When you invest in something and your underlying thesis is wrong, you will lose money. You will lose even if your underlying thesis is the current thing, or popular. As a matter of fact, investing in and in the style of what everyone else is doing is a recipe for failure. Great investments with outsize returns are individual bulls that face the herd, not ones that go with it.
Over the past few years, a lot of venture capital funds have been raised on the premise that they will invest in “underserved” markets. Funds targeted a specific group based on sex, gender, skin color, and race. A lot of money has been invested here.
What’s the underlying premise of these funds? The core underlying thesis?
The core underlying assumption is that existing funds were run by white males who were racist. For some reason, they didn’t understand or, wouldn’t invest in companies run by (fill in the blank).
I think funds that are based solely on that premise will not do particularly well when it comes to returning money to their limited partners. We will see and we will know within ten years or so.
People that invest in venture funds realized that over the last fifty years, they have only invested in funds that were run by white males and Shelby Steele’s “White Guilt” came into play. Most of the people that run the fund of funds and institutions are white males by the way.
Yesterday, I mentioned how venture conferences all over the country are doing stuff on financial inclusion and other topics. I do know this, if there is a big enough market for something, a business somewhere will find it and serve it.
What I’d like to learn more about is how to define and find those markets that will become big. I don’t need to be lectured on how I have discriminated against people when I haven’t.
Pre-Covid, the last good thing I saw at a venture conference was a discussion of quantum computing. I knew nothing about it.
I was reading this article in the Financial Times this morning and it is thought-provoking.
In it, the author John Gapper makes some very provocative points. For example, he talks about the meltdown of Cathie Wood’s Ark ETF. She had invested in a lot of highly speculative stuff. That works in a rising market with cheap money, but when the doors fly off everyone flees to safety.
Wood carefully nurtured her own image which made it worse.
Gapper interviewed the CEO of Danone who said they would pull back from more speculative products in their line and concentrate on yogurt. What that tells me is the opportunity costs of producing the “innovative” products are higher than the marginal profit. There isn’t a big enough market yet to justify producing it.
I think that can also be said for Beyond Meat. Beyond Meat’s underlying thesis is there is global warming and it will be so bad that we will all have to give up meat. Cow farts contribute to global warming, right? Of course, it completely ignores the high costs associated with growing enough plant-based stuff to feed the world but we are saving the planet here and costs don’t matter right? I also don’t think people in India will murder all their cows to save the planet when they are sacred to their society.
Personally, I have seen data that shows how hoofed animals and grass actually capture carbon from the atmosphere and it looks like oceans do to. That ignores the fact that our environment is always changing. I disagree that the planet is warming because of man and at the same time am a strong believer in conservation. You can do both.
Will Beyond Meat survive an inflationary and higher interest rate environment? It all depends on how big their core market is. Big enough to make marginal revenue equal marginal costs, then they will make it. Otherwise, sayonara.
I think the same can be said for venture funds that are raised under a false thesis. The venture world is not racist. It’s pretty merit-based when it comes to doling out capital and investing in companies. Where VC isn’t always merit-based is when funds raise money from institutional investors. Go to Harvard Business School, Wharton, or Stanford you have a much better chance than if you went to State U. So, yes, if you were a non-white male and didn’t attend one of those schools and didn’t have the “credentials” those people had, it was super hard to break into venture capital or even raise a fund. Welcome to the club.
It’s not that venture capitalists are inherently racist. They aren’t. But, a lot of non-white male entrepreneurs didn’t have the network or, didn’t know the path, to get in front of them to pitch.
Venture capital cannot and should not be doled to companies based on country demographics. Just because the US population is 51% female doesn’t mean 51% of venture capital ought to go to females. It’s a dumb argument.
In VC, everyone doesn’t get a trophy.
Starting a company from an idea and turning it into something of value that people are willing to part with valued assets to consume is an extremely arduous thing to do. If it was easy, everyone would do it. That’s why when you see people like Elon Musk build Paypal, Tesla, SpaceX, and The Boring Company creating trillions in value you have to think he has a decent shot at doing something with Twitter.
VC funds are not charity. They aren’t non-profit. They aren’t non-government organizations looking to solve an issue. They invest real dollars into businesses that look like the craziest thing in the world but would be super cool if they actually worked. They expect to get an outsize return on those dollars. By outsize return, I mean for every dollar invested they want at least twenty back. That covers the failure rate since at least 50% of every dollar you invest will go to zero. This isn’t the stock market or bond market.
An entrepreneur can come from anywhere. They can be anyone. At the earliest stages, VC’s invest in those people. Building a company is so difficult. Investing in startups is also very difficult. Stratifying your investment criteria by demographic statistics which are meaningless when it comes to building a company and going to market automatically makes it harder.
Great points, and thanks for the link to Gapper's FT article - which made some excellent points but I think missed a larger point we have already seen in action around here - empty shelves for staples and sales on overstock of high-priced niche goods.
(I think you mean "recipe" for failure rather than remedy in the first graf.)
Very well said, Jeffrey, thanks. I am still appalled that BlackRock, Vanguard, Church of England, etc. have been anointed with the de facto regulatory duties of ensuring that publicly-listed companies become woke (diversity, carbon neutral, etc.) rather than the more usual mandate of “create shareholder value”. I also note that these same mega institutional investors have assets under management that seem to have grown in lock step with government (at least the US) monetary supply expansions. I guess it pays to be an unaccountable arm of the government.