MorningWord 7/8/20: Venture’s View

by Dan July 8, 2020 9:05 am • MorningWord

If you don’t follow Fred Wilson, the famed venture capitalist and founder of Union Square Ventures’s AVC blog, you should. His daily posts are short and to the point, and most days I find his views on private tech applicable to what I am thinking about in public markets.

In his post this morning, Hyperactive, he begins with the “conventional wisdom (when the pandemic started) was that the capital markets would take a beating, including the venture capital market for startup capital” and goes on to explain why Q2 was likely a Hyperactive (emphasis mine):

First, venture capital firms raise funds and it is our job to put them to work. If we see interesting opportunities, it is our job to invest in them. We are not paid to hoard the cash.

Second, the stock market for tech companies has been on a tear in the last three months and that weighs on the minds of investors. A bullish stock market leads to a bullish venture capital market.

Third, the pandemic showed that software based businesses, e-commerce, software infrastructure, and other sectors popular in startups and venture capital are resilient and attractive right now.

Fourth, sitting at home all day, not being able to travel, not being able to socialize, creates an efficient work environment for many (but certainly not all).

And finally, there are so many great founders out there coming up with excellent business ideas. The pandemic has not slowed that down. If anything, it has sped it up.

I wanted to offer some of my thoughts on the highlighted bits above as they might relate to public equity markets, how they might be similar or different, and how they affect one another.

First, We are not paid to hoard the cash, there are hundreds of billions of dollars in public market sum (assets under management) where the portfolio managers can actually paid to be in cash, and not invest their capital. Ultimately most pm’s goal is to beat their stated benchmarks over defined periods of time, that is how they are able to retain and raise more assets.

Second, a bullish stock market leads to a bullish venture capital market. This can be a chicken or the egg kind of thing. In the case of 2019, while the stock market was soaring, there was no shortage of private tech companies that sought greener pastures in the public markets. Few were received well, the largest by size (LYFT & UBER) saw dramatic declines from their IPO prices and WeWork failed to launch. It is worth noting that public market investors scrutiny of these companies’ losses and their hefty valuations put only a slight damper on the exits of most VCs who had been invested in these companies for more than a few years (with usual time horizon 5-10yrs), booking massive returns. These exits result in big distributions, new funds launched and see Fred’s first point, then they get back to finding the next LYFT or UBER.

Third, the pandemic showed that software-based businesses, e-commerce, software infrastructure,…are resilient and attractive right now. This has clearly been the story of Nasdaq’s massive outperformance relative to the S&P 500 and the Russell 2000 (small caps) and almost every other stock market the world over. The pandemic has uniquely accelerated many tech trends that were already solidly in place prior, but the rich have gotten richer and the moats have been widened as MAGA (MSFT, AAPL, GOOGL & AMZN) all sport $1 trillion-plus market caps equalling more than $5.5 trillion in market cap, greater than the entire Shanghai Composite’s value. If I were a VC, I’d be a tad worried that the next disruptive companies that I invest in will be able to see the light of day without any meaningful regulation that avoids the stifling of future innovation by the MAGA crew.

Fourth, work from home creates an efficient work environment for many. This one is tricky. We are seeing mania behavior in the stocks of companies like Zoom (ZM), Docusign (DOCU), Zscaler (ZS), and Fastly (FSLY), to name just a few, that are benefitting from a dramatic pull-in of demand for their product and services from a fairly captive audience. The valuations of these public equities are starting to feel a tad unsustainable, despite the fact that I can say ZM has a great product, better than those of much larger competitors like MSFT, CSCO & GOOGL, but trading at 40x this year’s expected sales and 30x next, deceleration of 2020 growth will likely mark a nasty correction, and the others are likely to follow.

And lastly, founders with excellent business ideas…the pandemic has not slowed that down. If anything, it has sped it up. This is also true in the public markets, those with moats, fortress balance sheets, and lots of commas in their market caps are just showing off now. There is nothing these CEOs can’t do until D.C. (likely after the E.U.) drops the hammer on them.

But to quote The Dude: its a very complicated case. You know, a lotta ins, lotta outs, lotta what-have-yous.

The stock market, both public and private can stay irrational, well you know the rest if you have a habit of betting against disruptive tech.

Sometimes I wish I had the ability to invest or opine on something and revisit the story quarterly or annually but this is the business that I chose and I will continue to look for guidance from all sorts of investors, definitely ones far less verbose than me.