Yesterday I tweeted an unpopular opinion that deserves unpacking.

Valuations are up. Unicorns are getting birthed faster than ever before. Multiples have hit all-time peaks. New investors are aggressively entering the VC ecosystem.

Who’s to blame? What does it mean? Unpacked:
2/30: VC is an asset class. Many people don’t think of it that way but it is. And it isn’t a big asset class. It’s small relative to other major asset classes like publicly traded stocks, bonds, currency or real estate. But the VC asset class is growing quickly and accelerating.
3/30: One driving factor is that alpha has mostly disappeared from the stock market. The vast majority of return can be attributed to a few stocks each year and only 1 in 25 stocks are investments worthy holding over the long-term (relative to Treasuries).
4/30: The number of listed companies has also been on a steady decline with big companies becoming bigger and smaller companies disappearing through mergers and failures. At peak, there were over 7,000 listed companies on the US exchanges and the number today is less than 4,000.
5/30: Another factor is that companies are staying private longer than ever before which means that the highest growth companies are generating significant incremental returns in the private markets. The area under the returns curve is rapidly growing!
6/30: Many VC backed startups of the past decade have grown into great companies and the IPO market has finally re-opened. This combination is generating cash that is flowing back to LPs at an unprecedented pace which then goes right back into the ecosystem.
7/30: And a massively misunderstood benefit to private investing is that private securities can be structured while public securities can’t. Not all private securities are structured, but the ones that are can lop off the left hand tail of returns.
8/30: So, with all these forces at work it’s not a surprise that money has been pouring into late-stage private markets companies. The asset class is finally big enough to matter (and getting bigger) and the alternatives are getting worse.
9/30: But if the return expectations from these investors is merely “beating the next best alternative” and the next best alternative is investing in the public markets, then these investors should be willing to pay more than historical norms for access to late stage companies.
10/30: This is having a ripple effect on the entire ecosystem because if later stage and public investors are willing to pay more it generates greater paper returns (and secondary liquidity returns) for earlier stage investors if nothing else changes.
11/30: But finding great early stage companies is highly competitive which means that when an early stage VC finds one they can justify “paying up to win” based on the increasing prices paid by later stage investors + the extra returns generated by staying private longer.
12/30: As an early stage investor, these changes in the overall ecosystem are exciting and terrifying. More expensive to play. More return to generate. It puts a premium on “getting it right”. But “getting it right has changed” given the public market’s appetite for growth!
13/30: Because public investors are in “risk on” mode, they’re allowing private investors to sell them half-baked businesses. It doesn’t matter if the third bet in an early investor’s Trifecta thesis loses. They’ve already sold their card for a premium after two winning bets.
14/30: One obvious solution to the above is for VCs to do more work and look deeper to find overlooked ideas and Founders to fund. This is 100% if not 1000% true. But re-training well known patterns of success takes experimentation and the feedback cycle in Venture is long.
15/30: My two cents is that VCs who figure out how to find alpha in early stage overlooked startups are going to crush it over the next decade. They’ll put money to work in companies with fantastic return profiles without being caught up in today’s early stage madness.
16/30: But VCs aren’t the only guilty party. Founders are fueling FOMO. Big outcomes in the public markets are driven by big ideas and Founders have reacted to this by putting plans forward that that describe massive outcomes happening at crazy speeds.
17/30: But isn’t the job of a Founder to be ambitious? To this I say “absolutely yes”. But startups are built in stages and there are big ripple effects to taking on too much money too quickly. Ambition is great, but one can’t forget that a business still needs to be built.
18/30: The Problem: Building a startup is a complex, multi-round game

The goal is to win the game, not to optimize a single move. Founders need to de-risk the drivers of their business, attract talent and capital, and scale their businesses to self-sufficiency. This isn’t easy!
19/30: De-risking Drivers

When a startup puts money to work it gains insight into the business’s underlying assumptions.

Positive results: Progress has been made towards de-risking the outcome.

Negative results: At best the business is no closer to de-risking the outcome.
20/30: A business will be attractive to downstream Investors if it’s growing quickly while proving out critical business drivers. Every Startup’s “everything goes right scenario” can pass this test but how often does everything go right?
21/30: Result

A “fully” or “overvalued” startup that isn’t able to significantly de-risk the business in-between capital raises will struggle to attract new investors. Most investors would rather pass than fund a down or flat round. Never forget that Cash = Life.
22/30: Attracting and retaining talent

Talent is one of the most critical components in building a startup. Without talent nothing gets done. A super high valuation feels great to existing employees, but this same headline can be a deterrent to new talent.
23/30: Investors and existing employees might be fine if it takes 1-2 years for a startup to grow into its valuation, but why would a new employee sign-up for this? New employees bear the cost high valuations and a startup needs to hire these employees to deliver its promises!
24/30: “Just let it correct” isn’t as easy as it sounds. Have you ever suffered through a down round? Have you seen what happens when employees have underwater options? Do you understand what it takes to claw out from under a preference stack? This is the definition of pain.
25/30: Result

A “fully” or “overvalued” startup is re-risking the business because navigating the needs of existing and new employees can be challenging. The valuation is the champagne and everything that follows is the hangover.
26/30: Scaling to self-sufficiency

The public markets have historically wanted self-sufficient companies. But investors are in “risk on” mode and therefore have embraced high-growth, money-losing businesses. But optimizing for this is risky because market appetites change!
27/30: Optimizing for today’s market conditions means proving you can build a durable and profitable business isn’t necessary. The sprint for the exit door means optimizing for growth even if it isn’t good growth and if the dance stops the business could fall apart.
28/30: Result

A “fully” or “overvalued” startup takes on additional risk if it tries to grow into its valuation as quickly as possible. Building a durable business takes time and startups that grow like weeds might actually turn out to be weeds.
29/30: The “so what” is that the VC asset class is evolving and as a result not all pieces are in balance. The system is optimized for “today” and it’s unclear how long “today” will last. Any shift in risk appetite will create ripples just like today’s “risk on” phase has.
30/30: As an investor, all I can do is give good, pragmatic advice to Founders and help them build self-sufficient, scaled business that have value in all markets. And when a company I’ve invested in decides to take on new capital I can help guide them to a balanced outcome.

• • •

Missing some Tweet in this thread? You can try to force a refresh

Keep Current with Frank Rotman

Frank Rotman Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!


Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @fintechjunkie

19 Jul
After months of hard work you’ve managed to raise a comfortable amount of new of capital for your #startup. Now what?

A simple thread for Founders and VCs about shifting from a “need to raise” to a “need to prove” mindset.
2/21: Preamble: Not all businesses are venture backable. If the size/outcome potential is too small then raising VC money and running a VC backed startup playbook might not make sense. This thread is meant as good, generic advice for early/mid stage VC backed businesses.
3/21: Venture investing is very simple at its core. VCs invest in Founders who are building businesses that solve big problems.

Every Founder’s pitch describes a large profound problem, their solution to the problem, and the financials the business will generate over time.
Read 21 tweets
16 Jul
If you want to constantly produce top quartile returns, you have to find at least one “return the fund” (RTF) investment every fund.

Here’s a simple exercise that’s helped me spot 1-2 RTFs every fund:
2/20: Step 1: Run the Math

It always starts with sizing what a company’s enterprise valuation has to look like upon exit for it to become a RTF investment. Fund strategy and size dictate what type of game you need to hunt.
3/20: Having an investment RTF within a portfolio that has a small number of logos w/follow-on capital concentrated in the better companies is a different challenge than having an angel investment RTF in a “One check and done” portfolio.
Read 20 tweets
14 Jul
"There are only two ways to make money in business. One is to bundle and the other is to unbundle."

A thread on this powerful but very mis-understood concept:
2/22: The practice of bundling is pretty intuitive: It focuses on combining multiple value propositions into a single, integrated offering.

Unbundling is the opposite: It focuses on untethering a single value proposition from a combined offering.
3/22: When constructed properly, the benefits of bundling are intuitive:

Customers can buy a suite of contextually relevant products/services through a single provider/buying process.

Providers can improve the LTV/customer by selling a bundle vs. a single product.
Read 22 tweets
10 Jul
There’s no denying that right now a lot of money is flooding into #startups. A lot!

But the money won’t always be there. What will happen once the cash stops flowing? Will there be a wave of startups forced to close shop or are there other possible outcomes? A few thoughts 👇
2/13: Answering this question isn’t easy because every startup’s situation is unique. But I can share a framework that can be used to help think through the possible outcomes.

I call the framework “Climbing the Relevance Curve” and it has three simple questions at its core.
3/13: Question 1: Will anyone notice?

At the foundation of the concept of “relevance” is the notion that a startup is either relevant or irrelevant through the lens of a counterparty. You don’t get to decide this. The market does.
Read 13 tweets
9 Jul
Poker, Peloton and Pulp Fiction. A game, a company and a movie. I’ve learned major life lessons from all 3.

Here’s the single biggest takeaway from each that helps me in my professional life.
2/14: Poker – Focus on the process, not the outcome

We all make decisions every day. Its not atypical for an average person to make thousands of small decisions in a 24-hour period and people in positions of authority make big decisions all the time.
3/14: Poker teaches that outcomes are a function of decisions and luck. Poor decisions that result in positive outcomes should be treated as a bad decisions and should be avoided. Good decisions that result in negative outcomes should be repeated.
Read 14 tweets
2 Jul
1/17: In honor of the @RobinhoodApp S-1 I thought I’d share a conversation I had a few weeks ago with a friend who used Robinhood as his on-ramp into the trading world.

Brace yourselves. It was a fun conversation but pretty eye opening in lots of ways.
2/17: It started with two texts:

“I bought 2 $9 CLOV call options on 6/7 for a total of $170. Expiration 6/18. The value is now at $2450. The share price is up again this morning almost $5. I want to lock in profits but don't want to miss out on future profit by selling now.”
3/17: “Any suggestions on doing this. I was thinking of selling 1 contract to get back my initial investment plus 1400% profit and let the other ride until the day before expiration. Is there any other strategy you may know?”
Read 17 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!

Follow Us on Twitter!