Hedge Fund Thinking for Startups — Full Breakdown & Transcri

[00:02] Street before I started my business. And the truth is the thinking, the way of operating at top hedge funds and quant trading firms is the exact same principles I brought to my business and ultimately led the business from growing

[00:17] ultimately led the business from growing from $0 with no investors to an $160 million acquisition in three and a half years. So the point of this video isn't to brag. Point of this video is to explain how I believe you should think

[00:30] as a founder. So many entrepreneurs, they just operate based on their instinct, right? Their gut. When really the way hedge funds operate and the best trading firms is on probabilities. They think in terms of expected value. They

[00:44] driven. And that's how you want to think. That's the point of this video to explain how to think like a hedge fund at your business. I'm a big believer in examples. So, let's just dive into it and go through a simple example. So,

[00:59] let's say you're a business owner and you're thinking about launching a new product, but it costs $200,000 to get off the ground. So, a lot of founders will just make it a gut instinct play. Yes, let's build this.

[01:11] But this is the way you really want to think. Obviously, the hardest part is actually assigning these probabilities. What is the probability of success and failure? And if you're successful, how big can you win? But let's say all of

[01:24] these probabilities on the screen are correct. So there's a 60% chance it's a complete failure and never makes a single dollar, right? Obviously that's really scary as an entrepreneur because you just burned not only investor

[01:38] capital or your own capital, right? Your own money, but you also burn time. But let's say your probabilities, you're from the future. You're completely thinking through these probabilities. Let's say there's also a 20% chance the

[01:53] product only makes $25,000 per year. That's an 8-year payback period. Not particularly good. You know, most founders would call that a bust. So, there's basically an 80% chance you fail. However, there's also some

[02:06] probability that your marketing takes off for it, your content goes viral, and you could make up to $10 million per year. There's a 5% probability. So, if you run through this expected value equation, you'll see it's 785 grand per

[02:22] year in profit. That is the expected value of investing $200,000. So, obviously, as a business person, that is a no-brainer trade. Nobody knows the future. You are not 100% confident that customers are going to buy something or

[02:36] your ads are going to work. You have to assign probabilities. But obviously as a founder putting in 200 grand, I'm ignoring the time cost in this example, ignoring the time cost in this example, but putting in $200,000 to get $785,000

[02:51] in expected value per year is a very good trade. That would be an absolute no-brainer for most business owners. Again, the hard part is going to be actually assigning those probabilities, but we'll get to that in a bit. So, what

[03:03] some people will say is, "Alex, you know, I can't bet $200,000 of money and spend the time because if I fail, then I'm screwed." And that's why as a founder, you need to iterate quickly. You shouldn't just be placing one bet

[03:17] and trying out one product. Ideally, if you raise money to start a company, you make 20 of these bets. And sure, each bet has basically an 80% chance of failing. the 20% chance that it makes $25,000 a year. I'm calling that

[03:32] basically failure. So there's an 80% probability each new product line fails, but the probability you fail all 20 would be less than 1%. The probability

[03:44] you go 0 for 20. That's why you want to iterate quickly and move quickly as an entrepreneur because again, you know, the more shots on goal you get with your business to try different things, to experiment, to try to launch new

[03:57] products, see if they take off in the market, see if customers like it, and then iterate from there. First of all, after every failure, you're not only going to get better, so the probability of success should improve, but you also

[04:09] have more shots on goal. That's really like an example of how I thought in the business thinking that we brought to Odds Jam especially me is thinking about every new product, every decision in terms of okay, what is the risk? What is

[04:23] put in? That's something we ignored in this example. What's the capital we have costs? And then what are the probabilities of success and failure? What if this product completely flops and we lose $200,000? That obviously

[04:38] sucks. But if there's a 5% chance it makes $10 million a year, that's an absolute no-brainer. It's worth some time. It's worth some initial capital. So, this is how you want to think. And this is how trading firms think. This is

[04:50] how I was taught as an options trader at Susuana International Group is if you are placing a lot of bets and you have the proper probabilities and you're really thinking through things, you may lose a few trades in a row, but over the

[05:04] large numbers, if your trades actually money. And it's the same thing as a business. If you are making the right bets and the right investments, then ultimately you're not going to go 0 for

[05:16] 20. That's less than a 1% probability of happening in this example. So, I can give you an example of a company that does a really good job in terms of thinking in bets and taking a lot of bets is Amazon. You probably have heard

[05:29] of Amazon Web Services of the Kindle, but you don't hear about the 98 other failures like pets.com because nobody cares, right? You take a ton of bets. I

[05:41] can't even fathom what the return for Amazon on AWS has been. maybe a thousand times, maybe 10,000 times. I mean, who knows? But that's what's amazing about business is you could have a return of a,000, 10,000, possibly even more just

[05:55] on some initial startup capital if you're rapidly experimenting. And I'll say the same thing applies to hiring. So, for example, at OddsJam, we hired our first employee. You know, these numbers aren't perfect, but let's say

[06:08] around $100,000 profit per month. That's what we are making. $100,000 profit per month. And let's say we can hire a customer support person for $7,000 a month. Just putting numbers to it. So, it's a cost of $7,000, but I'm currently

[06:25] spending, you know, 4 hours a day because there's no employees on customer support. I'm answering people's questions. I'm charging credit cards. I'm helping people if they have issues with their account. So, basically, the

[06:39] question is, with the extra 4 hours per day, how much can I grow the company? And let's just say for the sake of example, it's I can grow the company with four extra hours per day, assuming I'm working hard those extra four hours

[06:51] and I'm not just watching forensic files or something like that or breaking bad. So let's say I can take the company from $100,000 profit per month to $120,000. Obviously, that would be a no-brainer trade. The net profit from this decision

[07:06] was 13K. So that's a no-brainer higher. And granted, there's obviously a time cost. There's a management cost. You're going to have to train this employee. employee. But let's just say for the first month, I spend four hours a day

[07:20] training this customer support rep. So, I'm not actually working on things that benefit the company. Then, sure, we take a $7,000 hit in month one because the company didn't grow, but month two onwards, I'm getting an additional

[07:33] benefit of 13 grand a month. That's obviously a bet that pays off big just within a month. That's kind of how you want to think as a founder in terms of hiring, in terms of sizing bets for product lines. You need to take this

[07:46] mindset of how much additional work could I do? If this person is hired, how much time is freed up for somebody else and what additional profit can they then bring in? So, the next thing great traders, great hedge fund managers do is

[08:00] they look for asymmetric bets. Where is downside low or at least cap and upside is possibly infinite or extremely high. So if you've seen the movie The Big Short, that was an example of an asymmetric bet. John Pollson, who I

[08:14] think made $4 billion on this trade himself personally and 15 billion for his fund, he basically had the idea that, hey, these supposedly very safe securities, mortgage back securities filled with mortgages actually are full

[08:30] of a bunch of crap. and the banks are giving out horrible mortgages to broke people with horrible credit and these bonds are going to go bust. So what did he do? He bought credit default swaps. He bought insurance on these bonds which

[08:44] is basically like if there's a super safe area where nobody expects a fire, going to be a fire and you're able to buy insurance on all those houses, you pay a small premium and then if you're correct, I mean obviously this is a

[08:58] horrible and sad example. If you're correct and all those houses burned down, you get paid out massive. So essentially, that's what he did with mortgage back securities. He was paying a small amount of his fund, right? His

[09:10] downside was relatively capped, but if he was correct, he had upsides on some of these mortgage bonds. I think paid out over 50x returns. So he made an absolute killing. And that is the best thing as a founder. I mean, even when I

[09:23] what I thought about. It's like, okay, this company didn't take a lot of startup capital. It didn't cost a lot of initial money. What is my downside? My downside is I'm quitting my job. I'm losing a great job, a job I love. I'm

[09:37] paid. So, I lose some money, but also I'm young. I can probably get another job. So, it kind of is what it is. The downside is relatively low. And then if driven sports betting tools and good access to sports betting data, you know,

[09:52] there's possibly some really big upside. And all great founders think that way. So the same thing is when I was working at a trading firm, you are back testing everything. Everything is extremely datadriven and it's the same thing as a

[10:05] founder, right? You should be AB testing your subscribe page. Can you improve your conversion rate from 2% to 3%. You are constantly working in testing things

[10:17] and trying to improve things. Obviously, there's times where you shouldn't be AB testing. For example, if you have 10 website visitors a day, you should getting more people to visit your

[10:30] website as opposed to optimizing the buttons for the 10 people on your site. But once you start to reach scale, you know, even just incrementally improving how many people end up subscribing to your product by 1%, 2%. It adds up

[10:44] massively. So, as a trader, you're constantly back testing algorithms, trading strategies. It's the same thing if you're a founder. You need to be data driven, constantly trying to improve as many things as possible where it's high

[10:58] leverage. So, I hope you enjoyed this video because I truly believe if more founders thought like traders in terms of expected value and probabilities, their companies would have a lot higher probability of success. So, hopefully

[11:11] you enjoyed this video. Let me know other video ideas and thank you guys so other video ideas and thank you guys so much for your