Grow Up
The Long Term Stock Exchange and Its Discontents
The relationship with between Silicon Valley and New York has been tenuous of late to say the least. Firms are staying private longer and longer, treating the once-prestigious status of being a publicly traded company like it’s a fourth place ribbon in a middle school spelling bee. But while the coasts have had rifts in their relationship before (i.e. 2001), they’ve always seemed Ross-and-Rachel-like: we know they’ll get together at some point even if they’re “on a break.” But while the number of privately-held, billion-dollar unicorns continues to rise and as equity capital markets continue to reward to both biotech and SPAC firms, we have yet to see a billion dollar technology company list on a stock exchange in New York this year.
Twilio, who filed a S-1 with the SEC earlier this month, will in all likelihood become the first Unicorn to cross the rainbow into the public market. In doing so they will leave behind the perhaps overly optimistic, long-term approach of the Valley and submit to the quarterly scrutiny inherent to Wall Street. This means annual audits, quarterly investor calls, and the unthinkable: an actual business model. The cringe of a flip-flop wearing, pressed juice-drinking venture capitalist is almost palpable.
The mindsets of Wall Street and Silicon Valley are not necessarily incompatible. Theoretically, firms should take a long-term view and use their businesses, in conjunction with capital markets, to fund new projects that will generate value in the long-term, which should please shareholders in the short-term. In practice, however, investors’ lust for profits in the short-run often prevent firms from investing in long-term endeavors — a phenomenon dubbed “the 90-day shot clock” by Michael Dell.
Meanwhile in the Valley, patient VC’s are forced to delay demands for real business models in order to have the privilege of investing in the next big thing. It’s what allows Dropbox to continue its failing freemium business model, and why so many investment firms today are now being forced to write down their investments in what was supposed to be the future.
It would appear that a compromise is in order: there should a way for firms to show a real business model without compromising their strategy because of the three-month shot clock. Eric Ries, famous for authoring The Lean Startup, has proposed a solution to solve what he calls “one of the worst problems plaguing our whole business ecosystem”– an alternative public stock exchange.
Earlier this month, Mr. Ries announced on his blog and on medium that he is putting together a group of technologists, lawyers, and long-term enthusiasts to create what he calls the Long Term Stock Exchange to combat “the malign philosophy of short-termism that emanates from our public markets.”
Although Mr. Ries claims that he didn’t want to “become part of Silicon Valley’s hype machine,” the heartfelt cries for reform were unaccompanied by any specific detail as to how the LTSE would operate in practice. I would presume, however, that it would entail annual, rather than quarterly, earnings reports and more lenient regulations surrounding financial disclosure.
I am afraid that if Mr. Ries gets his way and the LTSE becomes a reality, we won’t see firms realign their strategy, and instead it would create a Neverland for immature companies.
Peter Pan have you met Pegasus?
8th Grade Uber: The Dangers of Immaturity
As I wrote about in detail previously, Marc Andreessen– the man who “invented the Internet” and became an overnight millionaire when the highly unprofitable Netscape Communications held its Initial Public Offering in 1995 — is now advising his portfolio companies to mature in the private markets. Indeed his advice should not be taken lightly, as the venture capital firm he co-founded with fellow Netscape alum, Ben Horowitz, that bears their respective last names, has had many successful and highly lucrative investments in recent years including Instagram, Skype, and Oculus VR.
Andreessen Horowitz — or a16z as they say in the Valley — has a tag line that is perhaps overly representative of the current state of tech. “Software is Eating the World,” is proudly displayed on the Sand Hill Road firm’s website. Indeed tech enabled software companies are swiftly disrupting legacy companies across industries. But that distinctly childish phrasing — eating the world — is also indicative of the immaturity of the businesses that are created from this innovation.
Unlike the ’90s when firms were going public soon after their inception, maturing in the private market has become in vogue creating a class of adolescent companies. And like the 16 year old student that repeated the 8th grade twice, Uber Technologies is the epitome of this new trend — last raising money at a $60 billion valuation. It should be noted that Uber has a rather complex capital structure, complete with preferred stock, employee options, and convertible debt, but a $60 billion valuation for a company that hemorrhages money seems a bit preposterous. While bankers in New York have tried to curry favor with the ridesharing giant, Uber has indicated that it will remain privately held until least 2018 and would appear to be a perfect candidate for the LTSE.
There are firms that would perhaps benefit in theory from listing on the LTSE. Alphabet and Facebook have both indicated their interest in a tiered stock system that gives insiders a majority of the voting rights, allowing the founders to peruse their long-term ambitions. Listing on the LTSE could attract the same type of investors that are comfortable with this type of multi-class stock system. But if other, more mature firms were to de-list from the NYSE or NASDAQ and relist on a more lenient exchange, investors could take this as a sign that expenses will increase and profits will be hampered in the short-term. Corporate boards will be hesitant to de-list from a prestigious exchanges, as their share prices would likely plunge. Therefore, I predict that existing publicly traded companies would remain off the LTSE.
Instead the LTSE will be the future home of companies like Uber that need to simplify their capital structure and provide some form of liquidity and for companies like Dropbox that need to give their investors a face-saving exit.
Like the strangely charming, 26-year old “children” that work part time at Smoothie King, the LTSE will house all the immature Silicon Valley companies who once seemed like a legitimate next-big-thing company, but whose future prospects seem bleak at best.
Low Frequency Information
Plans for a LTSE will in all likelihood face backlash from investors, as not everyone is calling for more relaxed disclosures. Rett Wallace, Co-founder and CEO of the financial data and intelligence firm Triton Research, argues in his medium post Low Frequency Disclosure that owners should be privy to more, not less, financial data.
In his classic, mildly-sardonic tone he lamented on medium:
Since the Securities Exchange Act of 1934 introduced the rules of the modern public secondary market:
* The time it takes to get a stock quote has dropped from 20 minutes to 25 microseconds.
* The time it takes to execute an order has dropped from 30 minutes to 200 microseconds.
* Government-mandated release of financial data for U.S. public companies has gone from once every 90 days to… once every 90 days. (And no exceptions, please — improper disclosure can come with subpoenas or worse.)
So while the owners of the company are kept in the dark until the 90-day shot clock expires, the operators of the company are privy to these metrics on a daily basis, and the board of directors on a monthly basis. And as Rett points out, these numbers are
“the actual metrics… not the lawyer-ized and GAAP-ified reduction.”
Perhaps the reason that investors are so hungry for short-term profits is because of the infrequently financial discloses, not in spite of it. If the LTSE were to come into fruition, we would see extreme volatility at earnings announcements. Management teams would pull out all the stops, lawyer-izing and GAAP-ifing every number to cosmetically improve their disclosures. Shareholders would never truly understand the companies they own.
But if numbers were disclosed the way operators saw them, there would be no mask to hide behind. The volatility inherent to quarterly earnings would be obsolete. Finally management and owners would see the company the same way.
If companies like Uber were publicly traded and investors had access to high frequency information, shareholders could finally understand more than just the product — they could understand the business. And if everyone had access to high frequency information surrounding Dropbox’s financials, the unicorn might finally leave Neverland.
