So, whats with the crazy run of Unicorns? Temporary insanity or a fundamental change in the universal constants? Or we are in a Bizzaro world?
In the opinion of this observer, FOMO.
Bear with me.
In some ways, Alpha seems to be disappearing from the market. There is too much money sloshing around1 as to completely mute the Alpha. So public market returns are hard(er) to predict.
Companies are staying private longer.
There is a lot more understanding / familiarity with / acceptance of PE/VC as asset classes, and not just for institutional investors. Not to mention the returns have beaten every other asset class.
As these trends interact, the inevitable outcome is that the later stage investors are moving money from public markets to private companies. This creates much higher returns for early stage investors (paper or otherwise).
Finding great companies to invest in early on has always been a highly competitive endeavour. Both in India and elsewhere.
This is where the greater fool theory kicks in. As a VC, I am now able to justify paying a higher price today to secure “the deal” because there are people willing to offer (relatively) higher values to me down the line.
Due to insane hyping and social media, this trend has been running up and down the value chain of investors much faster than it historically has. So even public investors who would be happy with 10-15% returns are in full on risk-taking mode and are buying businesses earlier. VC Funded businesses. Whose prospectuses (prospectii?) say that they are loss-making companies and may never turn a profit.
What this is also doing is somehow allowing people to leave their brains at home. Founders are selling hyper-growth via hyperbolic narratives, and people are lapping it up. Now, the job of a founder is to be optimistic - no knocks there - but the VC is paid to be circumspect. FOMO short circuits this critical part of the darwinism that should be baked into VC.
Now, with the pretty much all startups spending like crazy on acquiring the same users (at least here in India), cash in bank = inevitability of success. The founder’s motivation is to describe a picture as rosy as possible to secure funding, but more importantly, deny it to competitors.
However, the VC’s job is to not buy the BS. Sure, if you are able to grow fast while meeting your business metrics and proving key hypotheses, more power to you. I have seen that happen only once out of ~50 investments I have made. 13 years, ONCE.
Once one starts digging into the numbers of some of the best funded startups, only one way emerges to describe what they are doing - they are burning money to grow to the next round. No nuance, no mitigation, no durability. Next round at 2x (or 20x) valuation is the be-all and end-all.
Durable businesses are built thoughtfully, over long periods of time. But today, the market is saying - we don’t wan’t to lose out on this, so sell us half-baked businesses. We want to pay for high growth, cash burning businesses today in the hope that they become durable tomorrow.
Once the final leg of the value chain (i.e. public markets) behave like this - the feedback travels up - quickly - which means all kinds of crazy valuations today by VCs and seed investors.
Which begs the question - What happens when the market appetite changes?More importantly, what does it mean when “smart” money behaves like its dumb?
Your thoughts??
thanks to the low liquidity environment and retail investors flooding in.
I should host you on a podcast to talk about this to founders!
The trouble is - there are some people who'll get the valuations etc. and get away with the non-durable behavior.
But they're inspiring an entire generation of founders into behaving irresponsibly about building businesses.
Can't last forever, now can it?