Josh Wolfe, CEO of Lux Capital, joins Michael Green of Thiel Macro to discuss the power of information asymmetry in venture capital markets. Institutions like SoftBank have been making big bets based on that information asymmetry, and appear to be cashing in for now. But Wolfe warns that the unprecedented levels of investment combined with the binary nature of success in venture capital markets could lead to unexpected losses. This clip is excerpted from a video published on Real Vision on March 15, 2019 entitled “Robotics Success and VC Madness.”
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How Venture Capital is Inflating Valuations (w/ Josh Wolfe and Mike Green)
For the full transcript visit: https://rvtv.io/2FCUvmr
JOSH WOLFE: Does it really matter if we're negotiating here and quibbling over $1 billion or $2 billion?
Well, of course, it does, but that I think induced a lot of growth investors to say, let's just try to speculate on
some of these big unicorns.
Going back 7 years or so, Andreessen- who I think is a brilliant investor, a brilliant technologist- basically
said, there's only 10 companies that matter in a given year. And statistically, that's probably true. Now
knowing which 10 is very hard, but he said, you just basically want to be in those companies. And I that
was a meme that really went very wide. And people said, okay, well, it doesn't matter if you invest in
Facebook at $1 billion, or $5 billion, or $10 billion because we're going to be hundreds of billions.
And so does it really matter if we're negotiating here and quibbling over $1 billion or $2 billion? Well, of
course, it does, but that I think induced a lot of growth investors to say, let's just try to speculate on some of
these big unicorns. And you've got this phenomenon of companies that were pining to signal that they were
going to be that next Facebook by attaining a billion-dollar valuation. And then you got a positive feedback
effect where people were funding these things, and to get access, would write a $100 million check at a
$900 million pre. And they would own 10% in a billion-dollar valuation.
And the problem for the early-stage investors and their limited partners is they were getting these huge
markups. And on paper, it looked phenomenal. And then they would go out and raise their next fund and
put it into more illiquid companies. But they weren't necessarily getting liquidity on that billion-dollar
company. And you have started to see over the past 3 or 4 years, a lot of these unicorns not go from $1
billion to $800 million. They've gone from $1 billion or $2 billion to 0.
And so there's this liquidity trap that is natural in markets because people are basically taking massive
amounts of capital, which in the venture world, there's a capital structure just like in the traditional public
markets. And you have common equity, which sits on the bottom of the stack, and then preferred, and then
debt on top. When you have preferred equity of a size that is so large, and with it, might have the classic
Carl Icahn, your price, my terms.
So SoftBank would come in, for example- we could talk a bit about them- and say, sure, we'll give you $20
million, and we want to own 20% at a billion-dollar valuation, and we want a 2X or 3X liquidation
preference. Now, you're talking about a payout where if they actually got sold for $1 billion, SoftBank is
not getting 20% of that. They're getting $600 million. And so all the people below the stack, that might be
okay because you're really actually getting your percentage of a $400 million distribution in a waterfall,
but what if it's only $400 million or $500 million? You're getting nothing.