Great post here by Mark Suster at Bothsid.es

Lots of good stuff here.

My key takeaway is here:

The vast majority of this recent boom in prices is not being driven by VCs but rather by hedge funds, mutual funds, corporate investors and other sources of non-traditional venture funding. In the chart below you can see that a decade ago for every dollar a VC raised from LPs a dollar went into a startup. Now for every dollar a VC raises $2.50 goes into a startup.

Many moons ago, I wondered where the hell the money was originating. Mostly non-VC money chasing yield has descended on the valley. And like the sub-prime mortgage crisis, the non-VC money figured out that using preferential terms allowed them to invest in riskier assets with less risk.

Shifting risk, and increasing the value of assets without increasing their value never ends well.

 

 

 

 

 

A friend of mine and I have been debating unicorns for months. And what we concluded is that there are two stories.

The first story is that there are a bunch of excellent businesses that are worth billions. These are the true unicorns. I won’t hazard a guess of how many or which companies fit that bill.

The second story is that there are a bunch of donkeys with horns that are using creative deal structures to acquire valuations that are questionable. And that the story of the true unicorns is hiding the story of the donkeys.

The recent article on TechCrunch tells us that the number of potential donkeys is on the rise.

And so my buddy and I debated the impact of these potentially faux-Unicorns.

The first narrative, dominating the press, is the effect of faux-Unicorns on investors. After a lot of discussions, we concluded that the recent faux-Unicorn phenomenon of artificially constructed valuations is benign to positive. Positive because it mitigates the downside risk, and because it captures more of the upside if an acquisition occurs at the cost of investing more capital in a business that has achieved a certain amount of success.

 

If you take a unicorn job in 2015 and never say the words “liquidation preferences”, you are the sucker at the table https://t.co/cbh3lPRA9a

— Alex Stamos (@alexstamos) December 24, 2015

 

 

The second narrative that is emerging is the impact of faux-Unicorns on employees. There we agreed that the story is downright appalling. The shift of risk from investors to employees who find themselves locked in, or worse, have their interests misaligned with the core investors, or even worse is not positive.

The derisking for investors and founders is increasing the risk of employees.

And so what?

The danger is that employees eventually figure this out. And they start demanding higher salaries, longer periods between when they quit and when they have to sell their shares or just plain refuse to work for any private company.

Furthermore, as more employees figure out that a Unicorn or a startup is not a path to riches, and that the investment strategies are being used that minimize their already minimal chances of wealth, people will over the long-term lose interest in working at startups.

And worse, because employees are not investors they have a hard time disambiguating faux-Unicorns from real Unicorns.

If a startup is a job where you work long hours, at low pay, to change the world, there are a lot of options that are not working in tech.

We can talk about culture, and opportunity and learning and if there is no money, then people will go elsewhere.

The people who work in the tech sector have the ability to do anything they want. And eventually, they figure that out.

 

 

 

In my career, I’ve chosen to work at larger companies instead of smaller ones. Or maybe, a better way to describe it, is that I have joined small sized businesses that became enormous.

And I was reflecting on the differences.

My favorite game of all time is Civilization II. Some players, like the beginning game:

The point is that you have the fewest pre-existing constraints. You can only make a small number of decisions. And each decision is a matter of life or death. You can very easily get destroyed if you make the wrong choices.

That part of the game is the most intense because every decision is, of course, critical, every moment obviously a life or death moment. You choose to explore a village, and if it turns out to be barbarians and you don’t have an army you lose the game.

In the later phases of the game, you have many cities and an accumulation of decisions. You can quickly destroy other civilizations, build wonders, and typically there is no existential threat. No decision is obviously existential. No crisis is obviously critical.

There are existential threats; they are just not obvious.

The challenge in this part of the game is how to marshall resources and make decisions to win the end-game while ignoring things that are not important.

When you join a large company, you are essentially being given someone else’s Civ game. Your job is to figure out what decisions your predecessors made that are prescient and build on those while figuring out what new decisions need to be made to win.

The funny thing about joining a Civ game in the middle phase is that you may have already lost. Some decisions made early on may have put your civilization in a terrible spot that are only obvious now.

And for many folks, this makes starting a game more attractive than taking on an existing game.

The funny thing is that when you launch a new game, the computer makes decisions for you, and those decisions, when combined with your preferred strategy, will doom you just as much.

The thing about the early part of the game is that when you lose you’re just a historical footnote, a leader of a small tribe. When you lose later on in the game, you may have a large thriving civilization that just didn’t make it to the finish line. You fail as a CEO of 10 person startup, and only your web page records your failure. You fail as the CEO of Yahoo, and it’s front page news on the WSJ.

The later part of the game in Civilization II can be more thrilling. You get to do more stuff, try more things, you are on a bigger stage and you are playing for all of the marbles instead of a chance at all of the marbles.

 

 

 

 

 

Yesterday, I wrote about the problems with Unicorns and their preferential treatments of investors.

Today, I wanted to make the asymmetry realer.

Consider the decision facing the board when it had an 825 million dollar deal on the table.

The board was considering four options in that order

1. Go public and be valued at more than 1 billion
2. Accept an 825 million dollar deal
3. Sell at a lot less
4. Keep struggling alon

The board, probably feeling optimistic decided to skip the 825 million dollar deal because the board felt that the upside of an IPO was worth the risk.

The question is what risk was the board considering and are these aligned for all stakeholders.

For the preferred investor, option 3 is more valuable than option 4 and for the employees option 3 is not an option worth considering.

Let’s explain it with numbers.

If the deal closes at 825 million, preferred investors make ~4$ a share. If the deal closes at 425 million, the preferred investors make 3$ a share. If the IPO happens, the preferred investors may make 5$ a share.

If you think that an IPO has a 20% chance of happening and a 425 million dollar deal has a 70% of happening then what you are doing is saying I am taking a chance at 20% upside with a 25% downside. Not a bad bet. Especially, if the downside bet is still a positive outcome. Option 4, continue to go at it is the worst option because the downside risk is to lose everything.

For the employees, however, an 825 million acquisition is worth 4$ a share, and a deal at 425 million is worth 0.44$ a share and is no different than struggling along. Your stock is worthless at 425 million so you might as well keep trying.

And if I were an employee, I would like the choices the board to be 1, 2 and 4, whereas the board is incented to choose between 1, 2 and 3.

And because the employees are not a stakeholder and not even a shareholder, the right decision for the preferred investors was made.