As always, thanks for reading. Want Snippets delivered to your inbox, a whole day earlier? Subscribe here.
This week’s theme: the first of two reasons why mildly scammy hustles are actually a feature of Silicon Valley, not a bug. Plus Slack’s public filing, the great unbundling of the IPO, and a possibly new way to think about the differences between public versus private.
A couple months ago, Matt Levine (whose newsletter Money Stuff is a must-subscribe) touched a few different nerves in Silicon Valley when he suggested the following anecdote: (Paraphrasing here for brevity)
Matt: “Startup culture and zero-marginal cost internet business models has enabled a particular kind of scam: I create an online platform for buying and selling X. My friends and I buy some X, sell it to each other a whole bunch of times, and show investors all this revenue growth on top of a software platform business model. Investors love it, and they give us money. We then go spend some of that money on yachts. The company dies, predictably (as there’s no real revenue or customers), and investors throw up their hands and say, “Well what can you do! Some startups fail.”
Many people in Silicon Valley: “Yes! This this absolutely spot on, and gets the zeitgeist right.”
Other people in Silicon Valley: “…Um, how many specific examples of this actually happening can you point to?”
To be clear, this kind of disagreement isn’t just a tech industry thing. It’s a familiar inconsistency that many people fall into, not just in tech but anywhere. We’re more easily willing to make accusations or speculations in general terms than in specific ones. In his book “What if We’re Wrong”, Chuck Klosterman offers an example thought experiment: “What do you think are the odds that, fifty years from now, one of the major historical United States Presidents will have a radically different reputation with the general public than they have today?” Many of us think about this and say, “Yeah, probably pretty high. Seems reasonable that in 50 years someone will go from being remembered as a hero to being a villain, or whatever.” But then, he challenges us: “Okay, let’s go down the list of suspects. Tell me what you think are the odds that George Washington will be remembered differently. Now Abraham Lincoln. Now FDR.” Now we get nervous: it’s a whole lot easier to make general statements than it is to call out specific people, and our answers reflect that.
In this specific example, the other reason that it’s hard to call out specific startups as actual scams is that… they usually aren’t! In the real world, startups aren’t fraudulently drumming up fake GMV and then claiming it’s accelerating revenue; if they are, and you fall for this as an investor, then that’s on you. What startups actually do to get ahead in the real world is they create narratives around perpetually accelerating growth that are based on a combination of overarching technological disruption narratives plus historical numbers that are genuine, but forward-looking “projections” that are a bit too good to be true. The current decade-plus trend towards recurring revenue businesses of various kinds (whether we’re talking subscription businesses, recurring transaction businesses, or even ads) lends itself well to this practice. We acquire customers for insanely inflated costs, and then assign a lifetime value to them based on overly optimistic assumptions around retention and monetization. (Actually accounting for these numbers is a critical skill for distinguishing between actually sustainable growth versus growth that’s built on top of a house of cards; Social Capital has written a lot about this, and if you haven’t read it, you ought to!) In a few years time, when recurring revenue starts to contract rather than expand like the pitch deck said it would, the company falls apart, dies, and we shrug our shoulders and say “Well, startups fail sometimes”. Is this a big of a hustle? Sure. Is it outright fraud? Not really. In fact, I think this kind of ongoing, low-level “light hustling” actually serves two very important purposes in the Silicon Valley ecosystem that we don’t talk about very often, but absolutely matter.
You’d be right to be suspicious that our duelling cultural attitudes of “if it was a success, then it’s because of a string of genius contrarian moves; if it was a failure, then it’s because competition was too intense and VC is evil” is a pretty ripe environment for dishonest behaviour. It sets a precedent that your actions will be remembered in one of two ways: either positively, or not at all. But there’s a problem with this theory, which is that outright scams in Silicon Valley are actually pretty unusual. Episodes like Theranos shock us because they’re so rare. But why? It’s seriously worth asking this question: in an environment that’s fuelled by FOMO, where technical complexity makes almost anyone an amateur, everyone is investing other people’s money, and there’s an expectation of routine failure, why aren’t there more huge scams?
One reason why there aren’t more big scams in Silicon Valley is that there are lots and lots of little ones that we fully tolerate as a feature of the system, rather than a bug. There’s a counterintuitive principle in systems design that states: sometimes the best way to avoid occasional huge disasters is by tolerating a lot of continuously small problems. Most of the time, we think about this principle as “If you have a system that works, think twice before fixing it any further by going after the recurring small problems. In doing so you may open the door to rarer, but larger catastrophes.” The converse is also true: the recurring small problems quite often serve to actively protect against large disasters, because they preserve a certain amount of alertness and proactivity in the people operating the system on the ground, a bit like how getting exposed to dirt and germs is actually an important part of keeping our immune system healthy.
Anyway, I think it’s worth considering the idea that a continuous amount of mildly scammy hustle may actually be one of the best defences against large, out-of-nowhere fraud that take everyone by surprise. (It’s also an interesting cultural difference between the startup community versus the crypto community: one important contributing factor to why there were so many devastating scams in crypto that brought ruin on naive retail investors is that so much of the language and the technology is steeped in this idea of “deep cryptographic trust”, or however you want to call it. A perception of infallible, rigid trust had a pretty predictable second-order consequence, which was lots and lots and lots of fraud. The principle works in reverse, too!)
However, that’s not all we get out of The Hustle. It also does something else, in keeping with our theme of differentiation from the past few weeks, that’s way more powerful. It’s a tool we use to anoint and differentiate founders, where the relationship between founders and VCs has come to resemble the old power dynamic between kings and priests.
A couple highlighted items this week. First of all, the SEC put together all of its by-the-book resources on ICOs and all things crypto, and it’s very good! (Also, it’s the law.)
Also, I only just recently discovered Jamie Catherwood, but he has some fantastic writing on bubbles, financial innovations, and the history of markets that I wish I’d known about in all our previous (and, undoubtedly, future) Snippets series on such things. His most recent piece, below, is really interesting:
Spotify bought Gimlet and Anchor, setting off a wave of speculation around the future of the podcast industry and on audio in general:
An interesting recent argument in the particle physics world around the future of enormous expenses like the LHC:
The State of the Union:
New digital worlds:
Other reading from around the Internet:
And finally, a neat story from the portfolio family with a personal connection: 120 years ago, the Belgica expedition captained by Adrien De Gerlache became the first expedition to survive a full year in Antarctica, including through the winter. As it would have it, my great uncle Emile Danco was on that expedition, although he was not so fortunate — he died fairly quickly after the crew arrived in Antarctica. (They named an island after him at least, and you can still find it on Google Maps.) Today, Saildrone is making new history by launching the first autonomous circumnavigation of Antartica on one of their flagship red sailboat drones. It’s pretty neat!
In this week’s news and notes from the Social Capital family, Slack had a pretty significant announcement: they’ve filed to list on the public stock market through a Direct Listing, rather than through a more traditional IPO.
It’s worth taking the time to appreciate that this is a real step in a much larger story: the “Unbundling of the IPO”, and the changing role of the stock market in the life of a public company. What, after all, is the point of the public stock market? If you want to raise capital for a business, you don’t need the stock market for that. If you own stock in a business, and you want to sell it to someone else for cash, you don’t necessarily need the stock market for that either. Large, privately held companies like Cargill, Deloitte or Mars are in many ways the envy of their public peers: being publicly listed, with its pressures and rules, can be pretty stressful, and there’ve been no shortage of opinion pieces complaining about short-term investment outlook causing “the death of American big-company innovation”, or whatever.
But going public still matters. It matters partially because it forces a particular kind of discipline — in your accounting, in your storytelling, and in the way you run your business — that is overall a very good thing. But it also matters, at least up until now, because the public debt and equity markets were the only bank account that was big enough to actually fund many of the huge projects we undergo as a business community. If you wanted to build a business that’s going to transform the world in a meaningful way, at some point in your ascention the only place you could go with enough equity capital to fund you, and enough trading volume to create a genuine market for your shares, was the stock market. The IPO bundled together these two needs into one big special moment: the ringing of the bell, the raising of a few hundred million dollars, and the creation in a moment of a whole lotta liquid wealth for early shareholders.
But that’s changing, though. First of all, private capital is available in bigger and bigger quantities: companies like Slack have been able to raise large amounts of capital, at very attractive terms, pretty much whenever they want. The capital raise part of the IPO isn’t so essential anymore: if you already have plenty of cash in the bank, why pay bankers a massive fee to get you more that you don’t really need? Direct listings, like Spotify recently completed and for which Slack has now filed, become an attractive option: get what you want, and not what you don’t. Unbundle the IPO! Second, don’t be surprised to see new alternate, creative forms of helping people go public (or otherwise get what they need) like through Social Capital’s SPAC, among other things.
If we think about this trend, though, what happens if we extend it a little further in its logical direction? What happens, say, if someone wanted to go public with a buyback? I can’t really think of a reason why you couldn’t do this! More generally, though, I think something important has changed in our perception of what, exactly, the stock market is for — at least, for the fast-growing tech companies that we know.
When businesses raise capital, they make a trade with investors: give me your capital now, and in exchange you’ll get a stream of future earnings. In the beginning of a business’s life cycle, you’ll be raising lots of capital, and not necessarily paying back very much. Later on, though, there’ll be an expectation that this capital continue to be productive — either because the business can continually reinvest it (a la Amazon), or because they have surplus cash that they can return to their shareholders in the form of a dividend or buyback. All businesses have their own unique needs, but there’s unrecognizable a “Phase 1 / Phase 2 / Phase 3” kind of sequence to them in general: in Phase 1, You’re net drawing in capital and everybody knows it; there’s a disequilibrium in your inherent capital needs. In Phase 2, that capital is in an equilibrium of sorts — you may not necessarily be net returning it (again, Amazon), but your public shareholders are like a flexible source of capital that is in a kind of balance with your own internal ability to generate free cash. Perhaps, at some point later, you return to a disequilibrium for whatever reason: maybe because it’s time to let the business go out to pasture, and harvest as much cash as possible out of it on the way out: so you take it back private again, in a “Phase 3”, and sell it to a PE firm who knows how to do that kind of thing.
I think what’s becoming more explicit is that, in the past, the general rule was that “Private was for small, and public was for big.” This clearly isn’t true anymore, as companies like Uber make plain. Now, we may be heading in a direction more like: “Private is for when you’re in disequilibrium (either net drawing capital in, or net harvesting capital back out); public is for when you’re at equilibrium.” Going public through something like a Direct Listing, the way Slack is doing, is simply a matter of stating, “We would like to enter Phase 2 now.” And then you just, you know, do. No big capital raise involved, because, why would you need it? You’re at equilibrium! This isn’t a new or particularly insightful way of looking at the nuances of the way the public markets function, but it might be a convenient rule of thumb for simply explaining: “Here is how the public markets fit into these phases of a company’s life.” When great businesses like Spotify and Slack start to buck the conventional rules and start new trends, well, it’s worth watching and thinking about it a little bit.
Congratulations to everyone at Slack: it’s a great achievement, and welcome to Phase 2! Stay tuned for more announcements as their listing comes nearer.
Have a great week,
Alex & the team from Social Capital