Validate Ideas With A Red Team

During his recent interview with Tobias, Matthew Sweeney, Managing Partner at Laughing Water Capital, discussed Validating Ideas With A Red Team. Here’s an excerpt from the interview:

Tobias: So, that’s some discussion there about how you’re validating the ideas. But are you doing channel checks, speaking to management teams? How do you validate the idea?

Matt: Yes, I definitely all of those sorts of things. It’s a bottom-up process, starting with reading the financial statements and the transcripts. I almost always speak with management teams, I don’t always, but I almost always do. I try to speak with former employees, that sort of stuff, competitors, read the filings on the competitors. I don’t really do any sell-side research. I don’t really use that. It just doesn’t really fit well in my process.

Basically, just turning over as much as I can trying to get to the thesis and then trying to destroy the thesis by questioning all the things that I’ve come up with through my first round. So, if you think of the initial round as financial statements, transcripts, management, and then you’ll be able to paint the thesis with that. And then you try and destroy that thesis by going to things like competitors and customers and former employees and say, “What is the truth from the outside versus what the truth is, as they project it through their financial statements?”

And then, the last part of it is something I call a red team, because I’m a one-man show, I don’t have a partner or anything like that, to help me realize the flaws in my thinking. But what I refer to as the Red Team is actually an idea that was put together by Scott Miller at Greenhaven Road, who you may be familiar with. If not, you should probably try and speak with him at some point. He is a fantastic investor and great human being. But he about a year or two ago brought together a number of like-minded investors to do an event with Annie Duke, who has written books about decision making. She’s a former professional poker player and the psychology because she almost had a PhD in psychology, she dropped out to play professional poker, but she’s an authority on decision making, I guess.

Basically, had an event, trying to explain how decision-making works, and how as investors, we can improve our process. And one of those things is being aware of your own biases. And the second thing is being aware that you can never fully defeat them. So, the red team idea is, if you take other people that have a similar but different skill set, and have them look at your ideas, but the idea that in advance, we’re going to make an agreement that nobody’s going to get their feelings hurt here.

The idea is that you would make me uncomfortable. And so, there’s a number of other investment managers I can rely on for that. And where I actually feel like I have a real advantage is that when I think of Laughing Water Capital, the largest cohort within the LP base is actually other professional investors. And that’s everything from former equity managers or current equity managers that used to have a small-cap strategy, but now they have too much money to invest in small caps. So, they invest with someone like me, while they also run their own portfolio, or private equity types, where a lot of times I hear from private equity investors that in their world, they’re always buying from the smartest person in the room. But in my world, I’m often able to buy from the dumbest person in the room.

The point is, just a network of people who are LPs, and their incentives are on returns just as mine are. So, they’re not afraid to tell me I’m stupid. And that’s really the goal. I don’t want anyone to tell me that my idea is great, or that my idea is “correct.” What I want is pushed back to help me understand what I’m missing, what I’m doing wrong, other things I need to think about, how the pieces needs to be adjusted over time, things in advance that would make me change my mind. All of these things are meant to defeat the demons that we all have, which control our behavioral response to decision making.

Tobias: What’s the source of that red team idea? Is that like a Bill Belichick? Does it come from Pats or something like that? I remember, maybe in the last year or two.

Matt: I’m not sure. As much as it’s painful, I’m a Jets fan, so I can’t really comment on Belichick or the Patriots. But, for me, the first time I had heard it, or at least got intimate with, it was this even with Annie Duke, so I thought I would credit her. It’s definitely possible it came from somewhere else.