Why Is It Still So Hard to Raise in a Time of Cheap Capital?

Today: The global savings glut and the startup world, more fragmentation, Coinbase, day trading.

The Agenda 👇

• Capital is abundant, except from a founder’s perspective

• India, and others, emulating Trump’s America

• Coinbase forces a reckoning in today’s capitalism

• Beyond the Bloomberg terminal: Traders using Reddit and TikTok

There’s a lot of talk these days about cheap capital and interest rates being lower than ever—even negative in certain contexts. It has various implications:

• It makes it easier for governments to borrow massive amounts of money to support a faltering economy given the pandemic. This is Macroeconomics 101: massive public spending can start the economic engine again only via a lenient monetary policy.

• It radically changes asset allocation on financial markets. Because the yield for most bonds is so low, the only way to make money with bonds is to count on their price being volatile and trying to turn that into capital gains. “Bonds have become stocks, and stocks have become bonds”.

• Overall, the abundance of cheap capital creates a problem for investors, who don’t know where to invest anymore to generate returns. This phenomenon of the “global savings glut” is the cause of many headaches for chief investment officers worldwide.

You might think it’s all because of the pandemic, but really this situation is nothing new. Back in March 2016, my colleagues at The Family asked me to write a paper about whether we’re in a tech bubble or not (see Better Get Used to Those Bubbles).

• One of the most interesting sources I studied at the time was a piece of research by then-Fidelity Global CIO Equities Dominic Rossi about the “global savings glut”. It’s not online anymore, but you can access it on my Evernote here.

For this conversation, the most relevant extracts are:

The thinking is that there are more countries with excess savings than there are with excess investment opportunities. With the accumulation of savings continuing, nominal and real yields will grind lower over time… Global gross savings are about 24% of global GDP and, when adjusted for depreciation of fixed capital (savings wealth consists of fixed assets as well as financial capital), we are still seeing savings of 11% to 12% on a net basis, which is substantively in excess of nominal economic growth.

This scenario describes a world where too much capital is chasing too little income. This realisation has a profound implication for asset values and investor asset allocation. If it is a persistent trend, then we will see a desperate search for yield, a bid for fixed income and interest in equity income as well as real estate and multi-asset income.

Shortly after that, I discovered Clayton Christensen’s vision of economic growth. The late Harvard professor had this (very convincing) theory that investors are addicted to the short-term returns that come from investing in what he calls “efficiency innovation”—that which destroys jobs and frees up capital because it makes production ever cheaper.

• Because it’s so easy to make money like that, there’s really no reason for an investor to consider another category, that of “empowering innovation”, which also generates returns (as well as many jobs), but only over the long term.

This was summed up well in Christensen’s article A Capitalist’s Dilemma, published in The New York Times a few days before the US 2012 presidential election:

America today is in a macroeconomic paradox that we might call the capitalist’s dilemma. Executives, investors and analysts are doing what is right, from their perspective and according to what they’ve been taught. Those doctrines were appropriate to the circumstances when first articulated — when capital was scarce.

But we’ve never taught our apprentices that when capital is abundant and certain new skills are scarce, the same rules are the wrong rules. Continuing to measure the efficiency of capital prevents investment in empowering innovations that would create the new growth we need because it would drive down their RONA, ROCE and I.R.R.

It’s as if our leaders in Washington, all highly credentialed, are standing on a beach holding their fire hoses full open, pouring more capital into an ocean of capital. We are trying to solve the wrong problem.

The Family’s mission is to help entrepreneurs succeed, and so, having learned all that, I kept asking myself: Why is it still so hard for a founder to raise money? Where’s all this cheap capital I’m reading about in the FT and Fidelity’s research publications?

It turns out it’s not that easy to allocate large amounts of capital when most economic agents (from businesses to governments to individuals) have been trained to think that capital is a scarce resource. I kept this idea somewhere in my head until, following Tim O’Reilly, I discovered Matt Stoller’s writing about big business and antitrust, especially his masterful How Monopolies Broke the Federal Reserve:

There’s too much capital all over the world in a savings glut, so interest rates are low or negative. At the same time, the only people who can borrow this surfeit of capital at low rates are those who won’t put it to work in anything but speculative endeavors. Otherwise, borrowing costs are insanely high. The world of finance and monopoly is a small world, a club, and they’ve pulled up the ladder to make sure no one else can get in it.

OK, that all sounds like he’s a Marxist revolutionary, but Stoller’s point is basically the same as Christensen’s: cheap capital is invested in “efficiency innovation” (code word: “financial speculation”), whereas those who really need the money (either to consume or to implement “empowering innovation”) still have difficulty convincing their bankers or early-stage venture capitalists.

In fact, studying the specific case of venture capital makes it easier to understand the problem with the current shift. There are three obstacles to matching capital and startups:

• Startups are widespread (Christopher M. Schroeder’s “great technology shift”), whereas those making capital allocation decisions are still concentrated from a geographic perspective. Hence we have an ecosystem bias, whereby most of that excess capital has to pass through only a few financial hubs such as Silicon Valley. The people there are not only biased from many perspectives, they’re also overwhelmed, and so they don’t just make more deals. (They’re content to see prices rise rather than volume increase, and hence the impression of a bubble.)

• I’m not saying they’re wrong. Indeed, we all know that venture capital is a business subject to diminishing returns to scale: the more capital you deploy, the lower your returns. It’s true beyond VC (Warren Buffett, very much not a VC, had to completely change his approach to investing once he became a billionaire), but it’s especially true in VC. Experiments designed to test that idea (either data-driven early-stage investing or very large funds such as SoftBank’s) haven’t produced convincing results. This is why most VCs still see their business as a craft. They might call themselves capitalists, but they retain the mindset of a merchant.

• LPs play an important role in this situation. Most of them won’t trust a managing partnership with their money unless there’s already a convincing track record dating back at least 8-10 years. Therefore there’s a cap on how fast venture capital can rise as an asset class. (That explains the current discussions about “emerging managers” in venture capital.) As for those LPs willing to wander away from established managers with an established track record, it’s actually very difficult for them to find where, exactly, they should allocate money.

I wrote a lot about this misalignment problem over the past few years. Basically, some LPs are seeking more exposure to tech startups and startup founders are obviously seeking to raise more capital. But they’re both dependent on two things they can’t control.

First, there are the legacy players that control the middle of the value chain: that includes multi-asset allocators as well as incumbents in the venture capital industry—all those who prefer the status quo over radical change. I wrote about this in Upending the Investment Value Chain, and then (echoing the specific case of my firm The Family) in The Family Raises €15M led by LGT Capital Partners.

Then there’s the journey of tech startups from ideation to exit. In that sense, without a favorable context up the stream for exploring new ideas (whether more basic research or upgraded regulations—both depending on the state), and without liquidity down the stream (acquisitions and IPOs), there’s not much you can do about the amount of allocated capital. If you want to dig deeper on that one, check out The ‘Pas de Deux’ of the State and Venture Capital (echoing Bill Janeway’s work) and Investors in European startups need a clearer path to exit (in Sifted).

It’s not that nothing is happening, of course. The global savings glut has triggered two very visible trends in the business world:

• On one hand, business strategists, walking in Christensen’s shoes, are busy upgrading the whole discipline to account for the fact that capital is now abundant rather than scarce. Check out Strategy in the Age of Superabundant Capital (in HBR).

• Meanwhile, we can’t keep up with all the new funds, all these emerging managers, the new approaches to investing—what I call the Diffraction of Venture Capital, which wouldn’t happen were it not for the global savings glut.

These things are happening faster in some places than in others. But even as it happens, it doesn’t make fundraising any easier (here’s the thing: raising capital is *always* hard). What’s more, we all have a role to play in hastening this change.

• I think we’re doing our part at The Family (even if we can always do better).

What about you? Have you seen the global savings glut? Has it changed your business life—and if not, what should we do about it?

🇮🇳 The Great Fragmentation (India Edition)

Our friend Vivek Wadhwa of Carnegie Mellon University wrote a piece about the need for India to claim ownership of the tech companies that are about to take control of that giant market. It’s only logical that following Trump’s demand that TikTok be controlled by American interests, any other country with a large market and/or high purchasing power will follow in those footsteps. Read Vivek’s piece Like US and China, India must ensure that foreign tech companies here are locally owned:

India could learn from both the US and China, requiring that Facebook India be sold to one of India’s tech tycoons. This would be one step to ensuring that all data be kept locally and tightly protected, and that the algorithms that determine the information that users will receive – which, after all, influences their behaviour -- truly reflect India’s culture and values. The soulless geeks of Silicon Valley and the ruthless autocrats of China simply cannot be trusted to do that. In fact, it would conflict with their interests.

By the way, if you’re doubting India is serious business, well, think twice:

StΞfano ₿ernardi 🌲 @stefanobernardi

YC is going to make so much money from its growing focus on Indian startups it's not even funny

⚖️ The Corporate Contract (Coinbase edition)

A long time ago, I wrote a short piece for the Global Drucker Forum in which I started tinkering with the idea of the corporation as a contract with three parties: shareholders, employees, and customers. By definition, the interests of these parties are not aligned, and a big part of capitalism’s contribution to human progress is helping them work together to create economic value.

An interesting feature of the business world is that any agreement reached between the three parties in the context of a given corporation is unstable, and the balance is bound to be tipped at almost every turn. These days, for instance, more and more large tech companies are confronted with the challenge of aligning their employees (who want their employer to take sides on issues of general interest) and their customers (whose views might differ from those of employees):

• Google has had a hard time doing it. Read Nitasha Tiku’s landmark 2019 article in Wired: Three Years of Misery Inside Google, the Happiest Company in Tech.

• Facebook is in an even worse position. Even Mark Zuckerberg said so recently, as revealed by Facebook leaks show Mark Zuckerberg defending his decisions to angry employees.

• Amazon doesn’t care that much about taking sides and they’ve made it clear from Day One, so they’ve managed to escape the whole controversy (another sign of Bezos’s superiority when it comes to managing for the long term).

More recently, Coinbase decided that it had had enough with taking part in the public debate, and its CEO Brian Armstrong basically said to his employees that they should now either shut up or leave. Read Armstrong’s widely commented piece: Coinbase is a mission focused company. Not everyone agrees, obviously:

EricaJoy @EricaJoy

sooo about this coinbase blog post. you know, when you publish something like this, you might piss off some of your team. and then they might talk. (p.s. to coinbase GSOC: it's nobody you expect and thankfully many cb employees know the importance of encryption and opsec. 😘)

Brian Armstrong @brian_armstrong

https://t.co/FudJSuaumB

(I’ll write more in the future about the corporate contract in the context of activism.)

🤑 Retail Investors (TikTok Edition)

In one of my essays last week, I linked to this article about professional investors using Reddit to follow the trades of retail investors. Another article, published by Institutional Investor, points out that a lot of trading-related discussions are also happening on TikTok, which constitutes a challenge for regulators. I find it interesting because we’re effectively confronted with a choice:

• One option is to ask that all these unregulated exchanges of information cease on Reddit and TikTok, and changes like reforming article 230 might lead to such platforms being asked to censor whatever is being said for investment purposes.

• Another option is to acknowledge that these platforms have now joined with financial markets permanently (and so not everything happens over Bloomberg terminals anymore), and to upgrade the regulatory framework accordingly.

Quite blurry, isn’t it? What do you think? I promise I’ll follow up on that one!

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From Normandy, France 🇫🇷

Nicolas