The Biggest Ponzi Scheme of all times

I’m regularly reading news about startups, passionate about technology, programming, hard stuff like quantum computing, computational ab initio chemistry… and as well old enough to have lived through the 1994–2000 hype cycle of the internet initial developments… I’m a fan of the future, and technology, don’t misunderstand the following. I know I will launch a lot of criticism.

Today I read that the latest SnapChat augmented reality feature is to be able to change the sky (color and clouds) of any picture… seriously I tell to myself, who needs that?… I could list an infinite number of similar news or “technology advances” financed by millions of dollars.

Everybody caught the start-up fever; some of my family members who didn’t even use a properly configured laptop or smartphone until recently, who probably confuse the Apache tribe and the software, run around California to get a piece of the show… There is not a single Mayor, University Dean or Finance Minister happy to spend tax money in its unique super-incubator(s)… read “free office space for geeks”, being it in Luxembourg where I reside or in France where I come from. This is happening probably now anywhere in the world, except maybe North Korea.

All reminds me a novel from Blaise Cendrars “Sutter’s gold” (“l’Or” in French) depicting a Swiss immigrant’s ruin after gold was discovered on his land. It’s the new “gold rush” and alike with its loosers and gainers, naïves and opportunists.

Motivation to write this small useless post, comes from the reading of a blog-post in French (“La plus grande pyramide de Ponzi de tous les temps ! — Blog Post published in La Tribune two weeks ago I recommend to read http://www.latribune.fr/opinions/blogs/le-blog-du-contrarian/la-plus-grande-pyramide-de-ponzi-de-tous-les-temps-748303.html ), which literally read my mind, conveying ideas I exchange with selected friends since a few years, a little voice telling myself, the music soon will end, and some will have no chairs to sit on.

Subprimes showed that the world is not as simple as it looks, that investing into real estate can be a dangerous game, especially if one looses the grasp to reality, forgets the value of assets, how “financial products” are built. I know, subprimes is not directly about real estate, but loans, “repackaged” loans… however loans to buy what, a bit of overpriced real estate. After a few cautious years, real estate is back: people invest into office space, it is probably sound for the one who think that the cubicle culture is there to last (I’m not convinced as you have noticed). People also invest into overpriced studios or one-bedrooms in the alpha-cities (NY, London, Paris…) but also in Luxembourg or the Mediterranean coast, the same are incentivized by the State to finance cheap homes for the more modest citizen at horrendous prices (where the sellers openly factor in the tax gains like for the French “loi Malraux” for ex.)…

Just because of helicopter money (super low interest rates) and because everybody thinks he is understanding the asset class because he bought once in his life some sort of real estate, the real estate craze is back. Some say markets have a memory of up to 6 years, it seems to be true.

Tech-startups are similarly affected by helicopter money, by an ecosystem where the last valuation, size of the round counts; where people tend to exchange two cats worth 500 k USD for a dog valued 1 M USD, as some might joke about it.

Obviously, there have been huge undeniable successes, like Google, Apple, Amazon, Facebook… These are however outliers, black swans giving a sense of normality, in reality exceptional occurrences.

Is now every AI startup (ill-named Artificial Intelligence), i.e. a bunch of geeks understanding how to code a backpropagation neural net worth an investment round of several million USD; is every delivery play, or e-hailing platform where students cross big cities with a bike to deliver hamburgers or pizzas worth so much attention? Not speaking of SnapChat and other mundane distractions…

There is just a very reduced part of these investments translating into what could quote as “true value” or “true business”, very little which percolates down to breakthroughs. Some say that 99% of the startups fail, some say its 95%.

Do you recall for example:

Beepi, riding on the hype of transportation startups and marketplaces, Beepi may have raised too much, too soon. They were running the business to raise money, and then to get someone else to take it on… after burning almost 150 M USD.

Drugstore.com and Beauty.com with great names have also been distractions: at the end of the day, it’s about getting new customers, increasing the frequency of transactions and increasing transaction sizes. They never exceeded the revenues of a few Walgreens after burning 157 M USD.

There is no point here to list them all… there are hundreds of such examples, all available through Crunchbase or CB Insights.

This is not counting the numerous companies failing before even getting any serious attention, having raised 1.0 M USD of love money; or being in incubators from The Jones-city, University, Company…

For the Ponzi-miracle to continue, there must be once in a while a huge and visible/marketable success, the outlier; this happens mainly in the USA or in China, unfrequently in Europe. Like in the lottery business, someone needs to win big once in a while, just to keep the money flowing.

People shuffle around well-groomed and calibrated Powerpoint presentations (“The Art of the Start”). When this Powerpoint does not end in the hands of a business angel willing to play professional VC, it goes to a VC seed fund. The definition of a seed fund is that it steps in early… another more provocative would be a small, or “poor-man’s” fund for beginners. This first step behind, the serious stuff starts, putting into competition the “bigger boys”, ideally the ones who have a “big name” around the table… All this ideally with a severely inflated term sheet. The secret hope of the contenders (VC’s and entrepreneurs) is to create the next monopoly in some industry segment in order to harvest the largest piece of the available value chain. It’s a theoretically a race against time to conquer the world, racing with money as a fuel and the objective to produce an outlier. The winner takes it all; the so-called Pavarotti effect steps in (why should I listen to a second-class singer, when with modern technology I can listen to the best?). Obviously, there are and will be much more loosers than winners.

All this could be theoretically virtuous, but when does it become a Ponzi-scheme, maybe unintentionally or explicitly? It becomes problematic when everybody knows and acknowledges that there is too much capital available for a given market segment, too much money chasing too few deals, when everyone tries to step out as early as possible, pushing the problem-child to the next level, VC, corporate, or listed market. How many funds chase the next AI leader?… All fake “the system works” to create great companies, first to please investors with great reporting, secondly politicians with high hopes to use this to improve unemployment figures.

As an example: VC investment in AI has risen from 3.2 billion USD in 2014 to 9.5 billion USD for the first months of 2017 annualized, with the number of funding rounds nearly doubling since 2015 to over 1,200 on an annualized basis so far, this year! Most successfully-exited AI companies sell for below 50 million USD after raising only a small amount of money. But wait a minute, 1200 deals in AI in the US for the year… how many in the world? Every year has its vintage of buzz-words, 2017 is about AI.

The typical journey goes like this: a small team comes together around 1–2 individuals, they forge real advances on programming key use cases (voice recognition, visual/video tracking, fraud detection, retail consumer behavior, etc.), sign a handful of prominent “customers”, call it “testers” who buy everything anyways, raise less than 10 million USD (often less than 5 million USD), then attract the attention of a major buyer looking to solve that problem set. These kinds of AI companies are now often valued as an amount paid per engineer rather than on performance (revenue, growth, profits); the average price per employee is around 2.5 million USD. In 2000 it was about eye-balls, how much page clicks you had on your ad or web page.

It’s not a single actor Ponzi, like Bernie managed to set it up, but multiple coordinated actors play; it’s a multilevel scheme, with VC’s at each level making enough return in real or paper to push it to the next level, ultimately to the listed market at high valuations, capture attention and new cash. Pension funds, wealth managers, funds with people’s savings ultimately hold in those Fund shares.

Said differently, the true purposes of this scheme are to build carried interest for the investment managers, and instant wealth for a selected number of entrepreneurs really outsmarting the system, the black swans. A small fraction has side benefits: the one renting space to incubators, building nice villas for some selected tech CEO’s… But the “value creation” isn’t proportional to the money spent. The system is a bit like the Wizard of Lies, aka De Niro playing Bernie, distributing the money in the right hand to the left hand and labelling it as “dividends” from “yield generating assets”.

In short, let’s wake up, if it is to use helicopter money, fine, but let’s do it in Europe as the Junker plan offers, let’s go back to fundamental improvements in infrastructure for example: finish a Maglev line, go with a speedtrain from Paris to Beijing; or build a quantum computer, send a new Cassini probe into space, let’s even go to Mars… but stop pouring money into SnapChat-like improvements calling it technology, and have huge pot-holes all over the place. Let’s stop this ideology now in Europe while trying to mimic the Californian Ponzi system.