2023-01-04

What’s a down round?

I’ve recently got interested in venture capital. I just finished “The Power Law” by Sebastian Mallaby, which is all about the history of venture capital, and why it worked so well in Silicon Valley and why it has been so hard to transplant it to other soil, in spite of the (arguably) huge economic benefits to those other soils of doing so.

Venture capital is different to private equity. Private equity takes boring, cash-generative businesses by stripping out all activities that do not generate cash refinances them, largely by replacing equity with debt, so the structure is more ‘efficient’ but much more fragile. Venture capital takes businesses with barely exist, except in the mind’s eye of the founders, and provides pure equity funding, and hopes for the best (while taking a modest equity stake).

There are lots of wrinkles that both PE and VC have developed over the years, to reduce tax, incentivize the owners and managers to operate the business in the best possible way, but this picture is roughly right. One big similarity, is that shares in PE- and VC-funded businesses are not traded on public markets, and so they both have a lot of opacity about what they are really worth.

The masterful Matt Levine explains one way in which venture capital managers pretend to the world that the assets they manage appear never to lose value. Basically, you issue new shares with extra rights, but you pretend they are the same as the old shares, which makes it appear that the old shares have gone up in value when, in fact, they have not. He is always worth reading, and for the moment his newsletter is still free! (But, it seems, you have to pay to read it on the website.)

Anyway, I think that a lot of PE and VC is ‘marked to fantasy’ and really is no more than a geared version of public markets, but with an artificially lowered volatility. I’d love to find a way of shorting this stuff, but because it’s all private that’s almost impossible on public markets … except, perhaps, one could short the shares of the managers (such as Blackstone) themselves. Do not try this at home. This probably won’t work, but for safety, I’d be trying to reduce my exposure to PE and VC as much as possible, that is, if I had any.

Pierre Jahan 📷 Canal Saint-Martin 1937. Paris There is something very lovely about a city with a navigable river.