How venture capital funded startups have run up massive losses while justifying premium valuations using creative profitability metrics. These private companies are now going public allowing early investors to cash out with sizable gains. Meanwhile, these new publicly traded companies are added to equity indices, forcing passive managers to purchase them for their index funds and ETFs.
In this episode you’ll learn:
- How venture capital and initial public offerings work.
- How many venture capitalists are there and how have they performed.
- Why do startups stay private for longer and then go public while still incurring massive losses.
- What is blitzscaling.
- How startups use creative profitability metrics to attract investment capital at premium valuations
- How the current venture capital regime contributes to income inequality.
- How to get an allocation to an initial public offering.
IPOs are initial profit offerings often used by startup ventures to fund their growth. Are IPOs a type of Ponzi scheme, however? David dives into how IPOs are funded, how startups use them to grow while losing billions, and how individuals are left with little option to participate, except in helping create a return for the initial investors through sales and passive investing.
The rapid growth of new venture capital firms
Entrepreneurs use private investment capital, such as from venture capital firms, to fund their ideas, build infrastructure, and keep their businesses running during the period where they have to spend more than they make in order to rise to the top of the competition. It’s a winner-takes-all mindset where startups try to push out all the other competitors due to their sheer size and marketing power. Facebook, Pinterest, Uber, and Lyft are all examples of recent new venture capital firm investments. The shocking thing is that about 2,000 new ventures have been funded since 2010. Billions are being poured into these startups, but billions are also being lost. The interesting part is that more and more investors are willing to shoulder the initial loss of a startup in order to capitalize on the gains when the coming conducts an initial public offering by issuing stock to the public for the first time.
The profits and losses induced by blitzscaling
Blitzscaling is when the venture grows at an extremely rapid rate—even while sustaining losses because it’s funded by private investors. Because so much loss is having to be sustained, the ventures hold off going public until ten or twelve years down the road. Unlike in earlier times when companies were profitable when they went public, more and more companies are holding their IPOs even while they continue to sustain large losses. That allows private shareholders to gain liquidity and realize sizable gains while public shareholders are left with a company that still hasn’t figured out a profitable business model.
While the strategies used by startups are beneficial to fast growth, they tend to lead to the view of labor as a commodity—simply part of the process. Employees aren’t as highly valued because of the fast pace, and the price of labor is seen more as a necessary evil rather than an opportunity to invest in the future of the company. Be sure to listen to the entire episode for David’s discussion of Uber and the negative impacts that new venture firms can have on the economy and society.
The roles of individuals and initial investors in IPO profit
As individuals, it is difficult to participate in IPOs and the potential initial price jump. Most IPOs are allocated to institutional investors while the proceeds from IPOs offer liquidity to family offices, institutions and other super-wealthy individuals who invested in them. Less wealthy individuals don’t often get to participate in the initial funding of a startup. Where individuals end up participating is after the company goes public. Once a new venture goes public, it is added to stock market indices, and are held by index funds and ETFs. The initial investors are still the ones gaining most of the profit, while individuals through passive investments have exposure to these new public companies that are still trying to figure out how to make money.
Ideas for making IPOs beneficial for everyone
David points out that not all venture capital firms are bad. Startups inspire innovation and growth in many marketable areas. They are actually self-regulating in many respects. If the expectations of the investors are consistently not met, then fewer investors will be willing to participate in the first place.
Long-term stock exchanges are one solution to the Ponzi-esque scheme of IPOs. If—once a venture goes public—individuals were able to purchase long-term stock, they could participate in the startup for the long run, possibly surviving the short-term loss and volatility that comes with new ventures. If individuals could purchase an index fund on the long-term stock exchange, there would be greater opportunity for larger investment in innovation and all the exciting growth and exploration of startups.
- [0:19] What are IPOs?
- [2:12] The growth of new venture capital firms.
- [5:22] Blitzscaling and the willingness of venture capitalists to initially lose money.
- [8:33] How start-ups are choosing to exit.
- [11:18] The cost of going public at premium valuations.
- [13:26] The social and economic repercussions of blitzscaling.
- [18:16] How money-losing firms try to create a profit.
- [19:38] How unprofitable companies convince investors to buy at high valuations.
- [21:20] How individuals participate in venture capital without investing in an IPO.
- [24:08] Possible solutions to IPO’s problems.
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