Keith Teare on THAT WAS THE WEEK in tech
That Was The Week 2023, #31
Venture is Good
In 2009 Facebook took a $200 million investment from Yuri Milner, the founder of Digital Sky Ventures (DST Global), in return for just under 2% of the company. 18 months earlier, Microsoft had paid $240m for the same stake.
DST's stake turned into well over $4 billion in value. As he says on his web site:
DST Global invested in Facebook from 2009 to 2011 and divested its holdings in 2012 and 2013 following Facebook's IPO.
I would date the 2023 crisis in venture capital as emanating from this period. Yuri, quite magnificently, showed the world that it was possible to invest in early-stage companies at high valuations and still make over twenty times your money. It was the dawn of growth investing in the venture capital ecosystem.
He went on to invest in Twitter in 2011 and made many more successful investments using the same strategy.
For the seed ecosystem, this was the beginning of the period that lasted from 2009 - 2022, when it was possible to see seed-funded companies grow into unicorns, often quickly, driven by rapid fundraises from growth-stage investors.
The period gave rise to Coatue, Insight Partners, Tiger Global, Fidelity, and other venture investors.
Q2 2022 saw the end of this period, and many of this week's readings focus on the consequences but draw all of the wrong conclusions.
Kyle Harrison's essay takes the lead spot, focusing on the "Greater Fool" meme that Venture Capital relies on the next investor making irrational investment decisions, and so is a place where Bernie Madoff-like fake value growth takes place. It's somewhat clear that Kyle does not agree with the characterization (right ?). But he does think Hopin's later investors bought into unfeasible beliefs to justify their valuations.
The Greater Fool theory suggests that the earlier investors were aware they were selling a dud and either remained silent or actively encouraged the hype.
The Financial Times definitely does believe venture capital is an extremely poor asset class. In "Venture Capital funds are mostly just wasting their time and your money," Bryce Elder argues that venture funds underperform every other asset class.
the average VC fund doesn't reliably outperform the average stock
From the point of view of this theory, Yuri Milner is probably the first "Madoff" venture investor, waiting for the fools to come. And future investors did come. But were they fools?
The real story of venture capital is different. There is no greater fool underbelly to venture capital. Founders and early-stage investors buy into world-changing ideas and try to build them. Often, they do not attract capital for years, and investors remain skeptical.
Even Hopin is one. When Seedcamp invested in Hopin's seed round, it seemed clear that virtual events would grow rapidly under the Covid regime. It made a second investment as that thesis was borne out. Events grew, and revenue too. So more money was attracted to a likely good outcome. This optimism is not only normal in venture capital, it is required to enable large outcomes.
By the end of Covid, Hopin had raised all of its capital. I believe no single investor was hoodwinked by earlier investors or the founder. They wrote checks with glee and a belief in a world-changing moment.
To look at the period as somehow contrived is a re-writing of history.
That said, growth investors' desire to allocate to high-value growth reached a limit in 2022 when public markets corrected and the multiples investors pay for revenue and growth contracted. At that point, IPOs froze, and later-stage investors had to write down the values of their investments. That process is still going on.
Clearly, lots of money will be lost, and pain will be felt. But to see that as a structural problem with venture capital is a mistaken diagnosis. Looked at as a whole, venture capital has catalyzed far more value than the money invested by it. As an asset class, it is the engine room of innovation. The Greater Fool theory is a cheap shot at a bad time.
This week's X of the Week is a chart from Visual Capitalist showing how emotional investing loses money. It compares staying in the market versus jumping in and out based on short-term reactions. Venture Capital is currently a highly emotional asset class, and the trend is for jumping out, in reaction to the 2020-21 price and volume peak. But this is exactly the wrong thing to do. The counter-emotional imperative is to remain in the market and focus on quality long term opportunities.
Of course, that does not mean venture capital is perfect. I am on the record that data-first late-stage investing can produce outstanding returns from private markets, using a different, fresh, and bold approach to venture. That would risk-mitigate venture capital in a manner that can produce private market wealth growth products like those invented by Renaissance Capital, and championed by others, in public markets.
So this week, my theme is: Venture is Good. The next innovation in biotech, energy, AI, and more depends on it, which means we humans do too. And those who see the future will definitely invest in the next Hopin. But also in the next OpenAI, Google, Amazon, Apple, and Tesla. And thank goodness. Long Live Venture Capital.
Essays of the Week