I just finished reading Dan Lyon's "Disrupted". I devoured it in a little over 2 days and took frequent breaks to email various friends and colleagues (many of them tech CEOs of non-unicorns, go figure) that they had to read it.
The story of Lyon's tumultuous ride at Hubspot, a tech unicorn which has never shown a profit, and will probably never show a profit didn't tell me anything I didn't already know. It didn't say anything I haven't been pounding the table myself about for over a decade, but the storytelling is brilliant and it's encouraging that the former Newsweek tech editor and writer for the hit series "Silicon Valley" (which I love) is shining some light on one of the big manifestations of financial repression that is quite literally wrecking everything.
As I parse it, here are the components of the tech mania we are enduring:
Incompetence is rewarded, not penalized.
Used to be a time when entrepreneurship, in fact capitalism, was about shooting for success at the risk of failure. Founders and backers had "skin in the game", which didn't mean they got to privatize the gains and externalize the losses, it meant if the businesses they built didn't make any profits, they would eventually fail and lose their invested capital.
Instead, as Lyons relates it:
"[Everything I'm describing about Hubspot is absolutely normal. 'You know what the big secret of all these start ups is? [Harvey, a serial entreprenuer] tells me. 'The big secret is nobody knows what they're doing. When it comes to management it's amateur hour. They just make it up as they go along'…
Even some of the biggest and best-known new tech companies are totally dysfunctional. Twitter, for example, seems to have survived in spite of its management rather than because of it. The company is valued at $13 billion and not long ago was valued at more than $30 billion[1]. Yet Twitter has never reported an annual profit, and has lost billions of dollars. For nine years Twitter has undergone wave after wave of management upheaval, hiring and firing CEO's, reshuffling, reorganizing, announcing new business plans, making acquisitions. The people responsible for this mess have become incredibly wealthy. Two of Twitter's co-founders are billionaires."
[1] Note: That valuation is in the same ballpark as the market cap of Caterpillar Inc., which earns $2.1 billion of net income on $47 billion revenues annually.
Twitter is not an outlier, and neither is Hubspot. They're the norm. As I've lamented previously (in my Growth for Growth's sake leads to Nowhere, and my look at the effect of Negative Interest Rate Policies: NIRP), our largest competitor in the domain registrar space has never earned a dime. But they have Superbowl ads, an F1 sponsorship and when I drive down the Gardiner Expressway on the way home I pass their billboards.
And now they aren't even our largest competitor since Google and Amazon entered our space as direct competitors as well. I hear a lot of brick and mortar businesses complain it's tough to compete with Wal-mart. I believe it, but hey, try competing with three Wal-marts for a few years and then come talk to me. At least Google is profitable, Amazon barely so. Godaddy has a return on equity of -18%, are pyramided 29-to-1 debt-to-equity, and nearly every penny from their billion dollar+ IPO went into the pockets of the private equity firms that backed them (one of which uses us as their DNS provider, go figure).
The point here is that it used to be normal to have to compete with companies who were trying the "grow-fast-lose-money" route because eventually some backer somewhere was going to insist on a ROI and the company would have to at least try to get profitable. Some entrants would go that route, others would try the organic growth ("Growth at a reasonable price") route, and the market signalling would sort it out over the long haul.
But since monetary policy is horribly distorted and is looking less and less like a temporary aberration and more like the new normal, this is a huge problem. Because it completely turns the idea of entrepreneurship and capitalism on its ear. ROI doesn't come from "normal course operations" of the business anymore, ROI comes from serial funding events at successively higher valuations, that's it. It terminates with either an IPO, where this all gets laid off on lumpenvestors, or some monster acquisition to a big company that'll do all kinds of stupid deals for ridiculous money or pension funds who are so starved for yield after a decade of ZIRP and staring down the barrel of an oncoming world of NIRP that they have to try their hands at this VC stuff to try and keep up with their future obligations.
Mark my words: I'll be surprised if Godaddy ever turns a profit (unless they engineer it, like issuing some low cost debt and doing a share buyback, which incidentally fuels something like 25% the EPS growth of the S&P these days. It's harder to find data on how much debt-fueled buybacks inflate the Nasdaq because more of the companies are money-losers and have no EPS…).
Maybe Godaddy get's acquired. Or maybe after the coming financial bust their share price will decline enough to make it look attractive to some private equity fund, so they'll get taken private, reloaded and then reissued in some other IPO down the road. One thing I guarantee with confidence: they will never declare a dividend.
To VC or not to VC?
Pick up any book on starting a business or becoming an entrepreneur and step one is always "organizing your funding", looking for funding, finding your first funding round. It's like bootstrapping a business is not even an option (although that's what we did and we were by no means alone, way back there in 1998). The problem as I've noted previously is that once you take VC funding, you have forever changed the dynamic of your company. It will never be about profits anymore, it will be about valuations. And that may sound like a subtle difference but that effectively puts you in an alternate universe. An incompatible one. A bizzaro-verse. As Lyon's observes:
"Halligan [Hubspot CEO] is under pressure himself. He has taken $100 million of venture capital from firms and is expected to deliver a return. His investors include Sequoia Capital, a firm with a reputation for throwing out founders who fail to meet expectations. Hubspot needs to pull off a big IPO, and to do that, the company needs to keep growing.
By the strange rules of bubble economics companies do not have to generate a profit before they can go public, but they do have to demonstrate revenue growth. Every month, every quarter, Hubspot's sales must keep rising. A start-up that stops growing is like a shark that stops swimming: dead in the water." (emphasis added)
It is worth repeating my own flirtation with venture crapitalism here, where the plan for a succession for subsequent funding rounds were in motion before we had even inked a term sheet for the first one:
I learned this from direct experience, years ago when I was looking for funding to buy out John and Colin (the other easy co-founders), I ended up going through this process. VC's were very interested in easyDNS, but they were ambivalent about the long term prospects. Before we had even agreed on our own initial deal, they were already looking out toward a subsequent funding round within 6 months. I found this insane, the company was already profitable and growing. It didn't need a funding round, I just wanted to buy out my partners.
But the VC's were adamant on an "exit plan", what was it going to be? When I explained my idea: that they would be collecting quarterly dividend cheques….forever. Their eyes glazed over. It didn't interest them. Finally one of them took me aside and explained, "Nobody here cares about dividends or long term profitability, we aren't in this for the long haul. These funds are setup with 3 to 5 year windows. After that, we return the capital to our investors because we no longer get paid for managing the investments." Which meant that they had to have "exited" all of the fund's investments before the fund was "wound up. They would of course, have already started another fund in the interim.
It is interesting to note, after I ended up not taking on this funding round and bootstrapping a plan to do my deal, my personal life took an adventurous turn when fate "long bombed" a baby into the lives of my wife and I. We ended up departing the country on less than 24 hours notice and setting up shop in a hotel in the US for a few months while we adopted our daughter. This wasn't a surprise, in fact I disclosed to the VC fund that we were in the process of adoption and that at some point this was probably going to happen, and when it did there would be no notice and my availability would be zero for awhile. Months even. "No problem" I was told, "family is important".
About a year after the deal didn't go through I ran into one of the "independent" directors the VCs planned to install on my Board and when I told him the Story of Emily (which most people are blown away by and say "WOW! What a great adventure!" when they hear it), this one said "You're very lucky you didn't take the VC deal. Because you would have been fired for pulling a stunt like that". That "stunt", of course, was being a human being and living a life for a few months that didn't directly "build value" for the next funding round that would enrich my ostensible backers….
The problem now is that not taking VC is becoming a harder road to traverse because unprofitable unicorns and 8 million pound gorillas are eating the entire space. Which space? All of them. Independent, organic growth driven businesses now face the flipside of "Too Big To Fail" (policies of which are destructive) but "Too Small To Succeed".
The Triumph of Inanity
I often used to remark that all this (tech-land) "is just the internet". Civilization got here (as-in now-minus-20 years or so) without the internet existing and if it somehow, suddenly went away tomorrow, history would probably, somehow soldier on without it. In other words, all of us tech luminaries should really get over ourselves – not everything we come up with is inspired, revolutionary, visionary or awesome (which Lyon's makes a point to italicize every time a Hubspotter uses it in the book. Awesome may be the single most frequent word in the book). In fact, probably only a small minority of it is. The majority is bombast, aggrandizement and marketing-speak.
Lyons berates the "frat house culture" at many of the unicorns examined in the book. Although it came across to me more like Kindergarten …with kegs. Hubspot in particular comes across as a Scientology Start-Up, where high level management sycophants are likened to "8th-level Thetans". Which is understandable because making unimportant, unremarkable, expendable companies into "must-have" tech IPOs is a long haul (sometimes two maybe three years!) You have to have a motivated staff and they have all had to drunk the Kool-Aid 100%.
Co-founders bring Teddy bears to meetings, blog about it, post photos of it online and congratulate themselves on some kind of new management breakthrough. Nobody in the rank and file will tell them "this makes us look stupid".
After reading Lyon's book I appointed this teddy bear our Chief Disruption Officer
The reason Disrupted strikes such a chord is because these antics that Lyons endured at Hubspot are a microcosm of the big picture. The book isn't compelling like a car-wreck because it's an aberration, it's compelling because it's indicative.
Hubspot is the poster child of our economy and our world.
We're in another tech bubble. Pure and simple. The reason why we're in a tech bubble is because there is too much debt and credit expansion, and the reason there is too much debt is because interest rates are being artificially suppressed and money is being printed, and interest rates are being artificially suppressed and money is being printed because "The System" as we know it is bankrupt, fundamentally flawed, immoral, soul-killing and one failed "can kick" away from becoming completely unglued.
The effects of financial repression are multi-faceted and they are felt everywhere in the economy but they are experienced by most of us as second-order effects. The only people seeing the immediate consequences of ZIRP, NIRP and cheap money are the people getting rich off it, who are a small, infinitesimal sliver of society very close to the nexus of centralized state power and finance. The microscopic "Establishment". Everybody else is experiencing the knock-on effects (otherwise known as "the fallout"). The primary means of experiencing these second-order effects is through getting screwed by them.
But we are in the hideous grotesque manic phase now. This is the blow-off top: We're talking fall-of-Rome, pre-revolutionary France or any other place where the gulf between the rule-makers and everybody else is becoming so stark and so inexcusable that any attempt to justify or rationalize it as democratic (or even capitalist) becomes so farcical and tragically comic that it makes a book like Disrupted inevitable. That it came out of the soft underbelly from whence innumerable wannabe tech unicorns are born (Boston) is hardly surprising. What went on inside Disrupt is happening everywhere: in politics, in banking, in healthcare, in education. But at least for the moment, a technology wonk can get away with writing it.
Lyons is a whistleblower of sorts, only this one doesn't have to flee the country. Had he been in any other sector of the economy the consequences for exposing the rampant fraud and thievery that guides every impetus of the would have been very grave indeed. In fact Lyons did face a black-bag operation worthy of Watergate directed against himself and he still doesn't know to what extent his personal privacy was and is compromised. Such is the system we live in, where "In a time of deceit – telling the truth is a Revolutionary act".
The Scandal of Money
The second half of the blog post title is the name of the other book I read this weekend, George Gilder's "The Scandal of Money" (no I don't read two books every weekend, I wish. My daughter had a swim meet and there was a lot of sitting around involved…) It came together with Disrupted in a very meaningful way because where Disrupted shows us a microcosm outcome of fundamentally flawed and failed economic policy, Scandal of Money breaks out the macro side of it. One may need to force themselves to read around Gilder's obvious Republican leanings (this is easy to do because he is quite critical of them and does not exempt them from his analysis of our monetary system).
The big idea in Gilder's work is that the economy is more than a system of incentives (as all mainstream thought presupposes) but is a system of information. The role of money as a market signaller is outside the scope of nearly all economic thought. Gilder tells us that with money divorced from hard underpinnings (he cites Nixon's abrogation of gold-backed USD in 1971 as the starting point, I personally think the creation of the Fed in 1913 as the beginning of the end). When all currencies only float in relation to each other and are subject to each governments' manipulations, then
"With no [hard] dollar anchor for long-term investment, financial horizons shrank and markets dissolved into trading over bets on bits….The collapse of productivity growth after 1972 must be deemed just another of the cascading effects of the destruction of money as a metric".
Iterate over this for a few decades and we arrive where are today:
"[Where there are] no limits to the tempests of short-term trading and trafficking in a surf of meaningless money values."
What exacerbates this today, and why I really think we're in the closing rounds of this charade, is interest rate suppression. First we had the decoupling of money from a hard backing. It's not that money necessarily must be gold-backed. Crypto-currencies like Bitcoin are so radical because they are inelastic. Inelastic currencies operate in alignment with the productivity growth that a healthy technology sector normally cultivates: they are both deflationary. However despite what you and I may think of prices falling over time (would you really complain that much if your cost of living decreased?) – the powers that be think that is unspeakably evil (because it prevents them from inflating away their debts).
But now we have not only ZIRP (Zero Interest Rate Policy), but get ready for NIRP (NEGATIVE Interest Rate Policy) – which has quite literally (aside from very brief, very minescule yeild curve inversions near the Second World War) never happened in financial history. In that sense "This time is different" indeed. Gilder observes:
"the flattening of interest rates [is] a global governmental raid on the future…The result is swollen asset values, quantitatively 'eased' but qualitatively – a bubble"
And that's where we are today.