The Michael Scott Theory of Social Class

Alex Danco's Newsletter, Season 3, Episode 2

I’m happy to finally share a thesis I’ve been chewing on for a little while. I call it The Michael Scott Theory of Social Class, which states: The higher you ascend the ladder of the Educated Gentry class, the more you become Michael Scott.

We should start with one background assumption, which is I’m going to assume you’ve watched The Office (The American version) or at least have a passing knowledge of the main characters. If not, then this idea will probably not land as hard, but I hope you read it anyway.

So, twelve years ago, Venkatesh Rao wrote a lengthy and fascinating series of essays called “The Gervais Principle”, which walked through the NBC show The Office, an American adaptation to Ricky Gervais’ original British series. The essays go after a particular aspect of organizational behaviour, around how organizations that survive tend to self-stratify into three predictable layers. (To a large extent, his analysis derives from another magnificent book, The Organization Man by Holly Whyte.)

In the bottom layer, you have around 80% of the office, who occupy the rank-and-file roles. They are the losers. Rao carefully notes that “losers” does not mean uncool, or unworthy; he specifically means “economic losers.” Losers are the people who are set in roles or stations in life where the output of their effort is wholly realized by someone else. As they learn throughout their careers, their skill or engagement might lead to incremental career progress, but no real leverage of any kind. Hence, they are “economic losers”, and they know it. They see the world through clear eyes, and cope. 

Three classic examples in the show, spanning the broad range of Losers, are Stanley, in sales; Pam, the receptionist, and Darryl in the warehouse. Stanley is a grumpy loser; he treats the entire workday as a “run out the clock situation”. Pam is a cheerful loser; she generally tries to make the best of things, although fully aware of her reality. Darryl is a smart loser; he’s wise to how the world works, and successfully rules over his little kingdom of the warehouse, but generally understands he’s staying where he is. 

Meanwhile, at the top you have Corporate. These are the sociopaths; the economic winners. They are smart, they care about getting power, and little else. The sociopath characters in The Office include: David Wallace, the CFO; Jan (before her series of breakdowns); Ryan the temp, who brilliantly grabs real power only to immediately squander it. And finally, the one character who never quite goes over to the dark side but certainly thinks about it (the real will-he-or-won’t-he drama of the show) - Jim. 

The losers and the sociopaths are actually pretty alike. They are alike in that they both see the world through clear eyes, as it actually is. The losers basically understand how the world works, and how their role fits within it. So do the sociopaths. 

But in the middle, in between the losers and the sociopaths, is a very different group. That group is the middle managers: the clueless. In The Office this group is an iconic trio: in ascending order of cluelessness, Andy, Dwight, and of course - Michael. 

When it really comes down to it, The Office is a show about these three people. Because the real subject of the Office, explored brilliantly over many seasons, is this three-layer structure. At the top and at the bottom you have rational realists, but what’s actually interesting is the clueless in the middle, and how they interact with everyone below and above them. 

Michael’s job both shapes, and selects for, a particular kind of detachment from reality. Middle management is a fascinating construct: your employees have literal jobs and responsibilities, and your bosses have literal jobs and responsibilities, but Michael spends his entire day in a construct of his own creation. Everything about his world is subjective and arbitrary. These are people who, in effect, have slipped into a job, worldview, and self-image that is friendly but deeply alienating. 

Once The Office gets really established by Season 3, the central drama of the show takes form, which is the Struggle of the Clueless between Michael, Dwight and Andy. Every other character in the show (except Toby in HR, whose explicit isolation from the rest of the group in both the org chart and the office floor plan is flawlessly executed) is at peace with reality to some degree; but not these three. They are tormented by their detachment from reality. But at the same time, they compete with one another to double down on that detachment. (See the ongoing gag around Dwight's “Assistant To the Regional Manager” title; Andy’s combination of tone-deaf keenness and anger management issues; Michael’s entire existence.) 

There are many fascinating parts of Rao’s multi-chapter series. I recommend reading through them all. But the most interesting topic he dives into, by far, is language. If you look at the way everyone talks to each other, you’ll find five distinct ways that the characters speak both within and between the three groups.

The first major speech pattern between the characters is Posturetalk. Posturetalk is everything said by Michael, Dwight and Andy, to anyone: the staff, the execs, or each other. Everything they say is some form or another of meaningless, performative babbling. This is the language of living inside a construct; where your entire world lives within arbitrarily drawn boxes, and you have nothing concrete to attach to. It’s the only language that Michael knows how to speak. 

When people speak back to Michael, Dwight and Andy, they use a different language: Babytalk. Babytalk is the language spoken from the literal, to the clueless. It’s placating, soothing, or often misdirection: “There, there. You have no idea what you’re saying. Why don’t I distract you with something over here.” 

The three other languages spoken, which don’t involve the Clueless, are Powertalk (the Sociopaths’ internal language, which is entirely about competitive information-gathering and retroactive deniability), Gametalk (The Losers’ internal language: recurring games or coded rituals to get through the day), and the rare instance where Corporate actually speaks directly with the losers: Straight Talk. It’s the one and only time where people actually speak directly, with zero encoding. 

Once you get familiar with this three-tiered realists-clueless-realists structure, you start to see it in other places. One of the biggest stages on which you could argue it plays out pretty faithfully is social class structure in North America.

The 3-ladder system of social class in the United States | Michael Church

Several years ago, Michael Church wrote a neat summary of the American social class system, and how the traditional metaphor of “climbing the ladder of social class” is wrong in an important way. There isn’t one single ladder; there are three - each with different values, norms and goals. You have the first, and largest ladder, Labour. Next, you have the “Educated Gentry” ladder that corresponds to what we typically call the Upper Middle Class. And finally, you have the elite ladder. And the remarkable thing about these ladders is how perfectly they correspond to the three-tiered pyramid in The Office, of the losers, clueless, and sociopaths. 

Climbing the labour ladder means making more money. At the bottom are really tough jobs, typically paid hourly, informally, or with tips. Above that there are stable, but modest blue collar jobs; then high-skilled or good Union-protected careers. Finally at the top you find “Labour leadership”, which doesn’t mean being a union boss, but means, “You’ve made it. You own stuff. You drive a new F-150, you have income properties, you enjoy nice things.”

If you’ve made it to Labour leadership, you are by no means hurting for money. But you have not actually escaped the category of “economic losers”, because the Labour ladder does not create paths to leverage. That is the fundamental difference between how the labour ladder works versus how the elite ladder works. The people on the labour ladder fully understand this. They see the world as it is, with clear eyes, like Stanley, Pam or Darryl - or the one person who actually makes the jump, Ryan - in The Office. 

Skipping the middle ladder for a second, we move to the Elite ladder. The Elite ladder has a lot in common with the Labour ladder: it’s straightforward. You move up by getting more money and more power. The only fundamental difference is that you climb the Labour ladder by working hard, whereas you climb the Elite ladder by acquiring leverage.

The bottom of this ladder is an entry point - junior Investment Banker roles you can jump into, or founding a startup now also qualifies. The next rung up are the executives who run successful businesses. They are powerful, but nervous. Above them is Old Money: the multigenerational dynasties with power that extends beyond business and into media and politics, like the Bushes and extended Vanderbilts. And finally, at the top of this ladder, are the Barbarians. These are the scariest people in the world. 

The middle ladder works completely differently from the other two. This ladder isn’t about money or power; it’s about being interesting. You climb this ladder by being more educated, and towards the top, by having costly habits and virtues. 

At the bottom is also a transitional layer: it’s how you get onto this ladder if you weren’t born there, often via Community or 1st generation College. Above that is the upper-middle class Petite Bourgeoisie. Higher up the ladder are “elite creatives”, people with obscure or virtuous-sounding PhDs, notably interesting lives, or Blue Check Marks on Twitter. (They may well earn less money than those below them on the ladder - this ladder isn’t about income.) At the very top of this ladder is an exclusive group: “Cultural leadership”. The litmus test for attaining this group is, “could you write an opinion piece in the New York Times.” 

Generally speaking, the farther you go up this ladder, the more detached from reality you get. Importantly, this isn’t seen as a problem: it’s actually a virtue, so long as you portray it correctly. Sixty years ago, this group sought refuge and status in the suburbs, explicitly detaching themselves from the reality of dirty, dangerous cities. Now, it’s fashionable to move back downtown, detaching ourselves from the reality of gas-guzzling, chain restaurant normie suburbs. The farther you go into expensive, performative habits (Doing triathlons, eating farm-to-table) and coastal echo chambers (“I don’t know a single person who voted for Trump”; “We should ban cars"), the farther you progress up this ladder. 

On the way up the ladder, you earn social status by doing things that detach you from normie reality. David Brooks wrote a fabulous book on this phenomenon called Bobos In Paradise, about the peaceful merger between the Bourgeois and Bohemian classes that created this strange but durable social tier. These are people that would be mortified to show off a $10,000 watch, but excitedly tell you about their $100,000 kitchen remodel filled with 100-mile diet cookbooks and single-origin Japanese knives, or their 6-month work sabbatical they spent powerlifting. This is a group of people where a Subaru is a higher-status car than a Cadillac, but the highest status car is none. (Or, now, a Tesla.) 

As with Rao’s piece, there are lots of interesting dynamics that Church gets into here, notably the challenges facing people who try to jump from one ladder to another (with the corresponding code switching and value-recalibration it requires). But what I want to highlight is something Church never covers, but you can see clear as day by superimposing The Gervais Principle on top. And that’s how clearly this three-ladder structure reveals itself through language. 

What’s interesting here isn’t the language of Labour or of the Elites - both of these groups see the world more or less as it is. It’s the language spoken by and to the Educated Gentry. Both reveal the extent to which this group has become detached from normal reality, and also the care taken by others (mostly labour) to manage this detachment carefully. 

So some examples of Posturetalk (the Educated Gentry talking to anyone; but mostly to each other) include Farmer’s Market Banter (“Praise me for how sustainable I am”), Academia Banter (“Validate my obscure pursuits”) and Blue Check Mark Twitter (“Enshrine my Takes”). Examples of Babytalk (speaking to the Educated Gentry) include Uber Driver Banter (“I’m willing to entertain this conversation but please give me a 5-star rating, I really need it”), Whole Foods Marketing material (“You areso wise for shopping here.”), and Prestige TV (“You are so smart for watching The Good Place”). 

The great irony of the Educated Gentry is that the more time you spend in it, and the more people talk to you with that language, the more you turn into Michael Scott. It’s a funny juxtaposition, because Michael Scott in the show is absolutely not in this economic class (he never went to college; his job falls solidly in the labour ladder), but his character is a bang-on portrayal of what’s like to aspire to Petite Bourgeoisie values.

Brock is 100% correct; it is a certainty that Michael Scott knows how to use chopsticks. He’d be proud of it. You could script an entire scene of The Office around the topic of Michael and chopsticks, filled with Michael’s posturetalk (his fully inaccurate beliefs around the culinary evolution of chopsticks, which he recites enthusiastically) and Babytalk from both his coworkers and his server ("Oh is that right? We don’t always get customers who are so knowledgeable. How about I get you another Nog-a Sake?”)

This keeps getting back to why the language part is so important. Michael’s pride in his chopsticks proficiency isn’t a superfluous detail, it’s a consequence of being spoken to in Posturetalk / Babytalk throughout your adult life. When you’re in that environment all day, this is a natural reaction: it’s a kid’s idea of what grownups celebrate. Look at any of Michael, Dwight and Andy’s interactions that highlight proficiencies they’re proud of: Michael’s made up but authoritative-sounding trivia, Dwight’s law enforcement and survival skill LARPing, Andy’s a cappella; these are all upper-middle class values that are stoked by the perpetual fear that your peers don’t take you seriously. (As Brooks points out in Bobos, the highest possible compliment within this social class is to call someone “Serious”, as in, “He's a serious kiteboarder” or “She’s serious about cooking healthy meals.”) 

Language is the fundamental reinforcement mechanism of why arbitrarily constructed environments eventually turn you into Michael Scott. The more you have committed to being seen as interesting within your particular area, the more you detach from reality and move into a construct of your own creation. As this evolution takes place, more of your and your peers’ language will become Posturetalk, and more of the language that gets spoken to you by outsiders will become Babytalk. 

As more of the language surrounding you becomes Posturetalk and Babytalk, the more conclusively you will double down on being “serious” about whatever you’re pursuing, as both a defence mechanism and in pursuit of real praise. This drives the cycle forward again, as your values and environment become increasingly defined by doing Triathlons or whatever. Eventually, you become Michael Scott. 

To conclude, I present to you the Michael Scott Theory of Social Class, which states that the higher you ascend the Educated Gentry ladder, the more you become Michael Scott. So: 

Serious Triathletes? Michael Scott. 

PhD Students? Michael Scott. 

Have an opinion on the right amount of hops? Michael Scott. 

More than 10,000 followers on Twitter? Michael Scott. 

Really into urbanism? Michael Scott. 

NYT Op-ed? Definitely Michael Scott. 

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Have a great week,


Why the Canadian Tech Scene Doesn't Work

Alex Danco's Newsletter, Season 3 Episode 1

Hello and happy new year! Welcome to Season 3 of the newsletter. I posted this week’s essay on my blog on Monday, and it’s safe to say it’s generated a fair amount of discussion since. I’m delighted to see these conversations happening, and look forward to what we’ll all get done together in 2021 and beyond. Thanks as always for reading and for keeping it interesting! -Alex

Toronto is not the next great startup scene. Neither is Waterloo, or Vancouver, or anywhere in Canada. 

I’m sorry that I have to write this. I really am. I want it to work. But the growing chorus of aspirational claims that “Toronto’s tech ecosystem is growing faster than anywhere else in North America” or “The Toronto-Waterloo corridor is ’the nice person’s Silicon Valley’” honestly do not portray an accurate picture of what we’ve built here. 

To be clear: I am not saying there are no individual success stories of Canadian startups, or that there are no good angel investors or VCs here, or that there are no individual instances of things going right. Shopify obviously worked out great, there are other big success stories like Lightspeed making their way up, we have some really good initiatives around bringing new builders into Canada, and there are a good many individually inspiring startups that I admire. 

There is certainly a lot of something here. It’s true that big companies are adding tech jobs here; it’s true that there is a lot of activity in the startup scene here. But we do not have a real startup scene that actually works; not yet. You cannot put the Toronto tech scene side by side with the Bay Area’s and say, “These are similar; ours is just smaller.” Come on; it’s not. The Bay Area’s startup scene continuously pulls incredible companies into existence. Ours… does not do that. 

The Canadian tech scene, as it currently operates, does not support startups. It stifles them. I’m sure for some of you it’s in your professional interest to insist otherwise, and look I respect that, but I care about us getting this right, and someone needs to say this so it might as well be me. 


There’s no easy place to start. The startup scene is a system, with many interacting parts: Angel and VC money, the peer set of other founders, engineering talent, the set of social norms; everything depends on everything else. But we have to pick somewhere to start telling this story, and I think the best entry point is to talk about angel investors. 

I remember back when I was at Social Capital, Jay and I would go visit other cities to check out local startups and university research facilities. Every time, we’d hear the same refrain from locals: “We’ve got so many great ingredients for a tech ecosystem here. We’ve got the science and hardcore R&D coming out of the local university system. We’ve got so much engineering talent. And there’s a lot of investment capital available. We’re just missing one thing, and that’s early stage investors.” 

Well, yeah. A startup scene needs angels. Without a source of fast-moving, pre-institutional capital, it’s hard to pull off a cold-start when you’re first funding a project. But you know what’s even worse than no angel investors? Having bad angel investors. 

In order to understand the difference between Good and Bad angels, I think it's helpful to have a quick understanding of Finite and Infinite Games, by James P Carse. This book introduces a simple but profound idea about there being two fundamental kinds of “games”, or multiplayer activities, that we engage in as people: 

First, finite games are played for the purpose of winning. Whenever you’re engaging in an activity that’s definite, bounded, and where the game can be completed by mutual agreement of all the players, then that’s a finite game. Much of human activity is described in finite game metaphors: wars, politics, sports, whatever. When you’re playing finite games, each action you take is directed towards a pre-established goal, which is to win.

In contrast, infinite games are played for the purpose of continuing to play. You do not “win” infinite games; these are activities like learning, culture, community, or any exploration with no defined set of rules nor any pre-agreed-upon conditions for completion. The point of playing is to bring new players into the game, so they can play too. You never “win", the play just gets more and more rewarding. 

Good Angels are playing an infinite game. They are contributing to a community; not in order to win something definite, but to earn the right to keep participating in the scene. They play the infinite game of growing their status within a growing community, which is a very good thing. And they often make a ton of money, leading to the perplexing advice for outsiders: “the way to make money angel investing is to not set out trying to make money.”

Bad Angels are playing a finite game. They are trying to win something. 

There are two kinds of Bad Angels. The first kind are literally in it for the money: they want to see financial returns in a reasonable period of time, and push their founders to run their startups as an investment, like real estate. The second kind is more subtle: they’re Angels who’re doing it for the satisfaction and the status, but only among their own, closed peer set. They are competing for zero-sum bragging rights, not working to grow the community. 

Bad angels waste founders’ time a lot. They’re always asking for something; either for P&Ls and business plans, or suggesting introductions that are clearly for the Angel’s social benefit rather than for the founder’s. Bad Angels care a lot about milestones. (More on this later.) You see these sorts of Angel investing clubs or societies on the east coast a lot. Canada has them too. 

Good Angels have an entirely different attitude about the relationship between angels and founders. They’re not trying to win something; they’re trying to create something. This is a good thing, because that’s exactly the mindset you need to have, if you’re founding a startup. Startups are also infinite games. At the moment you found a startup, at no point in the next ten years (or whatever appropriately long time horizon) will you have “won” anything; nor is there a fixed set of rules you’re agreeing to. You are playing in order to keep playing. Your goal is growth, and growth is never done. 

Of course, that’s not the only way to run a business. The majority of businesses can be appropriately described as finite games: you’re going after a bounded, definite opportunity; with a clear concept of what winning looks like. Canada loves these kinds of businesses; probably because our economy is made of banks and mines. 

But these aren't startups, the way we use the term startups. Startups are a bet that the future will be radically different from the present, and they are valuable on the way up because they are, effectively, a call option on that future coming true. Their founders set out to discover that future; their value is indefinite, not definite. One day they might become giant, cash-gushing businesses; but not anywhere near your current horizon. Your only goal right now is grow, explore, and earn the right to keep growing and exploring. 

So, as you might guess, there is a cross-catalytic relationship between Good and Bad Angels, and finite versus infinite-mindset founders. Each pair attracts each other, for obvious reasons. But just as importantly, the two kinds of angel investors mutually repel each other. If you have a critical mass of Good Angels, the bad ones will get pushed out (they’ll just stop getting invited to deals). And if you have a critical mass of Bad Angels, the good ones will leave (they won’t be having any fun, so they’ll go find a different hobby.)

If you have a background in electronics or in systems diagramming, you’ll recognize this setup: this is a toggle switch. It could break towards either side, but once it gets “set” on one side or another, it’ll tend to stay there. 

So where do Good Angels come from? There is really only one reliable source of Good Angels, and that’s big liquidity events of other startups. Any other source of money is potentially suspect. But Angels who’ve made their starting nest egg from founding or growing a startup of their own understand the infinite game, because they’ve played it. And they want to keep playing it, because they like it, and Angel investing is how you do that. 

Massive exits in a community have three really important feedback effects on next generation of startups. First, they create Angels, and motivate the existing ones with FOMO (nothing motivates you to invest more than having passed on eventual unicorns). Second, they inspire startups with the infinite mindset, as role models. Third, they set a high bar for what is possible, forcing the community to think about growth all the time, and releasing all of these operators back into the ecosystem who know what unbounded, indefinite growth feels like.  

In contrast, in startup communities that haven’t had a lot of big exits yet, not only are you missing a few of those good ingredients, you also create one very bad ingredient and that’s a preoccupation with getting liquidity events. This is extremely dangerous, and the Canadian tech scene has fallen far down this trap. We’ll get back to this idea in a minute.

Deal Speed and Founder Leverage

The most visceral difference between the Canadian startup investing scene versus the Bay Area is speed. It is not an incremental difference: they operate on entirely different time scales. Bay Area startups can go from initially announcing their pre-seed round to closing an oversubscribed round of SAFE notes in 72 hours. In Canada, you’re generally lucky if you can get a deal done in 3 months

Speed of deal completion is important on its own right (founders do better when they spend more time building and less time fundraising), and it’s also a good indicator for who has the leverage in the founder-investor relationship. In the Bay Area, it’s very clear who has the leverage; it’s founders. Deals get done quickly, cleanly, in-and-out; if an investor is a pain or slows things down inappropriately, they stop getting invited to deals. 

There’s an interesting question here: in big startup ecosystems, why do deals happen faster and on more founder-friendly terms than in little startup ecosystems? It’s obvious that in ecosystems with more investors, they have to compete with one another. But there are also more startups. Why do more startups = more leverage for the startups? 

The answer is actually pretty simple: the more startups in the scene, and the more deals happening in real time, the less time you have to think about any one deal - regardless of how many investors there are; it is solely a function of how many startups there are. And when you have very little time to evaluate each deal, you onlyhave time to ask: “what can go right.” And that’s a negotiation that’s on the startup’s terms. You only have to time to ask, who are the founders, how fast are they growing, and who’s investing. In other words, “Are you playing the infinite game, and will you get the runway to do it?” Those are the right questions to ask. 

In contrast, in the Canadian startup ecosystem where fewer deals happen, there is more time to evaluate any one startup or any one deal. The world of startups is fully knowable, and there’s plenty of time, so the time spent on a deal will expand to fill the time available. And if there’s a lot of time available, then deal diligence will quickly enter determinate territory. You will find time to ask, “what can go wrong.” And you’ll find a lot!

This is bad, for two reasons. It’s bad because the very best startups, who have the longest time horizon and are most curious about the world, will look disproportionately uninspiring. They’ll have the fewest definite wins relative to their ambition, and the most things that can potentially go wrong. Paradoxically, you’ll also select away from the companies with the fastest growth rates, because fast growth rates (the best possible thing you can have as a startup) are not a definite accomplishment; you can always poke holes in them, you can always intellectualize reasons why the growth rate will stop. The longer you diligence a turbocharged growth rate, the more excuses you’ll find for why it can’t persist. 

Conversely, it’s bad because startups will learn to optimize for how to get funded. So if seed deals take 3 months, then founders will learn to build companies that look good under that kind of microscope. And that means they’re going to optimize for playing determinate games, so that they can show definable wins that can’t be argued against; rather than what they should be focusing on, which is open-ended growth. (Canadian investors love to say, “Your growth is impressive, but we want to see some concrete milestones. We’ll fund you once you’ve achieved this definite accomplishment.” Startups listen.)

Unfortunately, in the long run, not only does this not select for the right startups, it undermines the startups’ own leverage. It’s a vicious cycle: the more that startups are selected for deterministic thinking, the more it ends up proving the VC’s skepticism right, and the less leverage the startups will have in negotiating terms next time around. 

Even though startup ecosystem size & deal speed seem like continuous spectra, in reality it’s more like they operate in one of two modes: fast mode or slow mode. In fast mode, ecosystems like SF actually preferentially select for the startups that go on to do the most impressive things. In slow mode, ecosystems like Canada preferentially select for the startups working on the most determinate, measurable things. Just like the angel investing ecosystem can get “toggle switched” into either of two modes, same applies here: it’s not really a continuum. Once you get into one or the other mode, reinforcing loops take over. So it really matters which one you’re in. 

Valuation and Milestones

Another fairly obvious difference between the Canadian startup ecosystem versus the Bay Area is that valuations are lower. It’s actually not just valuations that are lower; the price of everything is lower (including salaries, which is helpful if you’re staffing entry level positions but a huge problem when you’re trying to recruit experienced managers & senior talent). But the valuation issue is pretty central. 

For a long time, Canadian VCs were effectively forbidden by their LPs to give out the rich, inflated, “indefensible" valuations that you saw in the Bay Area. (You spend how much of our money? At that valuation? For this?) In recent years, as it’s become clear to everyone that you actually need those high valuations to support a critical density of early-stage startup creation, that attitude has softened. But the “Canadian Discount” is still a very real thing. 

In contrast, Canadian investors love to plan ahead for exits. You can’t blame them: they understand the value of these big liquidity events, and that we need more. They understand what we’ve been missing. It’s hard to overstate how much of the narrative around Canadian tech concerns: “we need to get more exits for the ecosystem.” 

There is a Canadian Startup Inferiority Complex at work, and it compels us to defend our achievements: “Look at everything we’re doing! Look at these achievements, and look all these milestones our startups are achieving! Surely, these milestones are adding up to success.” We need a narrative that we’re on our way, that we don’t have these exits yet but we’re working on them; and that turns into a culture obsessed with milestones.

This preoccupation with milestones kills startups dead in their tracks. 

Why are milestones so dangerous? Because when you define clear milestones, you initiate finite games: you’re defining and bounding the problem of startup-building, and inadvertently creating a “win/loss” condition upon the completion of the milestone. Just as before, when you start thinking in terms of milestones, you are no longer asking, “What can go right”, because you’ve already defined the boundaries of “right”. As soon as you start thinking in milestones, you enter the mindset of “what can go wrong”, and you actually break the special magic that makes VC work at all.

VC is a financial invention that’s been perfected to purchase call options on a different future, not in definably achieved milestones to date. The point of startups is to go through the J curve in an all-in bet on a belief about the future. When you are in the J curve, your “milestones” are not actually definable in a positive economic light; certainly not relative to capital raised. 

I’ve written before about how “the greatest trick VCs ever pulled was calling it ‘valuation’”, and how the numbers on VC funding rounds are not actually pricing formally calculated valuations, they’re pricing discounts to the next round. Successfully funding a VC-backed company all the way through series C or whatever (at which point something resembling an actual valuation can take place) is essentially an exercise in rolling forward a “discount on a discount on a discount”: I’ll pay this $6M pre-seed valuation, not because there’s $6 million of tangible value here, but because it’s a discount to the next round (20), and then the next (50) and then the next (180). VC financing is a controlled bubble. 

This method, as recursive as it sounds, is a legitimate financing innovation: it lets startups dig deeper into the J curve, repeatedly financing their business off of the possibility of “what could go right". But for it to work, you can never at any point formally value what’s been built. If you do, you puncture the bubble. (The exception is 409A valuations, which you want to be as low as possible. The sleight of hand with these, of course, is fantastic. Valuations are high and aspirational when we need them to be high, versus low and literal when we need them to be low.) 

Our Canadian obsession with milestones, unwittingly, turns every startup financing event into something like a 409A valuation. Which is the exact opposite of what you want to do! This is a large part of why Canadian startups have lower valuations across the board than American ones; every time we define a “milestone”, we puncture the valuation bubble and then have to start again. Yet the investor community is continually compelled to do this (especially at early stage; what we’d call pre-seed and seed today), because of the need to show that we’re winning our finite, definable, “winnable” games. 

Quite in character with our love of milestones, Canada loves anything with structure: accelerators, incubators, mentorship programs; anything that looks like an "entrepreneurship certificate”, we can’t get enough of it. We’re utterly addicted with trying to break down the problem of growing startups into bite-size chunks, thoughtfully defining what those chunks are, running a bunch of promising startups through them, and then coming out perplexed when it doesn’t seem to work.

Nondilutive Funding and Fancy Buildings

Hopefully by now you can see this picture coming together: the difference between the Canadian startup ecosystem versus the actually-functioning one in the Bay Area isn’t an incremental difference of degree. They’re two systems running in totally contrasting modes: one runs fast, rules opportunities in, rolls valuations forward, and is optimized for infinite-game-mindset founders. The other runs slow, rules opportunities out, feels the need to “defend” valuations (thereby collapsing them to their literal milestone value) and optimizes for fixed, finite games. 

Unsurprisingly, the second one isn’t working. But it’s a priority of ours, on both a local and a national level, to somehow make it work. So we do the obvious thing: we add money. 

One government program in Canada you may have heard of is called SR&ED credits (“Scientific Research & Experimental Development”), a government tax rebate program to encourage R&D spending by Canadian businesses. If you’re an established Canadian tech company, like let’s say Ubisoft, this program is totally helpful and as far as I can tell it’s a perfectly fine way for the government to subsidize technical employment. 

But SR&ED credits also have a lot of appeal for startups. It’s “free money” to offset your R&D costs, and who doesn’t want that? So there’s a whole cottage industry in Canada around getting this money into the hands of startups, and helping them maximally leverage SR&ED as non-dilutive funding for technical work. 

Unfortunately, SR&ED isn’t actually good for startups. It’s really unhealthy for them. 

The problem with SR&ED credits, honestly through no fault of their own, is that you have to say what you’re doing with them. This seems like a pretty benign requirement; and honestly it’s pretty fair that a government program for giving out money should be allowed to ask what the money’s being used for. But in practice, once you take this money and you start filling out time sheets and documenting how your engineers are spending their day, and writing summaries of what kind of R&D value you’re creating, you are well down the path to destroying your startup and killing what makes it work. 

The problem starts when founders think about SR&ED as “free money”. It is not free. It has a cost of capital, like any capital. But instead of costing you your equity, it costs you your time, your focus, and above all it costs you something you can never get back which is your indeterminate curiosity. 

SR&ED forces you to play finite games, because it forces you to articulate what you’re spending this money on. And so you have to justify, at the very least, what problem you are solving and what specific steps you are taking to solve it. You enter the world of problem definition, where building your startup becomes Serious Work, with official time sheets and government forms. 

The minute you take SR&ED money, some meaningful part of your startup becomes a government work program. And the minute any of your startup becomes a government program, I can pretty reliably tell you what’ll happen to the rest of it. By seeding an ecosystem full of SR&ED funded startups, the Canadian government inadvertently drained the spontaneity and curiosity out of our startup scene. It’s hard to recover from that.

Once you understand the problem of SR&ED credits, as well-minded as they are, you can easily understand by analogy what’s wrong with almost everything else the government does to support startups here in Canada too. We build spectacular buildings in downtown Toronto for hundreds of millions of dollars in order to “create space for the tech industry”, and then wonder why these startups suddenly become obsessed with doing all of the wrong things. 

Meanwhile, we obsess over mentorship programs and other kinds of “non-dilutive help”, without realizing that there’s a cost to everything, including these relationships - and the steepest cost a founder can possibly pay is to give up an indeterminate trajectory. I mean, guess who these mentors are? They’re either people who have build successful Canadian businesses (finite games!) or, alternately, people from the tech industry who are signing up for formal mentorship programs rather than becoming angel investors. This is devastatingly expensive to startups; not only because these relationships consume the founders’ time, but because they helpfully impose “adult supervision” that robs founders of the very indeterminism that makes their companies valuable.

But because those costs aren’t easy to articulate, but the benefits can be easily tabulated and showcased, we just pile into them - and when the startup scene doesn’t seem to spontaneously self-organize into something like the Bay Area, we conclude, “Well, startups are hard, we need to support them more. Let’s build them some more buildings, and get them more grants!” 


So, let’s work our way backward through everything we’ve talked about here and understand how the Canadian startup scene has gotten stuck in the wrong way to do things. 

Programs like SR&ED, Institutions like MaRS, and other well-meaning but disastrous government initiatives to support the startup ecosystem relentlessly pump money into the startup scene. This money is advertised as “free” or “non-dilutive”, but in reality it’s the most expensive kind of money you can imagine: it’s distracting, it begs justification, it kills creativity, and it turns your startup into a government work program. 

Once your startup becomes a government work program, even if you pretend otherwise, you are forever onwards compelled to play fixed, finite games with your time and with your resources. You have to define what problem you are solving, and what you’re doing to solve it. You have to demonstrate value created.

The minute you spend any time doing that, with any part of your startup, that becomes the work product of more and more of the startup over time. Once you slip into playing fixed, definite games, that becomes everything you do. You become a milestone-oriented company, rather than a growth-oriented company. And there’s plenty of non dilutive money and government support for supporting and rewarding those milestones, so you can play this game for some time. So will your other founder peers, and this will just be normal.

But by becoming a milestone-oriented company, you’ve unwittingly destroyed your ability to actually put VC money to work, the way startups can do in California. And even before you take VC money, by becoming a milestone-oriented company, and learning how to talk and act in order to highlight those milestones and raise money off of them, you’re going to preferentially select for Bad Angels and disappoint Good Angels. The Good Angels simply won’t be having any fun: they won’t find the infinite game they’re looking to play, so they simply won’t play at all. So the early-stage funding environment gets saturated by the wrong type of money: well meaning, perhaps, but toxic to startups. And so startups start out hobbled, and likely never recover. 

And this keeps the cycle going: the failure of these startups to sufficiently mature into unicorns (how can you blame them) compounds investors’ insecurity and obsession with “getting some exits for the ecosystem”, reaffirming their experience that these investments never generate any real returns, and reaffirming all of their decisions to say No rather than Yes. The ecosystem becomes defined and bounded by its small thinking.

And then, imagine you want to start a startup. Would you do it here? Or would you just get on a plane, and go to California? 

Unfortunately, this decision compounds generation after generation of startups. For every batch of 10 new founders, the 2 most creative ones immediately leave (because it’s the right decision), leaving behind the other 8. They then start and grow their startups in this fixed-mindset, milestone-oriented environment, and become the environment that the next 10 founders step into as they graduate from Waterloo, or wherever. When the two particularly creative founders in that batch look around, yeah they’re probably gonna go to California too; again, leaving behind the other 8. 

It was a bit of a bummer writing this essay. It’s not fun to write about this systemic trap we’ve gotten ourselves into; especially because there are so many individually good people and startups and firms in Canada who are trying their best to do good work. This is a system problem. 

My hope is that people in Canada reading this will realize that the problem facing us isn’t a lack of anything. The problem with our startup scene isn’t a lack of money, startups, investors, hustle, great Universities, technical talent, or creativity. Our problem is actually the presence of actively bad things: all of our non-dilutive (but extremely expensive!) innovation credits, the presence of incubators and entrepreneurship programs, and the accidental costs of milestone thinking. If we want to build a real startup community in Canada, we need to let go of those crutches, and choose the Infinite Game. 

That’s part of why I think that if any city in Canada has the potential to actually develop a Bay Area grade startup scene (smaller, sure, but actually the real thing), it’s clearly Montreal. Of the major cities in Canada, Montreal is the only one that naturally has an infinite game mindset. (But it really, really does. Montreal is a special place.) If Montreal weren’t in Quebec, it would be an unstoppable startup scene. 

Anyway, I’ll wrap this up for now, but I hope we get this right eventually. In so many other ways beyond the tech scene, Canada is a special place. We’ve pulled off something absolutely incredible in our experiment of speedrunning multiculturalism; we’re (in my opinion) one of the overall nicest and freest places to live in the world; Canada is great and there’s a lot to be proud of here. But Canadian tech, specifically, can do better. I hope we do! 

For other stuff to check out this week, first of all I don’t think I’ve actually talked about this on the newsletter yet - you have to check out what Patrick O’Shaughnessy and his team have put together in Colossus.

As you know, I’ve always been a long-time fan of Investor Field Guide and of its recent companion, Founders’ Field Guide. The amount of sheer knowledge and learning potential in there, in those episodes free for anyone to listen to, is just staggering. I don’t know how many times I’ve had the same conversation with people about how you could fill a world class MBA program 5x over with the free content in those episodes; the problem is just that it’s hard to access, trapped inside all that audio.

So, I’m just overjoyed (and also a little intimidated) with the drop of the next phase of that franchise, Colossus. Colossus is a learner’s dream come true. It’s an organized, searchable repository of all of the knowledge from all of Patrick’s guests, both founders and investors. If you haven’t yet, you need to go explore what’s in there.

Two recent episodes I encourage you to check out:

Ram Parameswaran of Octahedron Capital: internet-scale businesses

Carlos Cashman of Thrasio: Lessons from the Amazon ecosystem

And finally, this year’s inaugural Tweet of the Week, right after news dropped of the Plaid/Visa merger cancellation. Folks, it doesn’t get any better than this:

Have a great week,


Shopify, SPACs and Status, Part Two: with Jim O'Shaughnessy

Two Truths and a Take, Season 2 Episode 42

Note: this will be the last newsletter of the year (obviously; there aren’t any more Sundays) and the last episode of Season Two.

It’s also going to be the last episode under the banner, ‘Two Truths and a Take’, which was a fun name that I enjoyed, but had two problems: 1) it’s a mouthful to say; and 2) no one really called it that, myself included. So starting next year with season 3, it’ll be the same newsletter under a new name, but really the name it’s been called all along: “Alex Danco’s Newsletter.”

I’m going to take a couple weeks off to start the year, and I’ll see you back mid-January. Have a great holiday season, and enjoy kicking 2020 into the garbage can come New Years!

Welcome back to part two of my big interview with Jim O’Shaughnessy. If you missed part one last week, it was a great time and you should read it first:

Shopify, SPACs and Status: my interview with Jim O’Shaughnessy (Part One)

We covered parts one and two last week:

Part 1: Shopify, Friction and Commerce

Part 2: Twitter, the World’s Learning Commons

This week, the back half, where it gets really fun:

Part 3: Founders and the Truth

Part 4: SPACS, Biotech, and Bubbles 

As before, if you want to listen to the real thing, which I highly recommend for the full effect, you can find it here

To catch you up on where we were, Jim had just finished telling the story of how Jamie Catherwood got his job at OSAM (by writing really high-quality stuff on the internet for a long time, but then pulling a fast one on Patrick: “Oh, in New York? Sure, in fact I’m there today!” he said, as he pulled on clothes at 4:00 am and hopped into the car.)

Alex: That is one of the classic hustler entrepreneur stories, right? Which is the... You finally get an investor's attention. And they're like, "Oh, let me know when you're next in New York." And you're like, "Oh, I'm actually going to be there on Monday." Buy the cheapest plane ticket to New York.

Jamie: Morgan Housel did that with Jason. Literally Jason said, "Let me know the next time you're in New York." And Morgan was like, "Oh, I'll be there tomorrow." bought an Amtrak ticket.

Alex: Oh, it's such a trope. It's a really, really good trope.

Part 3: Founders and the Truth

Jim: This reminds me of an article you wrote, Are Founders Allowed To Lie? I love this article by the way.

Alex: You've decided to get me canceled I see.

Jim: You are about to be the main character on Twitter.

Alex: I'm going to be the main character. I feel badly about this. So, I wrote that post and in it was some story that I have heard 100 times about the Microsoft founders making some stuff up and playing a little fast and loose with the truth when they were getting an early deal done. I had copied this anecdote out of Byrne Hobart's newsletter (another amazing newsletter.)

This is some story where, I don't know, I've heard this story so many times, I'm just going to copy and paste. And then immediately Tren Griffin, who is somebody who actually knows what he's talking about, goes on Twitter. And he was like, "Excuse me, this is completely factually wrong. None of this happened the way you're talking about how it happened."

And so, I dunno, I was stressed out about something at work. So I was like, "I don't want to deal with this. I'm going to let Byrne deal with this.” So I just tagged Byrne with a question mark on Twitter and then muted the thread, which is truly a despicable thing to do. But I was like, "I don't know man, I got to do other things. I have to do work."

Jim: Talk about throwing someone under the bus.

Alex: Unforgivable behaviour. So, anyway, Tren, if you're out there listening to this, you're right. I'm sorry. I just didn't have time to deal with that. I corrected it later.

Jim: It's funny because we recorded with him like two weeks ago.

Alex: That's great.

Jim: He didn't even bring you up, Alex.

Alex: Clearly, maybe Byrne made such a good impression on him that bygones are bygones. Anyway. So, this essay that I wrote, Are Founders Allowed To Lie. Look, this is one of those taboo topics. But that is very important with the whole idea of startups, which is... At some literal level, if you were trying to make the future and you are trying to conjure something out of nothing that does not exist, it is very hard to get things going, if you were only ever allowed to tell the literal truth all the time.

Jim: Right.

Alex: Right. And I don't just mean truth by commission, I also mean truth by omission. If you are consistently compelled to tell the literal truth about what is going on at all times, very, very hard to create forward progress where none exists.

Jim: But also that's, I mean, you've seen the movie Liar Liar, right? With Jim Carrey. It's back when Jim was still funny and he played a lawyer whose children asked for a wish that their daddy could not lie for one day. Hilarity ensues. Anyway, so, when I read the article, it was like, well, of course this is a question of degrees, right? I mean, you can omit certain things. You can massage certain things.

Alex: Right. And so there's a concept called Kayfabe, which is a term from pro wrestling, that is really valuable for understanding the contract that is at work here between the founder and other people. The scenario is basically as follows.

If you decide you want to go out and change the world in some useful, positive way, the main thing that you have to do is to get other people to feel the same way about what you're trying to do. And you need them to feel that emotion above a certain threshold for enough period of time, for them to actually start helping you, make this thing happen, right? The limiting factor is the ability to get these feelings to take place. Now you have to ask, "Okay, how are you going to go about getting these feelings to happen?"

And here's where pro wrestling is actually useful as the way of understanding this. If you go watch pro wrestling, if you go look at people who are wrestling fans, you see something interesting happened with them, which is, they're watching a show which is very clearly scripted. You're being presented with something that is not factually happening. It's a performance.

Jim: Right.

Alex: But, they're experiencing very real emotion when they watch it. They actually feel the feelings of the storyteller. And they actually feel the highs and the lows. What's being presented is clearly fabricated. But the outcome of what's being presented is very real. And there's no cognitive dissonance here, right? It's like asking somebody who just got off a roller coaster, "Don't you realize you weren’t actually on a runaway mine car?" It doesn’t matter. It felt real to me. And that's what matters.

Jim: Right.

Alex: Now, this is what founders have to do with other people around them. So, employees, partners, investors, anyone around you, is get them to feel the feeling of, I want to do this.

Jim: Yeah.

Alex: Right? And you're going to tell a story about all the progress you're making and all the inevitability of what you're doing and how this vision of the future that is coming true as we speak. There’s a contract that I am willing to engage into with you: Look, I'm going to present you this story of what I'm doing that is clearly embellished and incomplete but is a genuine portrayal of an aspiration, rather than necessarily the literal truth of what's happening. But the contract is that I'm going to present you this in a way that makes you feel a very legitimate feeling in pursuit of helping what I'm telling you about become real.

Again it comes back to this idea of Kayfabe. It's about authenticity and fidelity to the idea as being more important than factual verifiability. If you look at why this works so well in Silicon Valley, it goes back in a lot of ways, like the hacker mindset of the early computer programming community, where there is a big mindset of, intention matters more than rule-following.

If you have good intent, that is more important than if you are literally obeying by the letter of what you are and aren't permitted to do. That's very much the ethos. It's very honour system based. And still to this day, Silicon Valley is remarkably run on the honour system. You cannot understand the startup community in Silicon Valley without understanding first and foremost, how deeply reputation-based it is.

And part of why this works so well in fact, is that in joining this ecosystem and participating in this world where you are, it's all about getting people to feel the right feelings and signal that you have the right intent. That makes this reputation-based world function so well as it does. There are many, many, many forces holding this together, but deeply at its core, it's like, there's a trust at the centre of it that's hard to replicate anywhere else.

Jim: So, there's a spectrum obviously, right? I joked that maybe we would call it the Elon Spectrum. And so, what happens if you topple over into the Elizabeth Holmes side of things? Does that... And by that, I mean, when everyone figured out what she did, right? Does that impact negatively this spirit of trust?

Alex: Okay, so there are a couple of things here that we should talk about. The first one is that Theranos is a remarkable story, but what's remarkable about it is how not a Silicon Valley story it is.

Jim: Wow.

Alex: Theranos is actually not representative of the usual process. And that is part of how things got to the way it was. If you look at Theranos as one example; Nikola, the truck where they rolled it down the Hill, did all of that really funny stuff. What is remarkable about this is that it is in many ways, an effective demonstration of how powerful the Silicon Valley system is. How yeah, you can go look around and find one or two Silicon Valley investors in there. But for the most part, their investors, their community was somewhat on the fringe of this. And this is not to say that Silicon Valley is not full of embellishment and lying and stuff like that, but it's not fraud. There's a big difference between what we're talking about versus actual falsehood.

One of the golden rules of engaging in this is this idea that as the founder, you are empowered with permission to, let's just call it, tell the “pre truth”. Have good intent, and then communicate that intent in a way that tells the future in advance and gets things to happen. And part of your ability to do that is conferred on you by your investors. Your investor is funding you with a Series A term sheet and going into your cap table and becoming the people who have the most at stake. They are effectively blessing you, like the priests blessing the King, with their divine power. 

Jim: The Imperator.

Alex: That's right. It's your power is bestowed on you almost as if by the divine to do this, but as it is given to you, it can also be taken away from you. And that's very important. So the power that VCs have over the past 10, 15 years has migrated from being a hard power. It used to be, we take 40% of your company and two board seats and you don't have control. We kick out the founder and put in our CEO. VCs’ power is no longer that power. It is really a more soft power. Which in many ways is actually more effective. It's based on your reputation and your community and your standing among your social peer set and the ability to confer, but also withdraw this blessing of having the tools to get things going. It's a fascinating social dynamic.

Jim: So what was the spark that led you to write this again? 

Alex: I was compelled to write it just because that particular week was Nikola, the truck company-

Jim: The truck company. Okay.

Alex: ... So again, this is a truck company that is not really a Silicon Valley company, but I had heard of it, people had heard of this Hydrogen company. So first thing is, they went public with the Jeff Ubben SPAC. And then, you have that Hindenburg research report. This is the big short sellers report. That's was one of the catalytic events for this whole big downfall of the story.

Together it paints this picture that is fairly embarrassing. But if you look at any individual thing that they did, most of them are, I don't know, I could see a founder doing that. And basically thinking it was fine. You roll the truck down the hill to make a video, big deal. They never actually said that the truck was moving under its own power. Like they called it a “road test”, which is really funny. It was on the road. They were testing. Where is the lie?

Jim: Clinton's deposition where he said, it depends on what your definition of the word is, is.

Alex: Yeah. So, and again, not to spoil the ending here, but I learned about this from one of the masters. Everybody knows here, who I'm talking about; I'm talking about Chamath. Chamath is a remarkable person because he has such a command of narrative. He is unlike anybody else I've ever met. If you were within a physical radius of him, everything he says is more compelling than anything you've heard in your entire life up until that point. And then he leaves the physical room, and for maybe 30 seconds afterwards the feeling persists. Then you realize wait a minute, none of that's true. But it doesn't matter; he has the charisma and the ability to just absolutely command a storyline in a way that was just remarkable.

Part 4: Spacs, Biotech and Bubbles

And so Chamath sat us down several years ago. And said, I'm going to tell you about this new thing we're going to do. It's called a SPAC. None of us had ever heard about this, but this is going to be the new way that companies go public.

We don't need to go into the whole mechanics of the IPO versus SPAC debate. People have heard this too many times, but the core message here was this idea: that as costs go down, not just transaction costs but also the costs and friction of communication, the essence of what is needed to go through a phase change from being private, to being public, will change.

It's a change. There is risk and effort involved. But “how are you going to get from A to B” is going to change from needing the massive, expensive apparatus of a bank, to solely needing the pure distilled essence of someone's confidence as they sponsor you through that transition. He was completely right.

I should also mention, by the way, that Chamath is uniquely equipped to be able to do SPACs well. Because you need three skill sets and few people have all three. You need the operating skill set to actually come in and do the role of being chairman and figuring out what to do. You need to know how companies work. Two you need investing experience. You need to be a savvy investor. You need to know how to be the sponsor. You need to know how to talk to the other investors. You need that experience.

Third, you need to be able to go on TV and run your mouth all day and have people love you. Right? Not many people have all three. Chamath absolutely has all three. He has all three in spades. It went through all the drama of the rest of Social Capital; it took a long time before he found Virgin Galactic. But now everyone's going to do a SPAC. It’s SPACs coming up left and right. You have celebrities doing SPACs.

Now, people are going to figure out really quickly that the identity of the sponsor matters a lot. Just like the identity of the bank that takes you public matters a lot. I know that on Patrick's podcast the other day, there was a fantastic episode with Rich Barton and Brad Gerstner talking about Altimeter’s SPAC. The identity of who takes you public matters regardless of what the mechanism is. And again, I would not be surprised at all if Chamath emerges as one of the original, OG premium vehicles for going public, just because this is a unique and rare set of skills that make him succeed.

Jim: So, what do you think the future of SPACs is then? Are they going to themselves get a hierarchy?

Alex: I'm sure. And there's no reason why the currently high fee structure of SPACs has to necessarily persist. Right now SPACs are expensive because people are still doing them one at a time, and you still need to take something public one at a time, and you were still paying retail to take the thing public. And so, currently today, a SPAC is just moving the costs of that from one place to another and charging different people. But there is no reason why you can't take 10 of these things public wholesale, right? Fairly soon some bank is going to say, let's start actually moving these things in batches. People will actually learn how to do this right, and save a lot of money in the process.

And then some of that money may get passed back to the companies going public. And others will get made by the sponsor. And others will be creatively passed back to investors through maybe it’s warrant structures, or maybe it's whatever else. I think in the short term, I imagine there'll be some experimentation with it. Right now SPACs are interesting. And they're trendy. They will probably go through a period of time where they lose their trendiness and people go back to saying they're stupid, but where the actual innovative work gets done. Where people actually dig in and figure out how to do them. And there'll be a two year winter where people are SPACs are dead. They were a trend. They went away while the important work has done.

Now I can actually just make a straight up prediction on your podcast. You can hold me to this prediction in 10 years if I'm wrong. I've already written it down somewhere. So this is just reiterating it.

SPACs are going to find true product market fit when a real sector bubble happens that is explicitly fueled by SPACs. And that sector is going to be biotech. Write this down. This will happen. 

Alex: So sometime in the next 10 years, there is going to be a big time biotech bubble. It's going to be a 1999 style bubble, where there is going to be this vision of the future: enough things will have happened in the world of synthetic and molecular biology. This is already happening; these are doors that are already getting unlocked today, as we speak.

Enough things are going to come together that the public is collectively going to start realizing that the TAM of this stuff is everything. It's the internet or computers, where people realized, oh my God, the TAM of this is All The Stuff. Similarly, the TAM for biology is all of chemicals, polymer manufacturing and fuel and healthcare. The TAM of biology is so big. 

Alex: So what's going to happen is there will be an increasing understanding that “this is going to happen”. This is going to be a bubble and people start realizing it's going to be a bubble. And they're going to start bidding things up in anticipation of the bubble. SPACs are going to come in as a new-ish useful financial mechanism for people to be able to speculate on the stuff in new ways.

Remember, new financial mechanisms are a classic recurring feature of bubbles because they let retail idiots get in more easily to things. In 1999, it was day trading. It was, “I can day trade from my home computer. This is so cool.” With crypto, similarly, it’s a new fundamental mechanism to speculate. Right? SPACs may very well be that mechanism.

There's perfect fit with bio. Bio is so powerful. And it's so interesting. And the other good part is, no one understands any of it. It's so hard to understand. It is completely and utterly beyond the ability of any investor to understand what the hell they're talking about when they talk about biotech companies. This is just a permanent feature of the sector. It will never change.

So because of that, you will have this scenario that is highly reflexive, where it becomes “Well, so-and-so is interested in this. So therefore I should get into it too.” And it becomes “Well, if I see this going up, then I need to get into this too, because there's zero fundamentals! Because there's no such thing as fundamentals in biotech. It is entirely an exercise in greater fool buck passing, even for real things.

Interlude: Since I might as well pull it up, here is the word-for-word prediction I’d made from last year:
“We’re going to have another bubble. This one will be less like Crypto 2017 and more like Dot Com 1999: it’ll be in the public markets, with retail mom and pop investors, and covered conventionally (and enthusiastically) in the media. And it’s gonna be in biotech. 

It’ll have the three ingredients you need for a genuine bubble:

First: “I’ve seen the future and it’s incredible, we have to get in now even though we don’t understand it.” Biotech is really an ideal sector for mass speculation. It impacts everybody, and it’s inside everyone and everything: the TAM of “biology” is infinite. It’s incredibly complex, so it’s easy for novices to grasp onto a story and its importance without understanding the reality of it. And it’s full of high-leverage potential: it’s totally plausible that biological breakthroughs in health, manufacturing, fuel, etc could generate tens or even hundreds of billions of dollars of value. 

Second: A critical mass of retail investors who are hooked on high returns, as the current bull run eventually runs out of gas (although that may not be for several years!). We’ll have the conditions where a large enough number of regular people, especially Gen Xers who did well in the past 10 years and who are moving into retirement, now have slush money to invest (and the time and boredom to get hooked on it). 

Third: A new kind of financial innovation that becomes the instrument of speculation. These aren’t a necessary component of bubbles, but they sure help. In this case, I bet there’s going to be some new clever financial product that bundles and securitizes the highly speculative IP of biotech companies, in a way that legally lets retail investors buy them through an ETF or something. You can imagine the rationale: ‘Imagine if regular people could’ve owned a basket of the fastest growing tech unicorns last decade; well, this is that, but for all of these high-potential biology breakthroughs. Make sure you don’t miss out on $BIOVX!’”

If people ever ask me for a truly YOLO stock pick - and I want to tell them something that doesn't actually give me any reputational risk, if I'm wrong - I tell them this: go do some basic homework and learn what are the like three or four picks and shovels companies in molecular bio and life sciences. And buy those. Because if a biotech bubble happens there's no way you're not going to make 10X at least on your money, on these things for a window of time. And the bubble is over and you have to have sold by then.

Jim: Yeah . That's the tricky part, right? Because we're getting into another field where I learned that we share a love and that's in mimetics. I've been studying it for the last three years, because I think it's incredibly important and really one of my ideas is that because of mimetic desire, because of copycat, because of all of those things falling into place, you can get markets into a place where they're no longer heterogeneous, but they're homogeneous. In other words, you get everyone thinking the same thing at the same time and information cascades become all the same information or let's put it this way. They become interpreted by people in similar fashions.

Alex: Right.

Jim: And so one of my little pet theories is that there may be a way using machine learning to find a simple - not prediction, but rather confirmation. That, you might want to look at this over here really closely because it's meeting all of these particular things. What do you think?

Alex: Okay, so my brain is struggling to take this in two or three different places. I guess my first question is to say, congratulations, you've discovered growth versus value. [Laughter] Someone has discovered it, once again. The second place my mind went to, which is related to the first one, is how much of everything we know now about the way the markets work and about how capital allocation works really is all John Malone. This idea of, “You're not making the thing, you're making the thing that makes the thing.” You're not making profits, you're making value. What is value, exactly? Is it the thing that makes the profits? Or is it whatever people decide value is? Strictly speaking in terms of mimetics, there is a difference between a growth stock that people are bidding up for a variety of different reasons of why they think it will grow, for versus something like a Bitcoin.

Alex: Bitcoin is a very pure example, where there's actually a recursiveness to the thesis: people think it's going to go up because people think it's going to go up. It doesn't actually pretend to be anything else. So It's refreshing in that sense.

Jim: I agree.

Alex: So, okay. Let me actually unpack this ability. So you're saying, is there a way that you could, if you could get access to what people are Google searching? And be able to tell when things are operating in one mode versus another, when is it heterogeneous growth bidding up versus when is it homogenous growth bidding up? Is that the question?

Jim: That is the question. I'm still working on the hypothesis and where I want to get data from social media. Certainly Google searches, certainly StockTwits, all of those things. And it could end up being a null hypothesis.

Alex: Yeah. What's your contra for this? What would be the sign that it's not working?

Jim: The sign that the signal is not normal?

Alex: What do you need to be the signal that this isn't working? For example, let me give you a specific example, to pick on this guy a little bit. It’s the concept of the anti-Galloway portfolio. Scott Galloway is somebody who is very bright and good at talking to people and good at creating a certain storyline of his. “Everyone thinks that Amazon is going up and they're all wrong. And everyone thinks that these companies going up and they're all wrong.” Look, there are reasons why you might not want to buy Amazon. But not those reasons! Those are stupid! That's a useful contra. Because it tells you something.

Jim: Yeah. No I love that one. And also known as the Seinfeld, George do the opposite of everything to achieve world dominion. It's going to be hard to ascertain without human judgment. In other words, I think in the beginning rounds, I'm going to use mixed models, AI models, and then have humans judge them. Right. Okay. So I think that this is right. I think that this is wrong and then see if there's any learning around that particular set of circumstances.

Alex: Yeah. Okay. Well, let me ask you. If you made this and it worked, would it look like Twitter? Let's look at Twitter, an area of your expertise. You have a particular dynamic of people looking at the discourse and then commenting on the discourse and it spits out a result, which is “who we're making fun of today”. And that result is a signal about something. Is it predictive?

Jim: And right there, that is the goal of this project, right. Is to figure out if any of this and I hesitate to use the word “predictive”. I would look for something more along the lines of, does it confirm?

Alex: Is it explanatory?

Jim: Explanatory, right. So I guess I'll fall back on the CDO debacle. right. So I was at Bear Stearns there and walking around and saying to anyone who would listen to me: “I will short my house if I can; this is insanity.” And that was pretty easy to see, from the lines of just math. You don't use 40 times leverage on illiquid instruments.

Alex: But on the other hand, the market can remain irrational longer than you can remain solvent.

Jim: Very true.

Alex: Are you really willing to bet on this, knowing that you could get punished down to zero before the market is wrong?

Jim: And, that's my search for a confirmation signal that has a high degree of reliability and some good base rates. So does it look like Twitter? I don't know. I think we might find some very unusual things that get said elsewhere. And by that, I mean, maybe when we start collecting all of those reports that are made available on Twitter and looking for mining keywords, it's obviously not a fully formed idea on my part yet, but if you can get something that has a relatively high base rate in confirmation, then I think you have an actionable “well, do the opposite.”. But you brought in the critical element of time. And so that is also a component in this, right? So during the  dot com bubble, I wrote a piece in April of 1999 called “The Internet Contrarian”. And in that piece, I said, this is the biggest bubble any of us have ever seen.

And I used AOL as an example. Its entire value was based on its future. IE growth investing. And so what's interesting about this is two fold. So I was 11 months early. Right. And this is the part that I really love after writing that piece based almost entirely on completely factual information. What did I do? I founded an internet company! I founded an internet investment advisor called Netfolio.

Alex: There are two ways you could look at that. One, you could portray it as, you are betting on the very thing that you were arguing against; watch what I do, not what I say. On the other hand, as Matt Levine pointed out, the person to most successfully short the tech bubble recently was Adam Neumann.  He successfully shorted tech by raising money on the current tech valuation and then turned it into private jets. So which one are you?

Jim: Mm-hmm.. I'll take the more innocent of the two. Thank you very much.

So if you were a young person, the only thing anyone ever talked about then was “the internet is taking over everything.” And I actually have a patent, which I think just expired. I'm not sure, but I love the language of this patent. It is issued to the company Netfolio for “dispensing investment advice over a worldwide network”.

Alex: Oh my God, you could shut down Twitter. You can do it. You have the power.

Jim: I'm sorry, Jack. [Laughter]

Alex: Sorry, Jack, you have to shut down the website. You need to get in touch with Ashley Feinberg right now. Tell her, Ashley, I have the power. Twitter is in violation of my intellectual property. 

Jim: Anyway, what's cool is Netfolio was the first to envision in that way, that everything would be done over the internet. You could, you could reject companies, you could tax manage it. The tech sucked though. But now Patrick has started a thing called Canvas at OSAM, which really actually works.

Alex: 20 years later, right on schedule.

Jim: Yeah. Right on schedule. Well, it's very different than NetFolio. I've got to give them full marks because it's an operating system really. And so if you're an advisor, you might do one thing and another advisor using it over here, we'll do something completely different. It just gives you really easy to use tools, to customize things, to do ESG, tax manage. 

Alex: What’s remarkable is how many of those Dot Com ideas are now working out now.

Jim: Bingo. Yeah.

We finish our interview with Jim asking me: if he made me World Emperor for a Day, and I could order the world to do two things, what would they be? To hear my answer, go to Infinite Loops with Jim O’Shaughnessy and go listen to the source material. I think you’ll enjoy it.

If you read one other thing this week, make it this:

Reverse engineering the source code of the BioNTech / Pfizer SARS-CoV-2 vaccine | Bert Hubert

This is a supremely clear, step-by-step walkthrough of the actual source code of the Pfizer mRNA vaccine, which teaches you a couple of amazing things:

1) how stunningly similar the logic of DNA transcription and translation is to how computers read machine code;

2) how the vaccine actually works; i.e. what does this genetic code actually produce, and why;

3) a few elegant hacks that the vaccine designers incorporated to make the vaccine perform even better; there’s so much cleverness in the fine-tuning, and this post explains a few of them really clearly.

And finally, for this week’s tweet of the week that made me laugh the hardest, congratulations to Facebook for the pettiest move of the year, right here:

Have a great new year, and I will see you in 2021 after a few weeks hiatus. Thank you as always for subscribing for another season of my newsletter. I’m so lucky to get to do this with all of you every week.

My very best for 2021,


Shopify, SPACs and Status: My Interview with Jim O'Shaughnessy (Part One)

Two Truths and a Take, Season 2 Episode 41

A few weeks ago I sat down over Zoom and recorded a podcast with Jim O’Shaughnessy, who interviewed me for his show, Infinite Loops. We ended up talking for over two hours, and it was one of the most fun and wide-ranging interviews I think I’ve ever done. 

Alex Danco: Shopify, SPACs and Status | Jim O’Shaughnessy’s Infinite Loops

If you somehow don’t know him yet, Jim is both a legend in the asset management world, the author of What Works on Wall Street, and also one everyone’s favourite regulars on Twitter. (His command of the Gif keyboard is unmatched.) He’s also the patriarch of the O’Shaughnessy Asset Management Extended Content Universe (which includes Patrick’s Podcast Invest like the Best, where you can find an old episode of mine last year) and Jamie Catherwood’s finance history franchise Investor Amnesia. (It’s now an online course too, featuring some incredible guest teachers, and I highly, highly recommend you check it out.)

We covered four big topics:

Part 1: Shopify, Friction and Commerce

Part 2: Twitter, the World’s Learning Commons

Part 3: Founders and the Truth

Part 4: SPACS, Biotech, and Bubbles 

For this week’s newsletter, please enjoy this edited and condensed transcript of parts 1 and 2, Parts 3 and 4 will follow next week. If you want to listen to the real thing, which I highly recommend for the full effect, you can find it here

Part 1: Shopify, Friction and Commerce

Jim: Well, hello everyone. It's Jim O'Shaughnessy with my colleague Jamie Catherwood for another edition of Infinite Loops. I am delighted to finally get Alex Danco as my guest. We have been trying back and forth, and it's usually my fault, not yours. You've been very gracious. But welcome Alex.

Jim: First off, let's talk about Shopify. You've been there what, seven months?

Alex: Six months.

Jim: Six months. Okay. Tell us what's going on.

Alex: Boy. What isn't going on? Shopify is a big place and we're doing a lot of things. It is a wonderful place. I should preface by saying: I have so much fun working there every single day. I had some idea that it was going to be a good fit when I joined. But I have been pleasantly surprised every day at what an engaging challenge it has been. In getting to work there, and learning how to contribute and learning how to be useful to this company that's doing something fundamentally important, which is creating an easier and better and more rewarding path into entrepreneurship for people all around the world.

If you are a merchant today or over the past 20, 30 years, you have faced a lot of headwinds that are really tough. The path into small business, especially small business selling things, used to be this unbelievable way to create self-sustainability, create community, to create sort of pillars of the economy and of local ecosystems, because entrepreneurship and merchanthood was something that we celebrated in America and around the world.

And sometime, over the last, maybe 20, 30 years, things have kind of gotten off track a little bit. We've gotten a little bit too obsessed with convenience, a bit too down the path of consumerism.

Jim: Yeah.

Alex: Consumerism is the state of commerce and the state of being a merchant, where we're buying a lot of things, but buying it in a fairly low friction, low trust, low commitment kind of way. It's hard to be a merchant in that kind of environment. You're competing against the Amazons and the Walmarts of the world. Who, don't get me wrong, have done great things. We're not anti-Walmart. Walmart makes a good quality of life accessible to people in a way that was not possible before. That's a great thing. But it makes it hard to be a merchant who is selling something really special that you've put your life into learning how to create craft around.

It makes it hard because again, this is not really Walmart's fault. It's more the fault of... everyone. We've forgotten how to shop. We've forgotten how to be interested buyers. The art of merchandising and of commerce has gotten lost a little bit, especially into this new era of the internet where everything is just so convenient and so quick.

So enter Shopify. Shopify's goal is really to bring back a part of the world of commerce that I call “high trust commerce”. It's commerce where you have this ecosystem of buyers and merchants who are all deeply committed to the art of commerce. We're committed to this idea that maybe shopping isn't supposed to be this completely frictionless experience.

Maybe shopping actually needs a little bit of challenge to it, because the challenge is the fun. And the challenge of shopping is what makes it special, like finding this exact thing you want and building a relationship with a merchant and trusting them, and then getting joy out of the whole experience.

You can think of the first part of Shopify's mission is “making a very frictionless but meaningful path into entrepreneurship for merchants who want to create that kind of rewarding relationship with buyers”. Who really, really care about what they're selling. But then- and this is something that you can look to Shopify to do over the next 1 to 5, 10, 20 years - is not only help merchants succeed at being great merchants, but help the entire community of commerce. So buyers, partners, supply chains, marketplaces, advertisers, everybody, everybody in the ecosystem. Engage more with what we call high trust commerce. Which is just truly better off for everybody. So that in a nutshell, that's Shopify. That's what we do.

Jim: It's so interesting. I had lunch yesterday with Dan McMurtrie. I don't know if you know Dan.

Alex: You must mean SuperMugatu.

Jim: Oh, yes. That's who I meant. Yes. Yes. But his thing, one of his theses during the lunch was that we're moving so quickly to not only permissionless commerce, but to no thought commerce. In other words, they don't even consider what they're buying and they're buying. What do you think about that?

Alex: This is an issue we think about a lot. Which is: where should there be friction and where shouldn't there be friction in commerce. So there are many parts of commerce where there is friction in the process and that friction is only bad. Like, you do not want to have to think about how you're setting up your payment processor. There's no benefit to this at all for anyone. It should just work. There's no point of going through that struggle for a merchant. It doesn't teach you how to do anything. It doesn't level you up in any way that's meaningful for the part you want to do.

Jim: It grinds you down.

Alex: That is friction we want to just get rid of. But then there is other friction where you don't necessarily want to get rid of it, because it's very important. Think about the friction of figuring out how to land your first sale. Do we want to make that one hundred percent easy? Not necessarily. No one can do that for you. You have to figure out how to do it. And then when you do, you will feel growth. That's good friction. And a lot of what we think about all day internally at Shopify is how do we surface and orient you correctly around the good friction so that you grow and feel yourself growing and then trust yourself more.

Now for buyers. You think the buyers are just an entirely different creature than merchants, but that's not necessarily true. There are some components of buying where we want to get rid of the friction. So a good example is page load times. We are obsessed with page load times at Shopify. Every 50 milliseconds a page doesn't load when you're in the middle of a shopping or buying process is a little bit of broken trust, with the merchant and with the process and with everything.

You get maybe a couple of Get Out of Jail Frees, but not an infinite number of them. It's not just the inconvenience of page load times, it's breaking trust. Commerce is a dialogue. And you remember that even online commerce is still made of people metaphorically talking to each other and gesturing with their hands and negotiating back and forth. And you don't want page load times in the middle of that. Really, really breaks the process.

On the other hand, what is the good friction involved in commerce and in buying? If we went and followed through on a mission of: “get all of the friction out of commerce”, you know where we'd end up? We would just make another version of Amazon. Or another version of these things that already exist.

So not to give away too many sort of secret sauce parts of Shopify and commerce, but I think we understand we want to help bring into the world of commerce. That friction is good to get rid of, but not challenge. Challenge is important, because challenge is kind of the essence of what commerce is.

If you strip away all the challenge out of commerce, what you're left with is a convenience store. And there's a place for convenience stores. They do something useful. But it's not for merchants. That's not commerce, that's something else. And so Shopify is... Shopify isn't a place to power convenience stores. That's not what we're about.

Jim: So give me a description of like, what would a perfect merchant be for Shopify?

Alex: I don't think there's a perfect merchant. But there could be a perfect trajectory of the merchant, which is what we care about. We care a lot about trajectory. One of the things we're most proud of at Shopify is the fact that if you look at the biggest merchants selling the most GMV on our platform, a large percent of them are merchants who did not exist 10 years ago. They started out on the Shopify platform or came to us very early in their life as a merchant and grew up to be these enormous success stories.

The thing that's amazing about merchants and about commerce is that this is the most unfixed TAM in the universe. People want to grow. People want to grow their stores and grow their businesses and succeed more generally. This is the opposite of a fixed pie you have to go after.

There's no perfect, ideal merchant for us in any moment of time. If you are a tiny merchant, we want to serve you. If you're a huge merchant, we want to serve you. If you are any merchant, we want to serve you. What we care about is that you are a merchant we can help grow. It's the trajectory that we really care about. So we care about merchants, who, the first thing in the morning, they look at Shopify and the last thing they do before they check out for the evening and go play with their kids, they look at Shopify.

Jim: Yeah. I watched a documentary on antique booksellers, last night, I think it was on Prime or Netflix or whatever. And I was struck by the idea that most of them are kind of downcast. They think their industry is dying. And what I found interesting was the characters are really quirky, really smart, and they would hunt the earth to find a book.

And one of the things that was brought up was with the internet, anybody who wants whatever, a first edition of TS Eliot's poetry, they type that into Google or whatever search engine. And there it is. Do you think that certain industries are going to either disappear or radically change because of the trajectory of where things are going?

Alex: We’re still the early days of how the internet is going to change things. I don't know how you can come up with any other conclusion. I think it's worth looking at the fact that the internet... The internet as we know it has been around for what, 30 years? 25 years?

Jim: Well, yeah. In usable form, I was one of the first users of all. I bought one of the first books on Amazon, etcetera.

Alex: It's been 26 years since 1994. So let's call it 26 years. In the beginning you had the web, you had the web browser, and you had the ability for anybody to go participate. It was open. Anybody could go make a website. Anybody could go crawl around there. Anybody could go in these communities. It was quite open. It was a science experiment for some time.

I was pretty young at the time. But so I've heard, most of the rhetoric from “serious people” at the time was, “Soon, we will roll out the enterprise-grade version of the internet that is ready for real commerce.” You had this idea of the Information Superhighway was a thing that was going to get rolled out. And everybody was like, "The web is interesting. But it obviously isn't the real version. The real version is going to be far more professionally made."

Alex: And the Information Superhighway never worked out, but a more consumer friendly version of it did, which was AOL. AOL understood really well that the internet was this new thing that was exciting, and people didn't really trust it, or know how to use it. But if you made it easy for them, if you incessantly mailed CDs to their door and you made this nice onboarding experience where people kind of understood what they were doing. You told them what an AOL keyword was, and you started getting them using AOL. Then if you could have people trust you, then AOL would make all the money. And they went a long ways towards pulling that off.

AOL made a tremendous amount of progress in onboarding people onto this thing. And so naturally, one of the killer applications of this idea of connecting people was, "Oh, you'll be able to sell people things." We didn't really know how that was going to work. Initially it was stores who said,, "Okay, let's put our catalog on the internet." And then at the bottom of the catalog it would say, "Call the number and then we'll order it for you."

And so that was clearly not the real way, but people experimented with it and played around with it. But the problem was that commerce over the internet was still fairly low trust. You didn't really know if you could trust somebody on the other end of the internet. You didn't probably know what to do.

And then this incredible, magical company figured it out. That company was eBay.

eBay got it right. eBay a hundred percent realized that the internet was a place for people who obsessively cared about stuff: collectibles, Beanie Babies or trading cards or whatever it might be. And were willing to go through a lot of challenges to find what they were looking for and engage with a seller and bid on it and go through all of this friction. And at the end of the friction, you get an amazing outcome. Which is they got this very rare, special thing that they were looking for. Like the rare book sellers; they'd get their first edition TS Eliot. They went through the challenge. And at the other side of the challenge was something great.

eBay figured out a couple of things. You needed certain ways to trust the process, like getting in seller ratings and buyer ratings and making certain aspects of the process a little bit more transparent and easy. There's this book called The Perfect Store that I think has been recommended on Patrick's podcast and also generally that everyone should read.

eBay had just completely seized this new world: "The internet is this perfect forum for bringing people together to engage in this challenge of doing commerce." But then, success became eBay's worst enemy because as they got bigger, the temptation towards convenience became too strong. So you started seeing things like the Buy It Now button, which initially was fine, but it takes you down a little bit of path towards like, get rid of all the friction, get rid of all the challenge. Make this more convenient.

And then eBay started pitting sellers against each other, as you're trying to please buyers more. And as they went down this path of optimizing for getting rid of friction, they killed what made the place so uniquely magical. And eBay's still around, obviously, but it is not on the pulse of commerce like it used to be. So that was a model of selling things online. We learned a lot, it had its moment, but the draw of convenience was too strong.

Concurrently, you had this other company who had a different idea about how commerce on the internet was going to work. And that company said, "You know what? Convenience plus selection is a really good mix for the internet. If we give our buyers both of those things and they come to expect both of them, there should be a virtuous cycle we can tap into where we can reinvest all of the proceeds of convenience and selection into more convenience and selection. And this will be a really nice flywheel.”

And so that company, early on in its life, looked at a couple of different names for the business. I think it was called Cadabra originally. My favorite of the original names was

Jim: I loved

Alex: It's still, if you go to, it still takes you to Amazon. It still works.

Anyway, Amazon has one of the great executing companies of our age. But what Amazon understands so well is that convenience ultimately is driving the bus, not commerce. Amazon is not a commerce company, they are a convenience company. And they apply that to everything. So it is not really a place where commerce happens.

Jim: Right.

Alex: And so it's great for people who want to get things conveniently. And that's a lot of things, for a lot of people. But it's not quite the same thing as shopping. You don't shop on Amazon. Amazon is a bad shopping experience.

So that is where Shopify would like to go make our mark on the world of online commerce. And so in 2020, 26 years in, eBay had their moment in the sun where they had understood shopping for that initial market. But, 20 years later, we still haven't figured it out. So Shopify really has this mission to go get that right, on behalf of our merchants, on behalf of buyers everywhere. We want to make shopping awesome.

Jamie: It's interesting that you use eBay instead of Amazon as the trust example. Because I remember last year, or maybe two years ago now, when Chris Meredith, our CIO, and I worked on this paper called Value Is Dead. We were looking at the comparisons between kind of the early manufacturing age and information age. And we read a lot about how Amazon pulled ahead early because they focused on the one-click credit card payment processing system. And that initially it was a real struggle for people to trust entering their credit card information online. But Amazon made that a real focus and kind of worked to overcome this internet trust issue that you were talking about with eBay.

Alex: So that's absolutely right. And is a really good thing to point out. Remember, in the early, early days of eBay, you had to mail eBay a check.

Jim: Yep.

Alex: The great anecdote from that book, The Perfect Store is that eBay's employee number two, I think it was, their job was opening checks in the mail that people sent them. The joke is, that's how you know when you’ve found product market fit.

What really made eBay win was connecting buyers and sellers who were so motivated to make these unique one of a kind sales that they were willing to push through anything to go do that. And that included navigating weird payment things, whether it was checks initially or getting started with PayPal. In contrast, If you were buying things for convenience on the internet, none of that was going to work. It has to be easy. It has to be one-click. Or as close to one-click as you can.

For Amazon, that was a differentiator: get your payment done, get people to trust that this payment is going to the right place. And ultimately it mattered a lot for them.

Tobi likes to say that “the web is great, but it has two critical design flaws.” The first design flaw was that payments weren't built in, even though they almost were. And that helped Amazon grow and win this whole slice of commerce. And the second flaw was that identity was not baked into the web. It was left up to websites to decide how they managed identity and how they attract people's identity. And that initially led to things like AOL having a large presence around owning people's identity.

But then down the road, this is how you get to places like Facebook who provide this incredible service for people, by giving them an identity that they can use to talk to other identities. But ultimately this turned a lot of the internet and subsequently a lot of the world of commerce into something that happened inside walled gardens. To Facebook’s credit, they've done an incredible job executing on this.

So part of our job at Shopify is to help bring our merchants into all the gardens with Facebook. And ask, "Hey, how can we bring everything that our merchants have to offer, and all of the commerce superpowers that we can give them, to where buyers are?" And to where Facebook wants all of this commerce to happen. They have been a great and really interesting partner for us to work with and learn from.

Facebook, in many ways, has done the hardest job of all. Which is, figure out how to really understand people and what they trust, and how people work. Facebook's business is understanding how people work. So we can learn a lot from them, in terms of how to best put that to work to help make commerce do well.

Jim: And another thing Dan and I were talking about yesterday was Facebook and its stranglehold on all emerging countries, all emerging economies. I wasn't aware that... We're invested in one of his funds called Anchorless, which operates in Bangladesh. And 95% of everything, commerce, communication, everything, is Facebook based.

Alex: Yeah. I remember there was a survey of some sort a few years back, I believe it was Indonesia, but I could be wrong. The survey question asked: have you used the internet in the past month? And maybe 80% of people said no. And then they asked, have you used Facebook in the past month? People are like, "Oh yeah, I'm on Facebook every day."

I don't personally know these markets very well at all, but you look at these new companies certainly like the Chinese internet giants and a lot of the relentless expansion of their international arms, but also these homegrown companies like Sea Limited that we don't know about. (And we need Julie Young to teach us about on Twitter). There is so much that Shopify can learn from these other ways that commerce can work.

Part 2: Twitter, the World’s Learning Commons

Jim: So, that brings up another thing I wanted to talk to you about, which is this idea that we share: that more and more knowledge creation is happening in the open. OSAM's motto is learn, build, share, repeat.

Alex: I like that.

Jim: And we have what we call research partners. These are people who do not work for OSAM, but we give them the data we have, which costs millions and millions a year, and these are people with mad skills and we give them access to it. And our first and probably best known writes under a pen name, Jesse Livermore. But what are your thoughts about what is driving the learning in public and where do you think it takes us?

Alex: So, this is a fascinating question. And I think about this all the time.

Generally speaking, if you look at what people are really after, in their life? People are looking for things that get them interested. People are looking for stimulation, people are looking for stuff to really gnaw their teeth into, that is interesting to them that they may not get in their day to day job, whatever it might be.

The open community of the internet is somewhere where you can find other people who are interested in those same things as you and who want to learn about those same things as you in a way that was not really possible before, without there being a substantial amount of transaction costs involved.

In the old days, if you knew about business and you wanted to go talk to other people who cared about similar areas of business as you, and trade your ideas, the only way for you to get to do that would typically be to meet somewhere that is not accessible to everybody. It'd be at the country club. That social function has existed forever: "Hey, talk shop, show off a little to each other, learn, be curious." But they were not available in the open.

The curious thing about the internet, is that the returns to being on Twitter and getting to just say whatever's on your mind and participate in FinTwit, and in all of these communities, has been radically different and in many ways follows the backwards set of rules as in the old days. About, not only what is valuable for you to participate in and what is interesting to you, but also what is considered valuable versus suspect.

I don't know about you, but I certainly remember being told: "Don't ever listen to anybody who is pitching you stock tips." Right? If they were any good, they wouldn't tell them to you, right? They would be monetizing it themselves. 

Jim: Right.

Alex: “You can't afford the people whose advice you actually want.” This is no longer true, necessarily.

Jim: No, I know. Some of the best analysts on stocks are kids on the internet.

Alex: The best analysis, the best work, the most thoughtful commentary and understanding and deep dives are free.

Jim: Free, I know. It's amazing.

Alex: Now, the challenge is that, that doesn't mean they're accessible to just anybody, because you have to know which ones they are.

Jim: Right.

Alex: Right. This is an abundance problem, not a scarcity problem. This is a problem of curation and opinion and understanding how to navigate this deluge of people saying what's on their mind. It becomes very reputation-based, first of all. And Twitter is perfect for this. People have said many times that Twitter is a better LinkedIn, because looking at who people follow is an amazingly high signal way to find out who you should pay attention to.

Jim: Right.

Alex: You go find people you respect and you look at who they're following. And that is a very, very high signal about who knows what they're talking about or somebody potentially you should pay attention to. You look at someone like Matt Ball talking about media. No one is better at communicating what matters in media than Matt Ball.

Jim: I read that. I read it twice because I'm like, "This is amazing."

Alex: Everything he writes! You always learn something, it's always so smart. I think I agree with it 85 to 90% of the time, which is the perfect ratio. It should never be 100, it should be just under 100%. And best of all, it is in Matt's interest for this to be available for free, right? This is not altruism or egotism. Matt's business is for everybody to understand what he knows. And how do you do that? Well, you share your best stuff.

Jim: Yep.

Alex: Right? There's the paradox of the free versus the paid tier of the newsletter, which is that you would expect that the best stuff is in the paid tier, but in reality, the best stuff is in the free tier.

Jim: Free tier, of course it is.

Alex: Because that's how you get people to subscribe! And so Twitter is like the free tier of the world's great thinking. It's where the best thinking takes place. And you're one of the Deans of this class and you've done a remarkable thing in terms of being associated as the... the “neutral good guy” that everybody likes and is always there with the right gif. And is generally “supervising”, I think, to make sure that everybody is staying friends, which is a remarkably valuable function.

Jim: We are so simpatico on this, Alex. I agree with you 96%. And I think that properly curated Twitter is going to have... The potential of Twitter is not even being touched yet. In my opinion.

Alex: When you say the potential of Twitter, what do you see as the big potential? 

Jim: So, to me, the big potential of Twitter is that it becomes a truly decentralized and yet connected intellectual marketplace where you can find and vet the very, very best minds in the world. And so, if the noise can get reduced just a bit and the signal pumped up a little bit, I honestly think it's like the extended mind of man, if you will. And also a very, very good system for preference falsification. 

Alex: There's something interesting about Twitter, which is that in order to use it correctly, you need a major suspension of disbelief going on in your brain. In order to actually experience how great it is, you have to at least somewhat hold the belief that it's all stupid and silly.

Jim: Right.

Alex: Right? You have to call it The Bad Website and you have to think, at least 20%, "Jack, please delete Twitter. And we'll all be so much better off."

I'll tell you an interesting part of Twitter that I imagine many of your listeners don't know about. It's Academia Twitter; Twitter in life science research especially, which is a world that I know a little bit, I was in grad school for neuroscience some time ago. It's a world that I got to know a little bit before I went off and did other stuff.

So academia is an interesting place because there is this funnel into academia that used to work and now doesn't work. And the funnel used to be: you go get your PhD, which is an apprenticeship under somebody who really invests in you and then teaches you how things work.

And at the end of your PhD, the idea was you went and got a spot as a professor doing research somewhere. And you would teach and you do research and this pipeline worked pretty well. This worked for 100s of years, mind you; this is a very old setup. In the mid 20th century, we had this new invention, which is called the Postdoc. After your PhD, before you immediately throw yourself headfirst into being a professor and all the overhead and administrative job that creates, you take two or three years to work in someone else's lab and only do really good science. Take advantage of the fact that you're still young. You don't need the big salary yet. You can just be totally free to maximize how productive you are and go learn about what you want to do, right? And go build more expertise.

Alex: So, for a period of time, the best years of your life as a scientist was during your Postdoc. And for some people that is still true, but for a decreasing number. And the reason why is because of the pipeline of people into academia. PhD production increased and increased and increased, and the number of faculty positions did not increase at the same rate. However, no feedback signal was generated to stop producing PhD students because there is an elastic capacity in the system to accommodate more and more of them, which is called the Postdoc. (I'll get back to Twitter in a second, I promise.)

Jim: No, I'm loving this.

Alex: So, you have this expandable reservoir of Postdocs who have become the actual workhorses for life science research in recent years. They're the people who are actually doing the science and actually writing the papers and actually doing a lot of what people think happens in labs, for very low pay in this really miserable career funnel. Because you're competing against everybody else who has to do the same thing.

Now you might ask, "Why does everybody put up with this? What is the force that is holding this together?" The critical barrier to getting hired for a faculty position and really getting that job offer from a good university is getting a certain number of publications in the tier one journals. And the way that you get into those tier one journals, if you do not have an established reputation, is by being in the labs that can get you into those journals. It is a little bit about the science that you do, but really it's about being in one of those powerhouse labs that can get you into and accepted in Cell, Nature, Science, or New England Journal of Medicine.

So this is a setup where, as a young scientist, you are effectively forced to pay tribute to the established scientists in the form of being a Postdoc in their lab for potentially years and years, so they will grant you the keys into the journal, so that you can build a reputation and then get hired. And because there is not really any other way for you to build your reputation at scale in the scientific community, other than publishing in the journals, you have to pay that tribute.

And because you have to pay that tribute, the entire financial model of how science is funded has become arranged around cheap Postdocs who get paid 40 to 45K a year, being in surplus availability. There's no other place that they can go. So that's how the labor market of science works. All backed up behind a gate: the fact that there’s no other way to build a reputation.

Now, Twitter has shown up and it has really caused some problems for the established model. Because now as a young PhD student, or Postdoc, you have the ability to go direct to your audience and tell them directly what you're working on and directly participate in talking about science with people, with no barriers. Are you able to find other people? Can you talk about what's interesting to you? Can you share your work directly? This is very cool.

Jim: Very.

Alex: Very cool, right? In the short term, it's not like people are not publishing their work. The journals are still the final destination of published work. But it is very dangerous to the existing model because it is creating a short circuit around the gate keeping aspect that forces the young scientists to pay tribute to the old ones, which was, there is no other way to build a reputation. But now there is.

Jim: This is fascinating. One of my theories is that you've seen, a lot of the histrionics you've seen, from the media gatekeepers, from academia gatekeepers. Basically, my theory is that the gatekeepers know they're dying and they're very, very unhappy about it. And I mean, if we look at the media, sure. Why are they doing what they're doing? Because it's a money model. You want to attract like-minded people. So, the New York Times goes left and the Wall Street Journal goes right. The TV networks do it, but in my opinion, they're losing. And that there... I don't think there's anything that's going to stop them from falling, right? Because as you just said, this peer to peer in Twitter is unstoppable in my opinion.

Alex: It is. Although, I'll put a caveat on that, which is that... And I'm curious, I would love to know what you think about this. So, Twitter is different every day, right? What's the line, “Every day on Twitter, you wake up and you log on and see who we're mad at.” I think actually the best way this was articulated was, “Every day on Twitter there's one main character and the goal is to never be it.”

Jim: Never be that character.

Alex: Twitter is at its best when everyone is talking about the same thing. So, Twitter during NBA finals, amazing, right? Twitter during... Even during the election, honestly. 

Jamie: Elon Musk's 420 tweet is always our prime example.

Alex: Twitter is great when everybody gets jolted onto the same page, for some reason. And the traditional media format is actually a good way of doing that. Because, it is not peer to peer. It is one to many. It is a broadcast format. And there's a really good synergy between those two things.

I think the most successful large example of Twitter actually working sustainably, the way that you could see it working as a business, is the sports Twitter. Or Game of Thrones. There's this incredible symbiotic relationship between the many on Twitter versus the one which is broadcast TV. And they both make each other better. And so, Twitter without the one where it's just the many, disintegrates into something that is still special, but not quite as special as when everybody is synced; when everybody is clocked into the same rhythm.

Jim: That's really a good point. So, for example, Jamie got his job at OSAM through Twitter.

Alex: Yeah.

Jim: And he had a long interview, if you will, by me reading all of his posts as the financial history guy, right? And now to be fair to Jamie, Jamie is also a very persistent guy. And he got Patrick's email by figuring out our corporate email system and asked him-

Jamie: Low level stalker stuff.

Alex: That's a great story.

Jim: ... Asked him if he could come up and have lunch with him. Patrick, unaware that Jamie lived in Washington, DC said, "Yeah, sure." So what does Jamie do? Jamie gets in his car. What time was it Jamie? 4:30 or 5:00?

Jim: 4:00 AM, out the driveway. So he could take Patrick out to lunch.

Alex: That is one of the classic hustler entrepreneur stories, right? Which is the... You finally get an investor's attention. And they're like, "Oh, let me know when you're next in New York." And you're like, "Oh, I'm actually going to be there on Monday." Buy the cheapest plane ticket to New York.

Jamie: Morgan Housel did that with Jason. Literally Jason said, "Let me know the next time you're in New York." And Morgan was like, "Oh, I'll be there tomorrow." bought an Amtrak ticket.

Alex: Oh, it's such a trope. It's a really, really good trope.

Parts 3 and 4 of the interview will be in next week’s newsletter. If you don’t want to wait that long, you can listen to the whole thing here.

If you’re looking for more things to read this week, my number one recommendation for you is the most recent issue of The Observer Effect, where Sriram Krishnan talks with Tobi Lütke about a whole range of topics - how he manages his time, personality traits and tests, Shopify’s org structure, jazz music, gaming, and two of his favourite books. It’s a sublimely good interview and I feel like reading it helped me get 1% better at my own job. (Maybe 1% is a lot. But more than zero!)

The Observer Effect: Tobi Lütke | Sriram Krishnan

Take time to read it slowly. It’s great.

And finally, this week’s Tweet of the Week that made me laugh the hardest:

Have a great week!


Fixing Audit Won't Fix Fraud: An Interview with Kris Bennatti of Bedrock AI

Two Truths and a Take, Season 2 Episode 40

Hi everyone, 

This week I have a really interesting interview to share. I talked with Kris Bennatti, the founder & CEO of Bedrock AI, about one of my all-time favourite topics: fraud. 

Kris is a data scientist by trade, and started her career in external audit as a CPA at KPMG. She’s now the founder of Bedrock AI, and leads a team of researchers who use unstructured data to understand and predict corporate malfeasance, fraud, and other bad things. She spends a lot of her time thinking about fraud, earnings manipulation, and low-integrity management teams.

If you’ve read this newsletter for a while, one thing you’ll know about me is that I’m absolutely fascinated by the topic of fraud. (For instance, see: here, here, here, here, here and here.) 

If you want to really understand how something works, study the scams and why they work. Fraudsters (the successful ones, anyway) have to understand exactly how a system works - not how it works on paper, but how it really works - in order to pull off their con. By studying scams carefully, you get a direct line of insight into how these complex systems actually work in real life. 

Auditors and short-sellers are both important parts of the fraud-industrial-complex. They’re both motivated to uncover frauds, but in different ways and armed with different resources. In this interview, Kris and I got to talk about these approaches, and why “looking at the data” doesn’t work nearly as well as you’d think for finding fraud. But scrutinizing the stories people tell in their financial statements and their investor reports can work a lot more powerfully, if you know how to look.

It’s a great time to be talking about this, since more than a few auditors are in a hot seat recently. EY Germany is under the gun after the Wirecard scandal. The U.S. is on track to force Chinese companies to get audits that can be overseen by the PCAOB. So please enjoy this chat; I think you’ll learn a lot from it.

Auditing isn’t something I know a lot about. But I have a sense that specific scandals like Wirecard have accelerated what was already an ongoing discussion about whether the auditing firms are actually doing a good job, or the right job. There have been a few high profile scandals and there’s a general sense that the Big Four audit firms are falling from grace. You seem to disagree with the basic premise of these discussions, is that a fair starting point?

Well not exactly. I think it would be great if we could improve the audit function and make the Big Four better. However, fixing the Big Four won’t fix fraud. So if their discussion is supposed to be about how we protect investors and prevent corporate fraud then we’re having the wrong discussion. 

The implicit assumptions that I see in most of the pieces I read is that a) the role of external audit is to ferret out fraudsters and b) the reason they aren’t doing so is because auditors are in bed with their clients. 

The biggest problem with these assumptions is that independence and competence aren’t the problem. It’s just really hard to identify fraud through an audit of financial information, even for a vigilant, independent entity. (I’m not making a judgment call on whether or not the Big Four are independent/vigilant.) The other problem is that audit firms don’t actually think it’s their job to find fraud. In my opinion, they have somewhat reasonable grounds for believing that. 

That’s quite the notion, that audit firms don’t actually think it’s their job to uncover fraud; let’s get back to that in a second. But first, why is it hard to find fraud through a financial audit? What do you mean by that?

Great question. Fraud, in most cases, doesn’t come through in the numbers. We’re in the business of modelling fraud but at Bedrock AI we mostly ignore financial ratios. Instead we focus on long-form text. Think about it, the whole point of earnings manipulation to make the numbers look normal. Any competent fraudster will put a lot of effort into making a normal-looking set of financial statements. 

This is especially true in the early years of a fraud. When the numbers start to unwind, suddenly everyone notices. By then it’s usually too late. All that to say, financial ratios are a pretty weak early predictor of fraud. (The papers that claim great results don’t hold up well in the “wild”.) For the same reason, when an auditor looks at fraudulent financial statements, they will see numbers that appear reasonable. 

I assume that the people who read your newsletter have, at some point in their life, taken a look at a short seller’s report arguing that a company is a sham. Very few short-reports focus solely or even primarily on financial statement metrics. Harry Markopolous’ 2019 GE report is the exception not the rule. Short-reports focus on relationships, customers, suppliers and operations. Auditors, on the other hand, do not audit operational metrics. 

I’m sure my friends still working at KPMG would say otherwise but auditors have a pretty superficial understanding of a client's operations. When I worked in audit, I often wouldn’t even read my client’s Management Discussion & Analysis (MD&A). A junior associate would tie in the financial figures and that’s where we left it. I assume the partner looked at it but checking the MD&A isn’t our job, that’s how far removed auditors are. 

I completely buy your point that financial information isn’t all that informative if it isn’t supplemented with operational info. By the time fraud actually makes it into the numbers themselves, it’s probably too late. So then if financial audits are failing to do what they’re supposed to, could you expand the audit scope so that auditors actually have a chance of catching this stuff?

Audits are already really bloated, in the U.S. in particular. Anyone who’s been involved in an audit who hears the words “expand” and “audit” in the same sentence will start yanking out their hair. New requirements keep being added to the audit process e.g. Sarbanes Oxley control testing, COSO 2013, ever expanding PCAOB guidance, and none are taken away. 

Simultaneously clients are becoming more price sensitive and putting downward pressure on audit fees. Public company audits have become pretty burdensome for management teams, one of many reasons that companies are choosing not to go public at all. The average auditor works much longer hours than they did 10 years ago. It’s not great for anyone involved. 

I recently watched a lecture from a symposium put on by the University of Texas Salem Center for Policy. During the lecture an accounting professor from Columbia suggests that auditors should be more like short sellers in proactively identifying frauds like Luckin (minute 37) and points to the example of counting customers entering the coffee shops. 

That is perfectly fine to do if you’re a short-seller with suspicions about a specific company; you cannot task auditors with doing something like that. Take a moment to consider the cost of adding audit procedures like sending multiple audit associates to count customers at multiple client locations for multiple days. Most companies only have 1-8 audit associates assigned to their audit teams, generally for less than 2 months. If you want to expand the audit to include operational metrics, you need close to twice the team, twice the time and, most importantly, auditors would need a different skillset, particularly in specialized industries like mining and pharmaceuticals. 

Okay, let’s say audit isn’t the answer to curbing fraud. Fraud is clearly still a big problem, particularly in a bull market like this one where it's hard to distinguish between good and bad actors.  If improving audit isn’t the solution, what is? Do you have one?

Well, if you’re interested in avoiding large losses as an investor or lender, the answer is to use Bedrock AI tools to find early red flags. I may be biased. 

Bigger picture, the answer is short-sellers, active regulators with big budgets and more capital market actors who are willing to look past EBITDA. Short sellers play a really important role in investor protection that I think is overlooked. They’re the only market actor with the economic incentives to actually check how many customers are entering coffee shops. 

Most people don’t know this but the SEC actually doesn’t do a lot of proactive enforcement. They primarily rely on tips and a lot of those tips come from short sellers and hedge funds. Canada, in particular, could do a better job of being supportive of the role of short sellers. In Canada we tend to demonize them as market manipulators. It irks me that short shellers get such a bad rap while stock promoters get away scot free. Stock promoters don’t contribute to efficient capital markets, short sellers (mostly) do. 

It seems like you’re letting auditors off the hook. Surely they have some role to play here.

Yes, they absolutely do. Auditors can and should do a better job at a lot of things. One area where they’re not performing is identifying/stopping aggressive accounting that essentially amounts to earnings manipulation but stops short of fraud. Many people don’t realize that accounting is very judgment based. There’s a lot of wiggle room before you cross any bright lines. When there’s grey area, the auditor will almost always side with management.

You said before that auditors don’t think it’s their job to find fraud? I’d love if you could go into that a little bit.  

An auditor’s role is to identify material misstatements in the financial statement, whether due to fraud or error. Audits are designed around identifying misstatement. In audit we used to talk about “professional scepticism” a lot but auditors don’t think of an audit as something specifically designed to find fraud. 

One reason for this is that even a well designed audit will have to rely on management’s representations at one point or another. An inventory count is a great example of this. If an auditor goes into a warehouse and says show me the widgets you’ve listed on your balance sheet, they will show you some widgets. Whether those widgets actually belong to the company is anyone’s guess. They could be on consignment, they could be stolen, they could be other widgets that look like the widgets you're trying to find but have a red screw instead of a yellow screw. The widgets could all be defective but without trying each one, you would never know. 

Needless to say, testing widgets is beyond the scope of what is expected of an auditor. Essentially, if every audit assumed underlying malfeasance, a lot more work would be required. That’s not to say auditors completely ignore fraud risk. Every audit does involve testing that is fraud-specific, it’s just somewhat limited. 

I had a call with a Big Four audit partner a few months ago that really drove home the point that auditors don’t see audits as “fraud-centric”. At Bedrock AI we do two things, we score filings in real-time in order to provide company-specific risk ratings based on the likelihood of malfeasance and more importantly, we highlight in-text red flags that are indicative/predictive of this risk. (This was a really hard problem to solve.) 

The in-text red flags include things that are outside of the auditor’s domain, like executive departures and aggressive Non-GAAP metrics, but also financial considerations like aggressive accounting policies, reversals to reserves etc. During the call, the partner in question gave me some product advice.  One of the things he said was more or less, “It would be great if there were a way you could sell this to auditors, but we don’t really do fraud, so that would be hard.”  I wasn’t surprised to hear him say that but I believe many other people would have been.  

To end, there’s a question I am obviously going to ask you: what is your all-time favourite fraud? The most interesting, or noteworthy in some way, or just generally what specific instance of fraud should more people know about? 

Hmm, that’s a hard question. I have many favourites but I’m particularly fond of the General Electric (GE) case. Just recently, GE got a Wells notice from the SEC which means they’re soon to be under investigation. This isn’t the first time. The SEC accused GE of fraud in 2009, related to “earnings smoothing” in fiscal years 2003 and 2004. GE is interesting to me because they’ve always flirted with the line between earnings manipulation and fraud. GE isn’t a sham. No one stole money or bribed a terrorist or booked non-cash transactions to a related party. The GE fraud was insidious and therefore, most people ignored it.  Smart money has been investing in GE as a “blue chip” stock for years. 

Simultaneously, everyone seemed to be aware that they were manipulating their numbers, before and after they got investigated by the SEC. Harry Markopolos put out a short report on GE in 2019. The report made less of a splash than expected because there were a lot of people saying “hey, everyone already knows this, it’s priced in”. I find that fascinating. 

As far as frauds people should know more about, in my opinion, Valeant (now Bausch Health) should be a household name the same way that Enron is. Valeant had a larger market capitalization than the Royal Bank of Canada at one point and it was all wiped out very quickly. If you want to learn more, I suggest the Dirty Money episode “Drug Short”. It’s on Netflix.

This has been fascinating and I am sure there are more than a few readers of this newsletter who could probably benefit directly from reaching out to you. How can people learn more about Bedrock AI and what you do?

We have three more spots open in our pilot program, starting in mid-January. If you are a pension fund, hedge fund or securities regulator and you’re interested in being part of our pilot, send a note to

Follow us on twitter @AIBedrock and on LinkedIn.  Our website is and we occasionally post updates through our newsletter. You can subscribe here

Thanks Kris for taking the time to come on the newsletter! 

Permalink to this post is here: Fixing Audit Won’t Fix Fraud: An Interview with Kris Bennatti of Bedrock AI |

I have two recommendations for you this week: with both of them I’m late to the party, having seen the internet erupt with praise over how great they are, and when I finally got around to reading / listening, yeah the praise checks out. These are both stellar.

A fantastic conversation between two very online people, both fantastic observers of Product and Tech culture: Sriram Krishnan, on-demand entertainment critic, social media product leader, and an investor | Sar Haribhakti

And this podcast episode with Nick Kokonas, founder of Tock. This is I think my favourite podcast episode Patrick has ever done. It’s very rare to come across examples, or teachers with hands-on experience, who can guide you through business at both the highest level (principles of options trading) and the lowest level (how to buy meat from restaurant vendors) and show you how, in a very literal sense, they’re both the same thing. Do yourself a favour and listen to this:

Nick Kokonas: Know what you are selling | Founders’ Field Guide, with Patrick O’Shaughnessy

Have a great week,


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