Doesn't really matter if we're negotiating here in quibbling over a billion or two
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
You know going back seven years or so Andreessen who I think is a brilliant investor a brilliant
technologist basically said there's only ten companies that matter in a given year and
Statistically that's probably true now knowing which ten is very hard
But he said you just basically want to be in those companies and I think that was a meme that really went
Very wide and and people said, okay
well
It doesn't matter if you invest in Facebook at a billion or five billion or ten billion
Because we go on to be hundreds of billions
And so does it really matter if we're negotiating here and quibbling over a billion or two?
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 got this phenomenon of companies that were pining to signal that they were gonna be that next Facebook by getting
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 a hundred million dollar check at a nine hundred million free and they would only 10% and 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 the next fund and put it into more eliquid companies
but they weren't necessarily getting liquidity on that billion dollar company and
You have started to see over the past three or four years a lot of these unicorns not go from a billion
To eight hundred million, they've gone from a billion or two billion to zero to zero. Yeah
and so there's this liquidity trap that is natural in markets because people are basically taking
massive amounts of capital which in a 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 dead on top
When you have preferred equity of a size that is so large and with it might have the class of Carl Icahn
You know your price my terms. Mm-hmm. So Softbank would come in
for example
We can talk a bit about them and say sure
We'll give you two hundred million dollars and we want to own 20 percent at a billion dollar valuation
And we wanted two or three X liquidation preference. Now, you're talking about a payout where if they actually got sold for a billion dollars
Softbank is not getting 20% of that. They're getting sixty six hundred million dollars, right?
And so all the people below the stack that might be okay because you're really actually getting your percentage of a million dollar
You know distribution and a waterfall, but what if it's only four hundred million dollars or five hundred million dollars, you're getting nothing. Mm-hmm
so the presence of Softbank
coming in and basically said you know what we're gonna 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
Well something just did that as though they wouldn't fund the other they would publicly come out and do the 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 gonna King make one
It's my view that
And this is a you know, 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 it around ten billion dollar valuation then twenty basically pricing up the deal themselves and when you looked at the earning release either
a quarter or two ago
Most of the profits that Softbank was able to show on paper or 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
Oh, 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 gonna be holding zombie shares. Mm-hmm
And I think that there'll be a rude awakening for a lot of people 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 via Tiger who is absolutely killed it in a really smart way
Viking and co2 and you know others that are riding 100 million dollar-plus checks
They do have the public market savviness and understand what the comps are
They are generally value add in the case of horse, 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 right which is they
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 rights is you're creating waterfall
characteristics similar to a securitized
debt stack the structure in pea 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
Right, actually that there's a very sophisticated step whether there's three steps. The first step is the finger in the air
the second is to the tongue and then the third is
Yeah, it's it's a highly efficient temperature gauge
I think that's right
And I 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 their components, you know ORS from a 20 million pre to a five point seven five billion dollar exit
Oh sure pick on something that worked. I didn't look at a single spreadsheet. I'm 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 gonna be relevant to this market and
if you would have told me that it would have been sold for three billion or eight billion or four billion or two 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 right but when you start making an observation about a historical
distribution of payouts
All right
And then change your behavior based on that historical distribution of payouts
What you're actually doing is changing the future distribution of payouts ie market and arrestins
Observation was correct as it describes the history of venture capital
But by choosing to act on it and act on it as a scale enough agent 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 outcome. 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 stay private for longer control
But but I think you're absolutely right that
By making the observation that there's a handful of companies that mattered and a price that you paid didn't
It attracted a flood of capital, but that's a lot of capital I believe is going to end up with a lot of donuts. I
Think that's correct. And I think the challenge is that there's a
Feedback loop as you go through that process, right?
So exactly as you highlight with Softbank where they're able to write up their investments and show profits
That in turn is then able to be presented to investors and say hey, look how stable
This process is or how profitable it is which induces more capital juices more capital to come in right? It's very dangerous
I mean it is in a sense like a Minsky, you know cycle. It's absolutely a Minsky cycle
All right, the challenge on all of this though. Is that in a world that is dominated by empirical finance, right?
Which is the historical returns are the only fact pattern the future returns are your opinion in my opinion?
All right, particularly in that process of migration where more pools of capital are coming in raising the valuations improving their returns
You can look like a fool a complete Kassandra are youing that this is bad in the future?
Because the immediate history is going to tell you the exact opposite and it's it's the analogies between the history and public markets
Which I try to study a lot
not anywhere near as as well as you I learned way more from youth and then I do for many of my venture brethren when
It comes to capital markets and you compare that to the venture world, you know
There are really ends of ones in
Venture like looking at comparables, you know
in
1997 you would have been an idiot or 98 you would have been an idiot first who the hell needs another search engine
only to miss Google
but then once you see the presence of Google
You would have been an idiot to try to fund the next 10 like OSes or you know, whatever it was
And so it's very hard because you have these aberrant outcomes
they are total anomalies and
Then people try to learn from these things and it's it's just it's way different and I would actually argue that the reason it's different
is because you do not have
The kind of information that is conveyed through price discovery in traditional markets
You do not have the number of really smart people that are looking at a security analyzing its history looking at the fundamentals
Debating it being long. It being shorted the absence of that kind of relative efficiency is
Totally missing adventure. And so you also get what you don't typically get in the public markets as much
massive
Dislocations between bids and ask and pricing events. So the step ups that we see in
You know a seed stage round
can be 10x into a series a
Now the scale of what you're talking you might be
Putting a few hundred thousand or a few million dollars in a few million dollar valuation
And then you might be raising twenty or thirty million dollars at a 50 million dollar valuation and a hundred at a billion the gaps
The the discontinuity is between those is huge
Now, you know liquidity is one form of that this sort of asymmetry of information
but it it starts before conception or inception of a company and
There's information asymmetries all the way and you could argue that they get reduced over time
But the first information asymmetry like the maximum information asymmetry is with the invention that a scientist has
and you know
there's just code from Linus Pauling Nobel laureate who said I know something that nobody else in the world knows and
They won't know it until I tell them that is the ultimate power in the world to know a secret
That soon the rest of the world will know but you're the only one that knows it. So that's maximum information asymmetry
The next is okay. Now the scientist is team with an entrepreneur
now the entrepreneur
Might have asymmetry cos not a lot of other people know about it or they've befriended the scientist and they started the company
But then the entrepreneur has any symmetry of both a false positive and maybe a true positive which is their estimation of their ability
Almost all entrepreneurs
Believe that they are more valuable than the market thinks they are because if the market thought those teenagers as well
Yeah, and by the way, the the disposition are there similar tantrums, they so much the wrong
You don't know if you should trust them with money
You know the entrepreneur if they were if they felt fairly valued by the market would go and just join
You know a consulting firm McKinsey
But they say no either because they were rejected and they say no I'm gonna go do it myself
and so to do something entrepreneurial in a sense is to have an overestimation of
The thing that you know or things, you know that the rest of the world doesn't now ninety percent, roughly
Let's just say failure means that
You know ten percent of those people are actually right or lucky right and maybe some of them are right and unlucky
but
So that's the next asymmetry the entrepreneur who thinks that they know something or maybe does in fact know something the rest of the world
Doesn't then the next stage is the investor
So now we come along and we meet the engineer or the fred mole and we think okay. Wait a second. We're early here
we've got something that nobody else knows and so we jump on that and that's really
It is the same phenomenon as the teenager who is discovering the band that nobody else knows about yet the book or the movie
Or the artist that is going to impart on them
Social currency because they have discovered the thing that everybody else is going to celebrate later. There's no difference
So for us it isn't an Excel spreadsheet, it's not a model
it's like based on the market and the understanding we have and the the
marketability of this entrepreneur and their ability to raise money and recruit people and convince them to part with their jobs and move across the
Country and join them do we think that these guys and girls are gonna be really valuable. It's a total qualitative psychological judgment
so now
we're in the first few board meetings and
and we know everything that's going on in the company or let's say
80% of what's going on in the company?
And if you have a good relationship with a CEO, you know a lot more if you don't think they hide things from you
but now a new investor comes in and so let's say we've invested in this case like a Norris at twenty million dollars free and
Then Peter tail comes in eighty or whatever it is
Does Peter know more than we do now?
Maybe he knows something about the market that we don't know or maybe he has an unfair access to be able to make introductions that
Are going to create value by reducing risk
But there's very improbable chance that a new investor knows more about what is happening in the company than an existing investor
So now we have asymmetry of information and so it's very different than public markets where you might have different preferences in time
or liquidity or expected return the
informational asymmetry
Starting from that scientist to the entrepreneur to the first founders to the funders to the later funders is just enormous
over time I think it starts to reduce and
Then ultimately you're going to the public markets and the public markets are saying well we demand to be able to look at the books
and understand and how this compares to comps and how it's going to be valued and what our
estimation is of how other public market investors are gonna value it and then you start to get more and more scrutiny and
Scrutiny, I think ultimately
Creates liquidity and it creates markets because you have more information
so that
Information asymmetry is I think where most of the returns of venture come from and being able to identify people early develop a reputation
so that you can attract the next entrepreneur who believes that they might be like your last entrepreneur and
have a reputation for being a good actor with other investors and not being zero-sum knowing that this is a long game and
Otherwise, I think it's a it's a asset class that fustrating Lee for us as insiders and definitively for outsiders. It's really dominated by luck
You