(upbeat music)
- Where do you see the future in terms of size,
Silicon Valley or just the tech world?
- Look, I mean,
technology keeps getting better and better
every single year,
and you have to differentiate between financial markets,
and the underlying technology itself.
Financial markets go up and down.
We have the Dot-com boom, Dot-com crash, et cetera.
We had boom throughout 2013 with Twitter going public,
and so forth.
Then they had some hard times
where there was no IPOs of major technology companies.
But every year technology gets better and better and better
on the terms of underlying,
so that will go on forever
in terms of the actual underlying quality of the technology.
But this is how technology gets financed,
and how you raise money and the donation of venture capital,
I mean, it's kind of interesting to watch,
because venture capital funds
are getting bigger and bigger and bigger.
- There's more and more money, yeah.
- A bit more and more money.
They're doing it for a bunch of reasons.
First reason is there's like this feedback loop
that's happening with venture capital,
where the top 10 venture capitalists get all the deal flow,
because they're in the top 10.
- Yes.
And they're in the top 10, so they get the best deals,
so they get the best returns,
therefor they're in the top 10.
It's like an information cascade.
It's like being Tim Ferriss
when he did his book The 4-Hour Workweek.
He spent his entire marketing budget in one weekend
to get himself in the top 10 list.
- And then the rest is history.
- Because once you're in the top 10 list for books,
you stay in the top 10 list.
- Yes. - Right?
- So, that's kinda what's happening in venture capital.
So all this money is kinda flowing
into venture capital funds.
So instead of being a hundred million dollar fund now,
they're a billion dollar fund.
The problem is a software company
can't take a hundred million dollars in investment.
I mean, what would you do with it, right?
Unless you're in Silicon Valley and the wages are stupid.
- Correct.
- Even then you couldn't really use the money,
right? - Correct.
- So companies are staying private longer,
and longer and longer.
Also the public markets for exiting technology companies
have not been available for many years.
- Right.
Occasionally it'll open for a little bit,
and a few technologies will come out,
but then all the crap comes out on the market,
and the market window closes again.
So, the likely route for a venture capitalist to exit
is through acquisition, if they try and sell to someone.
There has been a lot of funny financial engineering
that's been going on in terms of
the whole Unicorn phenomena.
So, there's this whole thing about, okay, you're Unicorn,
you've got a billion-dollar valuation,
therefor you're a superstar company,
you're on the world stage--
- Yes, the whole world's watching.
- But I've got a whole talk on YouTube
called How to Not Get Screwed in Venture Financing,
which kind of explains what's actually going on there.
Let's say you're a company doing 20 million in revenue,
alright, and you're growing at 40% year on year, right?
Well if you take all public companies and technology,
and you plot them where on one axis
you plot enterprise value to sales, right?
Which is effectively their market capitalization
minus the cash in bank, divided by sales.
So it's what multiple the market is giving them
in their valuation over their sales.
Alright, so if your revenue's 20 million a year,
what's the multiple on 20 million
you'll get in terms of valuation.
And on the X axis you plot what's your revenue growth
year on year, 0%, 10%, 20%, 30%, 40%.
If you draw a scatter plot,
and these things change over time,
but if you draw a scatter plot, say around now,
if you're growing about 40% year on year,
typically if you're lucky you can probably a valuation
of 10 times your sales.
So if you're doing 20 million in revenue year on year,
and you're growing at 40%, right?
Per annual year on year.
You should be like a 200 million dollar valuation.
So what was happening in the Unicorn phenomenon
is these VCs would come along going,
hang on a tic, what we'll do is this.
We'll find these companies doing 20 million in revenue
year on year, that we think are good opportunities,
they've got good growth,
40% year on year is really great growth.
And we'll go to them and say,
how would you like to be a Unicorn?
What I'll do is, I'll give you 100 million dollars
investment at a billion-dollar valuation, right?
And every startup founder would go, okay great,
I'd love to get 100 million and a billion-dollar valuation,
I'll be a superstar.
I'll be in the news, I'll be on the front cover of--
- Doesn't mean they deserve it.
- I'll be on Wide magazine, I mean whatever, right?
But now, 20 million in revenue, growing 40% year on year,
a billion-dollar valuation
doesn't really make a lot of sense.
I mean, how many years would you have to operate
before you actually pay back a billion dollars, right?
So what was happening was,
through the magic of venture capital financing,
they'll say, okay, here's a term sheet,
a hundred million invested, billion-dollar valuation,
but what I want is I want a two times
participating preferred liquidation preference.
And what this means is, liquidation preference,
it's really a construct designed to limit
the downside of the venture capitalist.
So for example, let's say I go and invest
a hundred million dollars in your company,
and your company blows up.
But there's 50 million at the bank at the end,
when we wind up and sold the assets.
Well, the venture capitalist will say,
well that 50 million should be my money,
because you just put in the hard work and the sweat equity.
I put in the cash.
So there should be some downside protection.
If the company goes broke,
and there's a hundred million or less left in the bank,
I should be able to get that back first.
And if there's anything more than that,
then you can share with me, right?
So it was really designed as a downside protection.
- Like an insurance policy almost.
- Yeah exactly, but this morphed into a double dipping
by venture capitalists.
So they could do things like say,
well I think if I give you a hundred million,
if the company sells for anything less than 200
or goes bust with anything less than 200,
then I should get everything,
because I've taken the big risk,
I've given you the money, right?
And in fact, in a participating preferred scenario,
above 200 then we share.
So let's take this example.
You've got a 20 million dollar company--
- Now I'm growing, growing, growing, growing.
- You're growing 40% year on year.
I say to you, a hundred million investment
on a billion-dollar valuation.
So a hundred million investment
on a billion-dollar valuation means I get 9%,
but if you sell for less than 200 million, I get everything.
- Wow.
- Now, from a VC's perspective that's a smart move,
because I know a company 20 million revenue,
40% year on year growth,
I should be able to sell that for 200.
So what the founder hasn't realized is, when they've got
the stars in their eyes-- - There's no lose.
- From the founders perspective,
they've swapped the company for a cool option.
- Correct, correct, correct.
- So they no longer own the company anymore,
they have an option where if it's worth more than 200
they make money, but below 200 they make zero, right?
And the smart venture capitalist is going,
well my downside's protected because I've got a company now,
I know I can sell for 200,
because that's what it's valued at.
It's got a hundred million extra cash in bank,
so it should be okay for a little while.
And if I get it to grow and be huge, that's great,
'cause I sunk a lot of money into it,
but in terms of the downside,
my downside's pretty good,
because my downside is I know I can sell for 200,
and I know there's a hundred million cash in bank.
- That's right, and also I think for entrepreneurs,
the founder, when they get this surge of cash,
it's very easy to get that they care less, right?
- Oh well, that's the thing, right?
- Right, it's like, oh I've got a hundred million cash,
no problem, yeah lets expand,
they just spend money without really thinking about it.
- So I don't think the best operators of businesses
are in Silicon Valley,
because there's too much cash that gets invested
in these businesses. - Correct.
- They get sloppy. - Correct.
- And the other thing is,
I mean you hire people over in the Valley,
they stay for six months and they want double or triple
what you'd pay them anywhere else.
The very good operators are the ones
that are in other parts around the world,
where the money is not so easy to come to,
and they've gotta learn how to run a business
off the smell of an oily rag, right?
They've gotta learn how to be--
- Resourceful.
- Like an owner.
Like, every dollar I spend,
how do I make more than a dollar back, right?
So they've gotta really fight it out tooth and nails.
For example, in Australia,
for many many years the investing climate
was terrible for technology.
The guys that come out the other side who are great CEOs,
they didn't raise much money, right?
For example, Atlassian,
which listed in the U.S. just recently,
that's a business now worth 30 billion dollars.
These guys didn't raise any money
until they 600 million valuation.
Then they took 60 million bucks,
and that was a secondary sale off mostly.
- They're just running good business.
- They just run a great business,
and they think very carefully
about where they spend the money.
When they spend it on marketing,
they wanna make sure every dollar
makes more than a dollar back,
and how fast do I make that money back?
And they're very careful not to waste money.
In the Valley you can raise 50 or a hundred million dollars,
you see the money go get spent--
- Spend money on a new office, get more space--
- Massage, ping-pong table,
wave pool. - All this stuff
that doesn't create more value for the company.
- That's right, and then if they don't
get to the next milestone in terms of valuation,
then they're basically dead.
- And then also, in terms of the venture capitalist,
they now have a lot of say of
how the founder needs to do things
or I think it almost effects the entrepreneurial spirit.
- Well yeah, the easiest way to lose control in a business
happens on the first round of investment
from venture capitalists typically,
where the VC comes along and says,
okay, the board, this is the way it'll work,
we'll have a board of five,
you pick two people, I pick two people,
and then we'll have an independent chairman.
Now what they say about independence is,
the great thing about independency is
the more you pay them, the more independent they get.
(both laughing)
- Which they work for the VC anyway.
- Yeah, well the flip side is the golden rule.
He who has the gold, rules, right?
So the independent chairman that comes along,
they know that the VC is where the money is coming from
so all of a sudden on day one,
it's a board of three versus two, and your control is gone.
Forever. - Right, wow.