that too), but deep down over the lifetime of a profitable company, most of the success or innovation isn’t attributable to just the work and guidance of the founder(s) but of the tireless work of the far more numerous employees – many of whom often guided themselves. Then why did the founders make so much money? It’s same reason why successful investors make so much money.

At the core, what makes money is having an idea about the future, taking risk by putting your money where your mouth is, and then getting it right. I view each investment I make similar having a mini startup. In investing, you have an idea about future business conditions, do the work and research to determine exactly what business models will benefit, and then take the risk by putting in your own money, dynamically adjusting risk and pivoting if necessary. Sure, you’re not doing grunt work like writing code, but these days startups aren’t doing that either. Startups operate on longer time frames and founders interact with people, but fundamentally the thing that makes money is having an inciting idea about the future, doing the work and analysis to determine what business model will benefit from such a future change, and then putting your money into that business model. At the end of the day, the reason a startup made money wasn’t because of the fact that they spent a lot of time coding. Countless startups do so, and most fail. The grunt work, while usually necessary (though coding grunt work less so these days) is not where the money is really coming from. The money comes from the risk. You can raise outside money to expedite the process and increase your returns (same things that hedge funds do), but that isn’t what determines whether you succeed or not. Funded startups fail. What determines success is whether you got it right (it’s true that having the right idea may not be sufficient if you don’t move as quickly or accurately as competitors, but I attribute that to poor business decision making rather than simply not working hard enough; especially in the age of ai, a large volume of work isn’t what determines success).

In fact, I see a potential convergence in the coming years between human work in investments and startups. If ai is doing everything, the thing that really matters is having an idea with strong conviction and putting your money where your mouth is. Whether that is buying .00001% of a large public company or funding 100% of your own new company, the fundamental idea is still the same. I think hedge funds are just as well positioned to benefit from the ai wave as nascent startups, since at the end of it all they will both really be doing the same thing. In fact, there are some ways in which hedge funds can benefit more, since if the chief beneficiaries of the ai wave are going to be large preexisting companies who will reap the lion’s share of the gains (a big if, I don’t make an attempt to justify it), then it is preferable to invest in incumbents rather than create a competitor. In either case, however, the fundamental way you make money will still be the same - having an idea about the future, putting in your money, and getting it right. Whether you do that on a startup scale or s&p scale is up to you.

Some may object that a critical difference between the two is that the startup owner spends much more time on their venture than an investor spends on their investments. The startup owner interacts with the business, gaining firsthand knowledge over the years and can use that knowledge to improve their business, whereas the investor just waits passively, watching from the outside hoping management does the right thing. Two things to say: I’m of the opinion that whether a startup is going to succeed is in large part determined at the beginning. Of course unexpected things can happen that can cause failure (the founder could get hit by a car), but barring those events, I believe that the winning founder didn’t become good enough to run their company along the way. They were already good enough, as exemplified by the fact that they put their money into the winning business idea, demonstrating their business acumen. In a similar way, the success of a trader’s investment is already determined at the beginning. There are decisions that the investor has to make along the way, like whether market conditions have changed, if they should dynamically adjust risk (increase or decrease it) and so forth. I believe that those decisions mirror the kinds of decisions that a startup founder makes for their business. Along the way the founder better understands their business, and I hold that along the way the investor better understands how their stock moves (though this is localized to the particular time period, not necessarily generalizable long after they exit).

There’s this common narratives that investors don’t have control of their future. That they are beholden to the decisions of a company’s management and the whims of the market. However, I hold that they’re just as much in control as the startup founder. The startup too must contend with outside forces that can topple their venture whenever - lawsuits, issues with vendors, environmental factors, as well as factors the investor must contend with like changing market conditions, difficulty raising capital, tighter credit. The narrative of the helpless investor neglects the fact that the investor really is the master of their own destiny and can, like the startup founder, choose and modify how they interact with the unpredictable outside world. They can modify their positions, introduce new positions in other markets and so forth. While it might seem like their options are limited, there really is a tremendous amount of flexibility they have in influencing their risk exposure and leverage via derivatives as well as complete flexibility to enter and exit markets whenever they choose. The startup founder is constantly making decisions, but these decisions are still limited - they’re still operating within a certain business model, in a given time have fixed suppliers and so forth. I wouldn’t say they necessarily have much more control over their future than the investor. The markets are going to do what the markets are going to do. This is true for startups just as much as for investors. All that matters is how one interacts with the outside market, whether they make the right decisions.

Now that ai is writing all the code, startup founders have just become like investors, putting their money into an idea and having someone/something else do the grunt work. There’s nothing wrong with that. But I think the common narrative is that there is still a distinction between the two, which in my mind is weakening. Sure, the day-to-day process by which startup founders make money may still differ from investors, but the fundamental origin of where each gets their money will be the same. And it’s the money that’s really the point for either of them at the end of the day.