Who is the greatest fool in the Unicorn-VC chain?
One of the most successful venture capital investors, Masayoshi Son, has noted that the “startup winter” will be here for a while.
What is interesting is that he thinks so, not because there is a shortage of VC, but because entrepreneurs will not accept lower valuations for potential unicorns. According to Son, one of the ventures he has financed, Klarna, accepted a new round of financing at a valuation of $6.7 billion compared with $45.6 billion in a previous round. Leading fintech venture Stripe has also accepted a lower valuation.
Son’s point is that the vast majority of ventures are not willing to accept lower valuations based on the new reality. According to Son, “Unicorn companies’ leaders still believe in their valuations, and they wouldn’t accept that they may have to see their valuations [go] lower than they think.”
Evidently many of these entrepreneurs think that the good times will return soon and that their VC-seeking ventures will return to the glorified valuations of the pandemic boom. Will the good times be back? Will venture valuations return to their pandemic highs?
Or are these entrepreneurs living in a fool’s paradise? Will they pay the price for believing in the recent inflated valuations? Should they accept capital now to be able to afford a longer capital-losing launch, grow with more expensive and dilutive capital, and seek to dominate their emerging markets?
Perhaps the real question is whether companies like Peloton, Posh, and LoanDepot were ever worth their stratospheric valuations? Or were they prematurely foisted on a gullible public due to the froth in the stock market?
Are these destroyed valuations the latest manifestation of the Greater Fool theory, which notes that investors can make money by buying assets at any price if they can sell them to another “fool” at a higher price.
The current high valuations that just got destroyed seem to have been the result of the stock market boom. When the underlying foundation of cheap money crumbled, the market did the same.
So, who is the greatest fool in the current unraveling of the unicorn chain?
• Is it the entrepreneurs who think that their ventures are worth gazillions even as they lose money, have negative cash flow, have to rely on inflated valuation formulas and hopes — and are unwilling to accept lower valuations when the outlook changes, and investors baulk at paying high premiums? Is it the entrepreneurs with limited cash in the till who are risking bankruptcy-valuations when legitimate investors depart, the buzzards arrive, and the whiff of failure is in the air?
• Is it the VCs who invested at inflated valuations because they were expecting a fast IPO in a levitating market, and were hoping to quickly flip the venture to a ravenous public? And the IPO carousel stopped, and the tide went out? As Buffett so eloquently put it, “it’s only when the tide goes out that you learn who has been swimming naked.”
• Is it the investment bankers who will sell anything to anyone if there is a chance of a fee — and produce convincing justifications of any price, until the market crashes and they are caught with egg on their faces but profits in the bank?
• Is it the pundits who appear on talk shows to sell their “valuation expertise” to a gullible public, after they have already invested for their portfolio or informed their paying clients?
• Is it the public that believes that tulips are worth thousands and that they will enter at the bottom and exit at the top?
My take: It is difficult to pinpoint exactly one biggest fool when there are so many “smart-money” investors in the chain. A cynical view would be that the fool is the cog in the chain who is stuck with the turkey when the music stops. In this chain, my award would go to the entrepreneurs who are not willing to raise capital at lower valuations – if they really need the capital to achieve their goals. Having chosen the capital-intensive strategy and sought VC, unlike finance-smart unicorn-entrepreneurs like Joe Martin who grow with cash flow, these IPO-chasing, capital-guzzling ventures cannot afford to lose their momentum. If they do, they are risking the loss of their growth and the potential to dominate – and being jilted by their fickle investors who smell a loser. VC is available when VCs think that there is unicorn potential. If the ventures are overtaken by others with more capital and the only differentiation is capital, entrepreneurs may be risking the venture. The good times may return, but the former unicorns may not.