Chamath Palihapitiya’s is always great to listen to as he tries to burn down many of the sacred cows of Silicon Valley. His interviews are authentic, and he has a high willingness to shine a light on the faults of SV. He’s been a strong dissident about the dangers of social media, and in particular the impact it is having on children.
In Episode 864 from This Week in Startups, Jason Calacanis gives Chamath time to discuss how he refocused his investment strategy and dropped his LPS to get back into investing in companies that matter, and why the current SV game is a sham.
The discussion on SV’s Ponzi Scheme is cued up at 21:42min to 36min
Silicon Valley Ponzi’s Scheme
“I will not be part of this charade anymore” - Chamath Palihapitiya
Fund Fees
It is possible for a fund to become more successful via fees, rather than profitable exits.
Investors “court” startups, and receive two things in return:
i) a yearly fee for investing other people’s money, and
ii) the upside of profits if the startup is a success.
If a fund has $500 million in management, at a 2% per year fee, they bring in $10 million in profit even if none of the companies in the fund make any money. When split among 4-5 partners, the take home for each is $1-2 million, and over the course of a decade one can make a significant amount of money.
Growth
But why would people continue to invest in a fund if nobody is exiting? If the fund is not “doing well”. This is because the metric being followed is ‘growth’. And here is where the Ponzi Scheme comes in.
Series A
Fund A comes in and supports a series A round. They demand that their money is invested into ‘growth’. Chamath claims that “almost 40 cents of every venture dollar goes back into the hands of Facebook, Google, and Amazon”. On paper it looks like a company is growing, although this is essentially non-profitable growth.
The rise in a company’s growth isn’t because of a magical “product-market fit” but because of a round’s venture capital has led to this superficially grown.
Series B
The company starts to get short on cash, and it appears its time to raise a Series B round. The fund from Series A tells the other funds, ‘look at the great growth we have from Series A’.
Now Company B funds the Series B round. Repeats the process. And this leads to the Series C round.
Second Funds
Series A by this time is looking pretty good. The IRR on Fund A is huge. And the managers of that fund, believe they are very good at identifying great businesses, so they go to start a second fund. The process repeats.
Endless supply of money
New funds are created, and new investors enter into the market seeing huge returns and opportunity for success. When the reality is, those who are winning are the fund managers making healthy fees.
The entire Ponzi Scheme is dependent upon the raising of future rounds to continue to pour money into the system.
How much to grow?
Investors try to grow at all cost. Numbers like 400% year on year growth - out of their companies. But this isn’t how to build a sustainable business. You can’t have superficial unprofitable growth for decades to come - this model is dependent only on continuous cash flow. It re-aligns founders away from what they should focus on.
If we look at companies that we respect, they have natural growth over the long run. Look at Amazon - Bezos has had 25% year-on-year growth, for 25 years.
“Grow real. Grow slow”
Future Investments
Chamath’s focus has returned to funding groups working on real problems, who if they succeed will have a meaningful impact on the world. And they should get their by building a real business with real growth.
