Let it Be Real: Silicon Valley Valuations

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.  


The Entrepreneurs’ Gene

So… you want to start a business. And you want to know the most important thing?

Forget capitalization, the right industry, the board of directors or the business model. Why it is the entrepreneurs’ gene, of course. For decades, scientists have been trying to isolate and replicate this elusive gene but have thus far been unsuccessful. The objective is to make the gene generally available so that anyone can be a Jobs, a Zuckerberg or a Bezos. (Note: in a free, democratic and fair society, why should only entrepreneurs be blessed with the entrepreneur’s gene? So elitist.)

Here is what scientists know about the Entrepreneurs’ Gene  

Entrepreneurs have a number of unusual qualities. First, they are smart – unsmart entrepreneurs become un-trepreneurs real quick. They are indefatigable, accustomed to years and years of long, grueling hours. They inherently know that to be an entrepreneur the gene requires nurturing, fueling, and developing with continuous inputs of data, insight, and experiences.

And they persevere, Thomas Edison, one of their Gods, famously said: “I never failed, I just learned 10,000 ways how not to make a lightbulb”.  The devout have no understanding of failure, but they do understand how to try, try again. Not the same way every time, mind you, because doing the same thing over and over expecting a different result is endemic of insanity, according to Einstein, definitely an entrepreneur.  Freud, recently voted into the HOF by the Entrepreneur’s Writers Association, would tell you that the entrepreneur is delusional and perhaps insane (Van Gogh was reputed to have the gene, and yes, he was maybe crazy, but ohmygawd inventive – have you seen his stuff?)

Entrepreneurs have an unbridled audacity of belief. The audacity to believe they have an idea that no one in the history of human civilization thought of before them. The audacity to believe that their start-up (not just can, but) WILL work; that others will follow, that still others will invest and an army of others will buy.

The Entrepreneurial Personality

And here’s where the audacity crosses over into insanity: they believe the rules do not apply to them. Eight or ten new ventures fail? Not mine. Regulations don’t allow it? These will change. VCs will never invest? They haven’t heard the pitch. Turns out that the gene makes the entrepreneur hearing impaired. They can’t hear the words ‘no,’ ‘impossible,’ ‘this can’t work’ or ‘are your nuts?’

Similarly, the laws of physics and just plain simple rules that others accept and regard are ignored by these renegades as if they don’t recognize them. These qualities start to emerge in youth, as early as pre-school: ‘Why is Johnny not joining circle time but building a 1:24 scale replica of the Eiffel tower with blocks instead?’, or ‘Why does Jane doodle – her stuff complex, advanced, inscrutable – when the class is supposed to be learning about the famous clothespin decision of 1932?’  

Scientists have also discovered that the entrepreneur gene is closely identified with the pirate gene, the guerrilla gene and in particular, the MacGyver gene. Entrepreneurs have to make everything out of nothing and decisions quickly, assertively and without hesitation. Some of these are a matter of life or death (we refer here to the life or death of the company, not the entrepreneur or employees). Invariably these crucial decisions are made with too little data and MacGyvered interpretations of the evidence.

Captain Kirk was an entrepreneur. Un-trepreneur Spock, God Bless, would always share with Kirk the odds of surviving, say, a surprise attack on the Klingons with some new, unproven torpedo (has anyone ever called Roddenberry out for having a ‘torpedo’ in space?) which were as infinitesimal as Congress passing something useful this session. Kirk would smirk (earning him the moniker ‘Smirky Kirk’) and do it anyway. He sneered at the chances, cast aside the playbook, ignored the rules to save the universe, in a crazily creative, ridiculously risky, never-been-tried-before way each 50-minute episode. And it always worked out. Now that’s an entrepreneur. Except for the always worked out bit. That’s Hollywood.

I also find that the gene is inherited, and sometimes by osmosis. Many entrepreneurs grew up with entrepreneur talk around the dinner table, and entrepreneur-friendly parents. ‘Oh, she’s getting Cs but has an IQ of 145? I’m good with that’. Lest we forget, Einstein redrafted all the universal rules of physics as a Swiss patent examiner.  I don’t know much about Switzerland’s patent office, but I have to imagine that it’s a black hole for talent, and despite his prophecy to the contrary, Einstein escaped – but he was probably the only one. Like I said, the entrepreneur gene is irrepressible. Its genius ascends on canvas, in a light bulb, or in the stars… but it appears.

Entrepreneuring is a total-brain full-contact sport. Be shy and die; delay – you’re prey; you can’t be polite and fight. Both brain hemispheres are tingling with firing synapses that meld into… analytical creativity. Oxymoron? Jay Walker, friend, genius, founder of Priceline talks about the difference between data… and information. Data is numbers, plain (very plain) and simple. Information is numbers animated. DNA is a string of amino acids, the building blocks of life. But these do not a life make. Entrepreneurs turn data into the blood, vessels, muscles, and heartbeat of a company. The best of the lot can look at columns of numbers – thousands – and select the one or two that are aberrant. Seen through the right lens, new worlds appear … and the difference between success and failure. Without creative application numbers are symbols on a screen signifying nothing.  

Entrepreneurs have visual acuity, both high and low. High – the big picture, perspective from 35,000 feet. Low refers to the unit economics – the single customer.  If the unit economics don’t pencil out, no amount of scaling will a business make. After a talk to an adoring crowd, the16th President of the United States was asked ‘Mr. Lincoln, why such a long speech?’ ‘Because I didn’t have the time to write a short one’ came the rejoinder. Entrepreneurs appreciate the elegance of concision and it’s power in communication. The best can put both the high and the low on the back of a business card. An entire business vision and unit economics in little more than a bumper sticker; a sound bite. Catch-phrases are repeated; speeches are read.     

Bobby Fischer, in his time the greatest chess player on the planet, was famous for playing two dozen games at once, processing billions of options in nanoseconds. His game was bold, inventive, and defied conventional wisdom.  But Fischer was no entrepreneur. Fischer could astonish, inspire… but he could not lead. And this is yet another quality of the gene, leadership. You see, the entrepreneur’s belief system is infectious. It is enveloping and passionate, and the best of them evangelize with the conviction and erudition of a Churchill, a Kennedy, a King. They dazzle; they mesmerize; intellectual shock and awe. They can flip the stubbornest of minds, the most jaundiced of opiners, into a legion of followers.

If you trawl for advice about the most important thing you’ll find plenty – too much actually – as though there were thousands of most important things, which is some place between a paradox and a contradiction. But for my money, it comes down to this: the entrepreneurs’ gene.

Michael Loeb Founder, CEO