F*ck the Noise. There is a VC Bubble.
I felt like I had to write this week, because there is a palpable strange VC energy circulating in my world. Maybe it’s something that’s just recently come to light and has been around. But I just smacked with some clarity. Let me preface the rest of this rant by saying that I am not a VC hater – in fact I often toy with the idea of raising my own fund one day when I’ve ‘retired’ from executing my own visions and consulting. I angel invest. I wound up starting Owney’s after wanting to get operational experience in the start-up world so I could make the leap from public equity investing to private equity investing. I believe in the power of start-ups and capitalism and the essence of investing in good, morally driven teams with clear visions to create jobs, pay taxes (which should raise standards of living for all), and help change the world. I don’t think there is enough diversity within who controls these investment decisions and I would be pleasured, humbled even, to one day participate in the process of connecting money with powerful ideas and smart, capable people.
But, I think there is an extremely tangible bubble in the world of VC right now. It’s being driven by many things -- mainly by a very ‘toppy’ stock market, zero percent interest rates and lots of cash on commercial and personal balance sheets. Institutional capital and money from High Net Worth Individuals (‘HNI’s cause we have to have an acronym for everything) are chasing returns they can’t find elsewhere. Alternative asset classes, one of which is private equity, is capturing that overflow. Throw in the trend in companies not ever wanting to go public (go look at the differences in the number of annual IPOs these days vs the 80s, 90s, 00s, 10s, etc) and we have a bit of a problem.
Of course, a nice cherry on top is our unique (most PC word I could come up with? Not sure why I’m all of a sudden trying to be PC ha!) 24 hour news cycle and social media bulldozers glamorizing, glorifying, idolizing all those guys in Silicon Valley making billions. All the people with money want in. They want to be a part of the next ‘thing.’ Why don’t we ever talk about how much money was lost in other start-up businesses in comparison to that ‘unicorn’? How many billions went to money heaven in other places to get to Facebook? In my CPG world – the press loves to use the headlines to ‘sticker shock’ people. XYZ brand got sold for $1 billion! ABC got $200 million! I’d like to question how much money was raised to beef up the value of that company to get to that sales price. How many down rounds were there? What was the ROI? Somehow that’s left out of the conversation - not nearly as glamorous, huh? And we will never know because it’s all private company information.
This past week all of these things I know kept smacking me in the face. Clients or parts of my network asking for my advice on whether or not to ‘take the check’ – seriously it feels like General Partners (GPs) are literally trying to throw money at entrepreneurs. And at a very rapid rate to close deals. That is not normal. These businesses are not VC ready by any historical stretch of the imagination. And as a founder, that cash is tempting as fuck when you need it. It’s so hard to say no. (Usually, people are trying to throw money at you when you don’t actually need it.) But it’s all fun and games until it’s not. I’ve also been recently privy to some straight up predatory VC attacks on companies in which recent investments have been made. These particular firms are taking advantage of a couple of covid related business hiccups and cash constraints to get a liquidity event.
As both an investor and an entrepreneur, I get it. Too many VC funds have been formed as a result of macroeconomic and press related factors. GPs are inherently entrepreneurial in their own right – they are beholden to providing very high returns to their LPs – Limited Partners. The VC business model demands the GPs to invest in a large portfolio of companies in a short period of time and then also get their money out of these companies in a relatively short period of time with a 10X return (on average). Most of their investments will become zeros or flat, so each deal that gets done the GPs are betting for a unicorn. Fuck all the rest of the portfolio, let it flounder or die. That one unicorn will get the funds LPs a very nice return that reflects the inherent risk associated with investing in start-ups (and beats the shit out of the market or 0% or negative rate bonds these days). That GP will start to develop or add cred to their track record and better equip them to continue to raise money cause who doesn’t want 30%+ IRR on their money? And eventually make the GPs real rich too if all goes as planned. Always be raising money, right? The GPs are under a lot of pressure to make bets and get their money out fast with a big fat profit. That model is fine in a small space. I believe that model is not scalable to reflect the amount of money I observe in the market currently. Too much capital in VC. Too much pressure on GPs to do what they ‘sold’ to their LPs. Not enough deal flow to support that. Not enough time to grow the investments. Entrepreneurs get tempted, lose control, power and eventually get fucked (sometimes to really no fault of their own). This investment model is broken for most sectors. If private equity investing is going to be a significant part of the world going forward, I challenge the convention of the model. It needs to expand to include more realistic returns that reflect the available investment opportunities. ESPECIALLY if you VC’s are going into the CPG space – these companies are out to build long term brands, that shit takes time, it’s not tech, it doesn’t go up 100000000000% overnight. There is inherent disconnect there. Change your pitch to LPs and your IRR expectations if you want in on this space.
Clearly this is a very broad topic and requires much more than a rant-y blog post. But, I would like to address the two parties directly now.
Dear Entrepreneurs : Fuck. The. Noise.
As I’ve discussed before, it seems like everyone wants to be an entrepreneur these days. I think the media and the internet and the glorified/villainized? very public billionaires have a lot to do with this. Regardless, this means a lot of people write about the topic of start-ups and lots of people have opinions (myself included, obviously). There is SO much noise out there. SO much chatter.
Seemingly, consensus is this is how you become ‘successful’ : bootstrap an idea, get some friends/family/angel money to start, create a MVP (aka Minimal Viable Product – WHY do we have to speak in acronyms these days? I often find myself Googling what shit means when it’s outside of my wheelhouse. Just unnecessary IMO – ha, I can’t help myself!), raise a Series A, B, C, D,…, get acquired for 10000x EBITDA or IPO the shit out of your company and become a billionaire. Done.
I call bullshit on this path for 90% of start-ups out there. Especially if you operate outside of tech. Challenge this convention. Why is this the path? There are many ways to skin a cat (also, why is this an expression? It’s horrid. But, I’m no wordsmith and I couldn’t come up with a better way to say that). I ask that you founders out there do some research to what typically happens to the founding team on that path. How much money do these aspirational companies raise? How much of that money is preferred share overhang with liquidation preferences for the VC (1x if you’re lucky, but multiples more if you wind up having to emergency raise down the road)? What did the founding team walk away with? How much dilution did they take from you? How painful was it managing investors? Do you personally actually need to aspire to have a billion dollars? What’s wrong with focusing on bootstrapping something to profitability? Can you capitalize through angels? Debt? Do you need to get VC money to burn away on fancy shit that doesn’t contribute to your organic business growth? Sometimes money helps achieve vision, sometimes it’s a distraction and it burns a hole in your pocket quite quickly. Please question why someone is trying to throw money at you when you probably know that they company doesn’t ‘deserve’ it yet. That’s a warning sign. The honeymoon will be great…
I am by no means saying there isn’t a VERY important place for VC and it might be EXACTLY what your business needs. There are plenty of advantages to that path – capital, connections, advisors, etc. All I am questioning (especially at this moment in time) is the fact that this path has somehow turned into the definition of success for everyone and every business. I am also warning you that I think there is a bubble in the market right now which creates pressure for GPs to make investments and also get their money back quickly which may or may not fuck you and your business. Just don’t let the rhetoric get in your head as to what is the best path. THINK OUTSIDE OF THE BOX. Rewrite the plan if necessary. Tune in and evaluate. Ask outsiders for advice. Weigh all options and paths. Resist the temptation. Or lean into it. YOU will figure it out.
Dear VCs : Let’s shake it up a bit. Challenge the way it’s been done.
I love that private markets are getting their comeuppance. I’m delighted that the future is in the start up community. I think this is the way to change the whole world, empower minorities, make the planet better, the list can go on and on. I believe so deeply in this power and I am grateful you are around to facilitate this through transacting.
Because of what I perceive as mainly macro-economic factors, I just challenge you to think wider about private investing as your capital base expands. Let’s think about investing past tech unicorns. There are plenty of other start ups that could use your help. Can we structure our funds and return expectations for LPs to reflect sectors outside of tech? CPG companies will not likely grow 100000x in 5 years. Can we build portfolios that are potentially safer but with lower returns? With less companies going public, can VC structure investments with dividend returns to LPs that BTM (Beat The Market *acronym*)? Clearly, it’s easy to beat bond yields right now.
I know you pitch your LPs about changing the world and the entrepreneurs (aka PEOPLE) you invest in. Let’s show a little bit more compassion towards them. I’m not suggesting charity -- this is business. I’m just saying let’s not treat them as a commodity. I understand you are under pressure and not all of you do this commodity-like-treating but it’s a common theme I’ve observed. These are real people that are giving you their souls (legitimately), dreams (not sure how to even describe that?) and their lives (you only get one) – take a minute here and there to remind yourself of that. Let that reminder guide your communications and actions. Even when you are disappointed and potentially angry in how your investment turned out – you are a professional investor, you should have properly understood your risk when you did your due diligence and made the decision to invest. PSA : this goes both ways, entrepreneur – buyer beware, you take the money, you have fiduciary responsibility too. We can ALL do better.
In sum, after two business degrees in finance, it’s so interesting to live through the theories. We constantly discussed the shareholder/ceo conflict in lectures. Watching (and being a part of) it play in real life is a totally different experience. Because it’s real (how prolific). I think we can rewrite some of how we tackle these challenges going forward. Hopefully a pop in this bubble will call to all these difficult questions to action. Change the conversation. Let’s not always just rinse and repeat.
