Let's think about the nonlinearity for a second.
And one of the topics you wanted to bring up was this idea of liquidity as a nonlinearity.
Yes.
And so one of the things that we see within venture capitals is that there's been this
explosion of liquidity, particularly exceptionally well-funded growth equity.
So not the true VC stage one, Series A-type round, although that obviously has benefited
from this dynamic, but the Series E pre-public here's $1 billion, here's a $20 billion valuation,
here's a $100 billion valuation.
Talk to me about how you think about this liquidity switch and the impact that that
has on your industry and the impact that has on innovation?
Well, it ultimately is going to define all the returns.
And if you go back a little bit and say, well, why are we in this situation, where we've
called this in the past, the minnows and the megas?
You have lots of these small firms that are starting up that are doing the seed checks,
and then you have these large players that are writing these $100 million plus checks.
Going back 7 years or so, Andreessen-- who I think is a brilliant investor, a brilliant
technologist-- basically said, there's only 10 companies that matter in a given year.
And statically, that's probably true.
Now knowing which 10 is very hard, but he said, you just basically want to be in those
companies.
And I that was a meme that really went very wide.
And people said, OK, well, it doesn't matter if you invest in Facebook at $1 billion, or
$5 billion, or $10 billion because we're going to be hundreds of billions.
And so does it really matter if we're negotiating here and quibbling over $1 billion or $2 billion.
Well, of course, it does, but that I think induced a lot of growth investors to say,
let's just try to speculate on some of these big unicorns.
And you've got this phenomenon of companies that were pining to signal that they were
going to be that next Facebook by attaining a billion-dollar valuation.
And then you got a positive feedback effect where people were funding these things, and
to get access, would write an $100 million check at a $900 million pre.
And they would own 10% in a billion-dollar valuation.
And the problem for the early-stage investors and their limited partners is they were getting
these huge markups.
And on paper, it looked phenomenal.
And then they would go out and raise their next fund and put it into more illiquid companies.
But they weren't necessarily getting liquidity on that billion-dollar company.
And you have started to see over the past 3 or 4 years, a lot of these unicorns not
go from $1 billion to $800 million.
They've gone from $1 billion or $2 billion to 0.
To 0, yeah.
And so there's this liquidity trap that is natural in markets because people are basically
taking massive amounts of capital, which in the venture world, there's a capital structure
just like in the traditional public markets.
And you have common equity, which sits on the bottom of the stack, and then preferred,
and then debt on top.
When you have preferred equity of a size that is so large, and with it might have the classic
Carl Icahn, you know, your price, my terms.
So SoftBank would come in, for example-- we could talk a bit about them-- and say, sure,
we'll give you $20 million, and we want to own 20% at a billion-dollar valuation, and
we want a 2x or 3x liquidation preference.
Now, you're talking about a payout where if they actually got sold for $1 billion, SoftBank
is not getting 20% of that.
They're getting $600 million.
And so all the people below the stack, that might be OK because you're really actually
getting your percentage of a $400 million distribution in a waterfall, but what if it's
only $400 million or $500 million?
You're getting nothing.
So the presence of SoftBank coming in and basically said, you know what?
We're going to do this in a huge way.
And combination of Saudi money, and others, and complex debt structure, started basically
becoming in a relatively-- not relatively-- in an absolutely inefficient market, the top-tick
price setter.
And suddenly, they were writing these large checks, owning very large pieces of companies
at extraordinary valuations, setting comps that other people would reference, while SoftBank
just did that as though they would fund the other.
They would publicly come out and do these Solomonic baby splits, right?
We're going to go to California and we're going to invest in either Lyft or Uber.
Fight it out because we're going to king-make one.
It's my view that-- and this is a borderline tinfoil conspiracy theory-- I think that part
of what's going on is SoftBank is investing in companies that they know that they will
be able to inflate the value of later on.
You saw this with We Work.
First investing at around $10 billion valuation, then $20-- basically, pricing up the deal
themselves.
And when you looked at the earnings release, either a quarter or two ago, most of the profits
that SoftBank was able to show on paper were from the write-ups of their equity holdings.
So I believe that a lot of the activity is done not just because they think they can
make money-- although I'm sure that's true-- but because they believe that it will serve
as collateral against a massively-indebted mothership parent company.
And so that has absolutely distorted the venture market.
And we have warned our companies, unless you and we are getting liquidity in one of these
monster rounds, you're basically taking the risk that you're going to be holding zombie
shares.
And I think that there will be a rude awakening for a lot of people that that's the case.
Now, it has attracted other people who are providing capital as alternatives to SoftBank.
And so you have crossover funds and you have really smart groups.
We get Tiger-- who has absolutely killed it in a really smart way-- Viking, and Coatue,
and others that are writing $100 million plus checks.
They do have the public market savviness and understand what the comps are.
They are generally value-add.
In the case of Auris, you know, all those groups that came in were, I think, super helpful.
But it's a very dangerous phenomenon where you have huge amounts of money coming in at
huge valuations on what are still largely unprofitable binary outcomes.
Well, so those companies hit on two separate issues, right?
One is at minimum in a Minsky-type framework, they're speculative finance, right?
They rely on the capital markets remaining open in order to cover their costs and service
their existing levels of debt.
At worst case scenario, they have Ponzi-like aspects, which is in order to keep going,
they need to keep raising more money, right?
The second component though that you're describing when you talk about these types of preference
rates is you're creating waterfall characteristics similar to a securitized debt stack.
The structure of the payout.
The structure of the payout is very different depending upon the underlying outcomes.
And pricing that is really quite tricky, right?
It's very unclear that anyone involved is actually making the type of calculated analysis
that says, well, I have an option that suddenly has very different components.
I actually think that there is a very sophisticated step-- there's just three steps.
The first step is the finger in the air.
The second is to the tongue, and then the third is to put it in the air.
To put it up, yeah.
Yeah, it's a highly efficient temperature gauge.
I think that's right.
And that would largely argue that most of the participants in the venture space are
not by experience equipped to do that type of calculation, right-- understanding the
option components.
To be fair, Auris from a $20 million pre to a $5.75 billion exit--
Oh, sure, pick on something that worked.
--I didn't look at a single spreadsheet-- not a single one.
We didn't model anything.
Right.
I mean, it was literally, you know, we're backing a team.
They're developing a technology.
We think it's going to be relevant to this market.
And if you would've told me that it would've been sold for $3 billion, or $8 billion, or
$4 billion-- like we had no conception of what that range could actually be.
So that's traditional venture capital, right?
And that's obviously meant as a compliment, all right?
But when you start making an observation about a historical distribution of payouts, and
then change your behavior based on that historical distribution of payouts, what you're actually
doing is changing the future distribution of payouts-- i.e.
Marc Andreessen's observation was correct as it described the history of venture capital.
But by choosing to act on it and act on it as a scale enough agent-- and SoftBank obviously
is even larger in this context-- but by acting on it as a scale agent, you've changed the
future distribution.
You won't know that until you observe the outcomes.
I think you've skewed the probabilities lower, right?
I mean, just by definition, the more people that are chasing things, you know, the greater
the competition.
Now if you have these layers in the public markets where there were pools of capital
that were voracious to be buyers of IPOs, then you would see this flood of IPOs, like
we saw in the late '90s and early 2000.
You don't see that today.
Now for a variety of reasons, the narrative is to stay private for longer, control.
But I think you're absolutely right that by making the observation that there's a handful
of companies that mattered and the price that you paid didn't, it attracted a flood of capital.
But that's flood of capital, I believe is going to end up with a lot of donuts.