Most private equity firms are paid on the 2-and-20 model: a 2 percent annual fixed fee on all the money it invests and 20 percent of all profits above a certain threshold. The United States taxes money made from investments—so-called capital gains—at a lower level than money made through ordinary labor, whether at a factory or in an office. The distinction is ambiguous and unfair, but even more so, private equity firms have convinced the IRS that their 20 percent income should be taxed at the lower capital gains rate than at the higher ordinary income rate.
First, because private equity firms own the companies they buy for just a few years, they must extract money from them exceedingly fast; there’s simply not much reason for them to consider the long-term health of the companies they buy. Second, because private equity firms invest little of their own money but receive an outsized share of potential profits, they are encouraged to take huge risks. In practice, this means loading companies up with debt and extracting onerous fees. And third, partly because legally separate funds technically own the companies, private equity firms are rarely held responsible for the debts and actions of the companies they run. These facts of short-term, high-risk, and low-consequence ownership explain why private equity firms’ efforts to make companies profitable so often prove disastrous for everyone except the private equity firms themselves.
Private equity firms are different from investment banks, which originally centered on helping other businesses buy one another or issue stock. They are also different from hedge funds, which tend to buy and sell public securities, such as stocks and bonds. Rather than buying individual securities, private equity firms buy whole companies. And rather than doing so on behalf of other businesses, they do so for themselves.
Teller realizes that when you’re building pedestals, you are also accumulating sunk costs that make it hard to quit even as you find out that you may not be able to train the monkey to juggle those torches. By focusing on the monkey first, you naturally reduce the debris you accumulate solving for something that’s, in reality, already solved.
Admiral McRaven offered a unique, high-stakes application of this concept of states and dates when describing the planning for Operation Neptune Spear, the raid on Osama bin Laden. The operation was broken down into 162 phases. Each phase told you what state you would have to achieve to continue, and what state you might be in that would cause you to quit during that phase. Because this was all planned out in advance, it left McRaven, as he told me, with only about five command decisions he might have to make on the fly once the mission had commenced and they were already in it.
The best quitting criteria combine two things: a state and a date. A state is just what it sounds like, an objective, measurable condition you or your project is in, a benchmark that you have hit or missed. A date is the when. Kill criteria, generally, include both states and dates, in the form of “If I am (or am not) in a particular state at a particular date or at a particular time, then I have to quit.” Or “If I haven’t done X by Y (time), I’ll quit.” Or “If I haven’t achieved X by the time I’ve spent Y (amount in money, effort, time, or other resources), I should quit.”
Essentially, when you enter into an endeavor, you want to imagine what you could find out that would tell you it’s no longer worth pursuing. Ask yourself, “What are the signs that, if I see them in the future, will cause me to exit the road I’m on? What could I learn about the state of the world or the state of myself that would change my commitment to this decision?” That list offers you a set of kill criteria, literally criteria for killing a project or changing your mind or cutting your losses. It’s one of the best tools for helping you figure out when to quit closer to on time. Kill criteria could consist of information you learn that tells you the monkey isn’t trainable or that you’re not sufficiently likely to reach your goal, or signs that luck has gone against you.
That’s the funny thing about grit. While grit can get you to stick to hard things that are worthwhile, grit can also get you to stick to hard things that are no longer worthwhile.
The monkeys for the hyperloop to be viable were things like whether you could safely load and unload passengers or cargo, and whether you could get the system up to speed and get it to brake without incident. A couple hundred yards of track wouldn’t tell you anything about whether you could conquer those challenges. In fact, Teller and the team at X figured out that you would have to build practically the whole thing before you knew whether it worked. You would have to build a bunch of pedestals before you could find out if the monkeys were intractable. They quickly decided not to pursue it. One of Teller’s valuable insights is that pedestal-building creates the illusion of progress rather than actual progress itself.
By definition, anybody who has succeeded at something has stuck with it. That’s a statement of fact, always true in hindsight. But that doesn’t mean that the inverse is true, that if you stick to something, you will succeed at it.
we started by working with the sales team to generate a list of signals that would tell them that an opportunity wasn’t worth pursuing. To do that, we sent out the following prompt to the sellers and the sales leadership: Imagine you were pursuing a lead that came through an RFP (request for proposal) or RFI (request for information). It’s six months from now, and you have lost the deal. Looking back, you realize there were early signals that the deal was not going to close. What were they?
