How Dependent On (External) Liquidity Is The Unicorn Economy?
All economies are subject to a natural boom-bust cycle of liquidity I call the the capital cycle, and the Unicorn Economy is no different.
Busts are not due to any malice, greed, or ignorance of an particular individual or group, but rather just part of the natural process by which an economy evolves.
Liquidity begets liquidity and rising expectations…until it doesn’t and the process works its way in reverse.
Economies dependent on external liquidity (like the unicorn economy), are particularly vulnerable to rapid bust phases. As I write this, emerging market and energy economies dependent on external liquidity are going through a bust.
This race for liquidity in those markets is pulling liquidity out of other markets, at a time when the Fed is implementing a policy of tighter liquidity in general. This is bad for the Unicorn Economy.
The seeds of today’s bust have roots in the past. In the wake of the financial crisis, the Fed engaged in aggressive easing of monetary policy, to counteract a liquidity crisis in US capital markets.
The goal of this policy was to add liquidity back to capital markets, to push up asset prices.
This policy was effective, and that liquidity found its way into the Unicorn Economy, pushing up the valuations for startups.
In the heat of the boom last year, liquidity was flowing into startups at a pace of $150bn a year.
In addition to greater liquidity in the hands of traditional VC players, the Unicorn Economy saw the entrant of ‘cross-over’ investors (themselves fleeing the low returns of public markets) which pushed up prices (and expectations) in the unicorn economy to the point where they can no longer be fulfilled by the majority of enterprises.
Whereas in previous capital cycles, new enterprises would race to turn the corner on the road to profitability and IPO before exhausting unicorn economy capital markets, this new source of capital has enabled enterprises to continue to invest in growth in users without growing revenues.
Leaving the market full of companies creating a lot of value for their users, but capturing little to none of it in the form of revenues. Meaning the core question in their business mode (can they generate cash?) has yet to be tested.
This headline chart again, now in context.
This also leaves the unicorn economy deeply vulnerable to conditions in broader capital markets, which look more dire every day. Unless monetary authorities turn face and provide capital markets more liquidity, it looks certain that the Unicorn Economy will face the bust phase of the capital cycle.
This bust phase will not only result in a contraction in spending by firms no longer supported by capital markets, but will lead to a contraction in the broader economy for which these cash flow negative enterprises represent an important source of demand (recall the enterprises for which Sarah is a customer).
Finally, this bust phase will be especially painful not only for those holding their wealth in equity in this economy (without the dual protections of favorable liquidity terms and a diversified portfolio), but those whose life portfolio (jobs, homes or businesses) are tied to this economic ecosystem.
If you carry exposure to this system, we recommend you hedge accordingly.
DISCLAIMER: I am biased. After researching #TheUnicornEconomy for months, last year I started an investment firm which enables people to hedge the very exposures I write about here. This means I have a conflict of interest.
Tags: #theUnicornEconomy #theCreditCycle #SnowVentures #diversifyYourLife #liquidity