Let It Be Real
By Michael Loeb
My Dad told the joke of “this guy” (joke maker-uppers are evidently misogynists – or is the opposite the case?) and the $10,000 dog. Each day he goes to a bar, mangy mutt in tow. This guy is subject to unrelenting derision from his fellow revelers, which only intensifies when in defense of his pet, he declares ‘this dog is worth $10,000’. After a time, he has quite enough of the mutt-busting. “Ok, I will prove it to you”, he countered in defiance, “Be here tomorrow.” The following day, like clockwork, he reenters the bar with a smirk wider than the gulf between Pelosi and Trump, and matching cats under his arms. “You see, I told you pagans that the dog you made so much fun of was worth $10,000 and now I have the proof”. “Say what?”, asked the confused chorus. “I traded him for two $5,000 cats”.
In 2016, the VC ecosystem echo-chamber fabricated 160-something unicorns, a.k.a startups with billion-dollar-plus ‘valuations’ (why the quotes? Read on). I asked two-dozen start-up CEOs, carefully selected for some gray hair wisdom, two questions: How many of these mythical creatures will be more than myths? And; How much green ($) will the founders ever see? Answers: few and little.
Fund managers are subject to a number of pressures, one of which is finding deals. On the spectrum of asset classes, venture is illiquid, risky and in theory, high returning. Committed capital from investors is ‘called’ over time as deals are consummated, requiring that funds are held in highly liquid, safe and therefore low returning instruments – in sum – the opposite end of the asset spectrum. Investment outcomes are generally thought to be highly dependent on a specific asset allocation formula. Investors count on VCs to make their investments with alacrity so as not to, egads, wither in the wrong class. And while not all entrepreneurs are serial entrepreneurs, fund managers are invariably promiscuous, always on to the next and bigger fund for the increasing fees – which investors are subject to shine (good returns) or rain (bad ones) – and marketplace juju.
In a low return world sloshing in cash, (why else would the Nets, a team that last ruled their conference during the Internet winter of 2001, be worth $2 billion?) startups are bid-up and are ‘marked to market’; that is, valued from the last overheated investment, often by another VC firm. This is long before the mutated unicorns become sickly, but in time for display on the VC scoreboard to impress the big wallets for the next fund in the series. I know what you’re thinking: the government (oy vey) should do something about this. Watchdogs are obliged to protect the little guy, and venture targets the ‘sophisticated’ investor. You better know what you are doing to ski the black runs or you may just fall – hard. You’ve been served; fat-cats beware.
A case, from zillions of postulants, in point. A VC fund in which I have invested (does this make me a hypocrite?) marked-to-market a lipstick-on-a-pig startup (old product, pretty digital interface) for which revenues this year will drop by a predicted 1/3rd, will lose over $200 million, owns little unique IP, but has a brand-name VC money sponsor (hint: there is an intimate connection to the White House’s alpha male) to $2.8 billion. Huh? For a negative growth newbie? Oh, but management has projected revenues to triple in 2018 with a $300 million swing on the bottom line to profitability. And no, it’s not in cannabis so ‘eating home cooking’ doesn’t explain the hyperventilation.
There is a reason why Warren Buffett doesn’t touch this stuff – he takes a long-term view. To be sure, the market puts a premium on innovation, novelty and first-in-market positions – that is where you find big growth and big opportunity. Investor insanity is fleeting and corrections are violent: my founder’s shares in Priceline went from $16 at IPO to $163 in months to $1.28 months later at the nadir of Internet meltdown #1 (there will be more). In the long run, the market values what is real: real companies inventing real solutions, real revenues, real profits, real value. Not unicorns, nor $10,000 dogs, nor two $5,000 cats.
We live at a time of great transformation, in which every industry will be subject to wrenching disruption. As an entrepreneur nothing could be more invigorating. There are great ideas – big and brilliant – which will be sown and burgeon in vast new companies. The ones that will stand the test of time, the ones of which Keats would say are not ‘writ in water’, will be made of sturdierπ stuff. So entrepreneurs, summon your genius and courage to build something good that lasts, something that fuels the soul, something that will make you and your investors money and your Mama proud. Let it be real.