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This is an excellent post, and I'm in agreement. I particularly like the counterintuitive point that if NO unicorns go bust in the next 2 years, that's more ind

This is an excellent post, and I'm in agreement. I particularly like the counterintuitive point that if NO unicorns go bust in the next 2 years, that's more indicative of the existence of a tech bubble than if one or two do go bust [1]. That's contrary to the inevitable media portrayal: I expect that the first unicorn to blow up will be heralded as the harbinger of end times. What I would like is for Sam to expand on what he thinks are some of the pitfalls of this new debt-like financing world. For instance, in the old equity-only world, it was well known that you could "never do a down round". This is because down rounds distort incentives to the point where the company might as well be dead. I suspect[2] that one downside of this "debt-like" world is that there are "implicit nonzero interest rates"[3] on all these debt deals. In the old equity-only world, having a flat valuation was bad but not a disaster. Only the down round was a disaster. I wonder if in this new debt-like world, the expectations have risen. In this world, even rising valuations could misalign incentives. I also wonder what those implied interest rates are at. [1]: Since NO unicorns going bust means that capital is far too accessible, when statistically you'd expect at least a couple unicorns to fail. [2]: I would prefer more expert input because I have low confidence in my suspicions. [3]: I put that in quotes because it's somewhat an abuse of terminology.

birken 11y ago
I'd love to see an entire blog post about Sam's footnote #1. Though I find it funny that every point about why this is bad for late-stage companies I believe applies exactly the same to post demo-day YC seed stage companies with extremely high valuations. Though I think in both cases if the company can be disciplined then cheap capital should be good, but staying disciplined is hard...
- cma 11y ago
  pg: "Yes, investors with preferred stock usually get their money back first. Sometimes they get a multiple, but that's considered overreaching nowadays and the more promising startups never have to agree to that. I suppose that is implicitly a target valuation in a sense. But no one views it as a target, because it only matters if things go badly." https://news.ycombinator.com/item?id=6896833 https://news.ycombinator.com/item?id=6896833 :/
vasilipupkin 11y ago
when you see such high preferences, that is the equivalent of a down round. A unicorn that is doing very well would not agree to a 2X liquidation preference at late stage. Which is why I don't think it's a bubble - an indication of a bubble would be if investors gave a troubled unicorn a bunch of money without such preferences
- arjunnarayan 11y ago
  I don't think this premise holds: > A unicorn that is doing very well would not agree to a 2X liquidation preference at late stage. Debt isn't always worse than equity. It is not a last resort source of funding. For example, if you are bullish, it is better to take debt than equity. It means you have to share less of the upside. If you believe you're about to experience a 10x increase in value, it's great to take money with a 2x liquidation preference and a 3x liquidation cap! You get to keep the remaining 3.33x for yourself. And startup founders are not usually the pessimistic kind... I think late stage debt-like investments are copying the leveraged buy-out model from places like Bain Capital. They do many of these deals on the east coast: buy a company, load it up with debt, go for aggressive growth. Here is one example: http://www.forbes.com/sites/tomiogeron/2013/01/15/sevone-lands-150-million-from-bain-capital/ http://www.forbes.com/sites/tomiogeron/2013/01/15/sevone-lan...
  - vasilipupkin 11y ago
    well, sure, but we are talking about late stage. A late stage company expecting a 10X increase in value without going public? from the perspective of the investors, they gave up a nearly worthless option on the upside, while protecting their downside quite a bit, while preserving the positive optics for the company and employees
    - arjunnarayan 11y ago
      Because they are a different class of investor, with a more conservative outlook. T-Rowe Price doesn't believe in the 10x. It just wants the guaranteed 2x. This is where the "investors are looking for a fixed-income replacement" part of Sam's thesis comes into play.
hackaflocka 11y ago
SA is saying that cheap money is still available to tech cos., hence there couldn't be a bubble? (Please correct me if I'm wrong.) It sounds a little like circular reasoning to me.
- hacknat 11y ago
  He's not saying that. He's saying it seems like the only type of tech company that is being penetrated, for the worse, by cheap money is late stage unicorns. His argument about the way cheap money is penetrating them is that the terms of the money look a lot more like loans than equity, hence, traditional valuations don't apply. For example Uber may have just received $100 million at a $10 billion valuation, but if the equity has a 3x cap, then how do you actually value the company from the equity just purchased? The answer is you can't, because traditional equity didn't change hands. VCs are dressing loans up as equity purchases. People are assuming that unicorns have to hit certain valuations in order for the VCs investments to not be repaid or scrapped. SA is challenging this assumption, though acknowledging that the situation isn't ideal and highlighting that it doesn't necessitate a bubble.

birken 11y ago

I'd love to see an entire blog post about Sam's footnote #1. Though I find it funny that every point about why this is bad for late-stage companies I believe applies exactly the same to post demo-day YC seed stage companies with extremely high valuations. Though I think in both cases if the company can be disciplined then cheap capital should be good, but staying disciplined is hard...

cma 11y ago
pg: "Yes, investors with preferred stock usually get their money back first. Sometimes they get a multiple, but that's considered overreaching nowadays and the more promising startups never have to agree to that. I suppose that is implicitly a target valuation in a sense. But no one views it as a target, because it only matters if things go badly." https://news.ycombinator.com/item?id=6896833 https://news.ycombinator.com/item?id=6896833 :/

vasilipupkin 11y ago

when you see such high preferences, that is the equivalent of a down round. A unicorn that is doing very well would not agree to a 2X liquidation preference at late stage. Which is why I don't think it's a bubble - an indication of a bubble would be if investors gave a troubled unicorn a bunch of money without such preferences

arjunnarayan 11y ago
I don't think this premise holds: > A unicorn that is doing very well would not agree to a 2X liquidation preference at late stage. Debt isn't always worse than equity. It is not a last resort source of funding. For example, if you are bullish, it is better to take debt than equity. It means you have to share less of the upside. If you believe you're about to experience a 10x increase in value, it's great to take money with a 2x liquidation preference and a 3x liquidation cap! You get to keep the remaining 3.33x for yourself. And startup founders are not usually the pessimistic kind... I think late stage debt-like investments are copying the leveraged buy-out model from places like Bain Capital. They do many of these deals on the east coast: buy a company, load it up with debt, go for aggressive growth. Here is one example: http://www.forbes.com/sites/tomiogeron/2013/01/15/sevone-lands-150-million-from-bain-capital/ http://www.forbes.com/sites/tomiogeron/2013/01/15/sevone-lan...
- vasilipupkin 11y ago
  well, sure, but we are talking about late stage. A late stage company expecting a 10X increase in value without going public? from the perspective of the investors, they gave up a nearly worthless option on the upside, while protecting their downside quite a bit, while preserving the positive optics for the company and employees
  - arjunnarayan 11y ago
    Because they are a different class of investor, with a more conservative outlook. T-Rowe Price doesn't believe in the 10x. It just wants the guaranteed 2x. This is where the "investors are looking for a fixed-income replacement" part of Sam's thesis comes into play.

hackaflocka 11y ago

SA is saying that cheap money is still available to tech cos., hence there couldn't be a bubble? (Please correct me if I'm wrong.) It sounds a little like circular reasoning to me.

hacknat 11y ago
He's not saying that. He's saying it seems like the only type of tech company that is being penetrated, for the worse, by cheap money is late stage unicorns. His argument about the way cheap money is penetrating them is that the terms of the money look a lot more like loans than equity, hence, traditional valuations don't apply. For example Uber may have just received $100 million at a $10 billion valuation, but if the equity has a 3x cap, then how do you actually value the company from the equity just purchased? The answer is you can't, because traditional equity didn't change hands. VCs are dressing loans up as equity purchases. People are assuming that unicorns have to hit certain valuations in order for the VCs investments to not be repaid or scrapped. SA is challenging this assumption, though acknowledging that the situation isn't ideal and highlighting that it doesn't necessitate a bubble.