Summary
Why VC is doing a magic trick to get investor money, and why you might want to avoid investing in these private placements--a quick case study with Databricks.
I received an email from a startup yesterday. It was from a startup that tracks other startup’s valuations (a public, private market). It was advertising the changes made to market visibility on their site. It’s a telling signal that this information is being released to the public. It means the scam is over.
After the whole SPAC bubble, we see that lots of these Venture-Backed companies have lost their value. Since most of these companies lost money, they had very few fundamentals to back up their sky-high P/E ratios. Now we see a common and unmistakable pattern with these public companies.
- Lay off workers to reduce payrolls. Growth is over. Time to cut costs
- Focus on profitability (the original owners cash out, leaving a financial “genius” to take over)–time to make money. If these companies had no viable way to make money, their stock tanks.
- Find an exit–strip the company for parts to private equity.
This is an example of a messed-up incentive structure that pays off the initial investors (who aren’t really taking on that much risk, if you think about it) through the public markets.
Let’s look at an example. This is the startup company’s data, so it’s their best guess for valuation. Here’s the Databricks chart.
Look at those sexy returns. Databricks is a high-performing tech startup that hires the best engineers to do the most fascinating work. Surely that’s why it outperforms SPY by multiples. As the next chart shows, this chart is a sleight of hand.
Over the last year, it barely has outperformed SPY with huge volatility. And I’m fairly sure that if we adjust for each of the huge funding rounds, we’ll find that unadjusted growth will end up being close to SPY, with a lot higher volatility. Maybe, in another post, I’ll take a look at the business and do the quantitative adjustments.
Then, who wins from the price level adjustments? I think this ends up being a transfer from the later investors (with the public being the true suckers) to the earlier ones. Like many things–it’s a pyramid, and behind the sexy marketing, it’s just garbage being lumped onto you.