The Ponzi Like System of Vulture Capitalism


Global Intel Hub -- First article of the new year!  Private Markets are just that: private.  That means they are 'dark' which is the opposite of 'light' - you have no information.  If you invest in a private company for example, you don't get access to financials or other company information.  For publicly traded stocks, this is a legal and regulatory requirement.  Private markets do not create a ticker tape of past trades, although there are data vendors that collect data and sell it for a fee.

Private Markets are comprised of a mix of Venture Capital, Private Equity, and if you want to include Real Estate it would be appropriate.

The VC strategy is based on a herd mentality, but the herd isn't the people it's an Oligopoly.  If you look at the strategy of Silicon Valley, it becomes quite clear.  A few big VCs dominate the funding market, and they all go in together. If something fails, they throw more money at it. In the rare cases of FTX, WeWork, Sequoia said it represented less than .2% of the balance sheet.

When it works well though, it is spectacular to marvel at.  Just take a look at Uber.  Here is a list of some of the other notable investors from Uber’s seed round and what their initial investments grew to over the course of 9 years (chart from the WSJ):

That seems like it's too good to be true, the obvious trade is just to invest where these guys invest.   But Uber is one of hundreds of thousands of startups, how do you know which one is going to be Uber and which one is going to be WeWork?

VC Research firm CB Insights monitors failures and keeps a record of Post Mortems on their website.  From the most recent Post Mortem report: [1]

Startup Failure Post-Mortems 2023 (Q3’23 Update) - Global venture funding rose 11% quarter-over-quarter in Q3’23. Barring Q1’23’s performance (driven by OpenAI’s $10B round), this marked the first funding increase since Q4’21.

While notable, quarterly venture funding was still down by 65% from its peak in 2021. And deal count hit a 7-year low in Q3’23. The TL;DR? Cash-hungry startups — particularly those that haven’t managed to raise since venture’s 2021 heyday — are still running out of runway fast.

In the face of this reality, several startups shut down in Q3’23. Harsh economic and fundraising conditions were cited as contributing to the downfall of many, including KoyoIntergalactic Therapeutics, and Casai. However, other factors were at play in Q3’23, including financial mismanagement and the disappearance of a tech CEO.

​​Read on for the detailed post-mortems of 10 startups that shut their doors in Q3’23. This analysis is not exhaustive of all startup failures that occurred over the period.

We use the words "Ponzi Like" because for the successful companies, the strategy is to pile in more capital at higher valuations to force the thing to work.  This typically works unless you have a very toxic founder like the WeWork founder, as an extreme example.  Other companies they simply let die on the vine, as evidenced by the CB Insights Post Mortem reports.

Some call the Central Banking System a scam, a Ponzi scheme - it very may well be, but it works.  The reason that the VC market is able to pull this off is because they have the capital and startups create jobs, and there are no victims.  Unlike an actual Ponzi scheme, there aren't clear losers in the VC world because investors need to be accredited.  In case you don't know, that means:

To be an accredited investor, a person must have an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. The income test cannot be satisfied by showing one year of an individual’s income and the next two years of joint income with a spouse.

A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. The SEC also considers a person to be an accredited investor if they are a general partner, executive officer, or director for the company that is issuing the unregistered securities.

An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. However, an organization cannot be formed with a sole purpose of purchasing specific securities. If a person can demonstrate sufficient education or job experience showing their professional knowledge of unregistered securities, they too can qualify to be considered an accredited investor.

Theoretically, an investor could invest in a startup and lose 100% of their investment.  But most private investors will spread the risk between multiple deals, OR become deeply involved in a project, often even taking a board seat.  Accredited investors can afford to take losses because they either have the net worth as a backup or the income to regenerate it.

Private Markets are less liquid, less elastic, and more volatile than public markets so the dynamics are a bit different.  VC Legend Peter Thiel explained recently that investors tend to undervalue something when it's working, and when something's not working, they don't realize how much trouble they are in.  See the video here:

This is very similar to the dynamics of investors who pile in to managed accounts after a long winning streak; fund managers often see record inflows just before a huge drawdown.  Conversely, when a manager is having a few bad months, no one wants to invest.  But if you do back testing on investing in portfolio managers, the best time to invest is right after a big drawdown (because good managers typically bounce back).

The crowd doesn't bother doing analytics like Peter Thiel, they have the diversity approach which involves funding many uncorrelated deals and putting more capital behind it if they fail.  That works great assuming you have billions to invest and you have access to these investments (most people don't).

Big Venture funds are basically selling access to early stage deals, but they don't tell you which one is going to be the next Uber.  They don't necessarily know themselves, however, you can bet their friends are going to get in before you.

Some firms like Venture Capital Cross are creating a new model based on a broker-dealer who negotiates for both sides in a success based fee model only, offering access to deals and providing capital to founders.  There are also tons of new courses, books, guides, and schools dedicated to learning the secrets of Private Equity, as seen on this page "Learn the Secrets of the Rich and Wealthy."

It's true that most high net worth investors are buying (investing) in Private Markets and SELLING in Public Markets.  The obvious question is, how do I get involved?  Education is key, as there are lots of idiots, scammers, and bad deals.  Investors need to inform themselves how to do due diligence, and how to distinguish between a real deal and an obvious fraud (amazingly, there are still tons of frauds out there and people fall for it.

We digress, however the point being that it is possible to get smart and make money on the Ponzi scheme of Vulture Capital, but you need to make sure you're buying at the right time and in the right deal and selling at the right time.

If you do want to have a serious conversation about Private Equity, we would like you to consider this Learn the Secrets of the Rich and Wealthy.

Frankly, it's only $25 bucks if that isn't the cheapest buy in to a real investment strategy, we don't know what is (there are VC courses and mentorships selling at many thousands of dollars per year.)

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