Valuation of startups should fall, says author of book on technology and venture capital

For Sebastian Mallaby, the rise in interest rates in countries like the US should make investors in startups more selective, which should lead to a drop in the market value of new companies seeking financing.

“This new financial climate will bring adjustments. In an environment where interest rates are at 6%, 7%, it is very expensive to lock your money, for the opportunity cost. To compensate, venture capitalists should expect higher returns, which which means that they would only support the best companies, and for a lower market value”, evaluates Mallaby.

“Prices will adjust. The valuation value of startups will have to be lower. But there will be many people wanting to invest in venture capital. It won’t be like in 2000”, he continues, citing the great crisis that hit the technology sector.

Mallaby, 58, is a British journalist and author of “The Law of Power – Venture Capital and Creating a New Future” (ed. Intrinsic). The book details the relationship between venture capitalists and the creation of American companies that changed the history of technology since the 1950s.

The work, nominated as one of the best of the year by the Financial Times, brings back the background of the emergence of companies such as Intel, Atari, Apple, Cisco, Yahoo, Google and Facebook, and how investors helped to transform good ideas into businesses capable of generating millions. of dollars in a few years.

The writer spoke to the Sheet by video call and also talked about other changes in the current scenario for startups.

How do you see the current scenario for venture capital, at a time of rising interest rates and the prospect of recession, especially in the US? Nasdaq has fallen a lot. Tech companies tend to grow fast but are more volatile and risky, especially in their early stages. In a world where people are afraid of risk, their appraisal value must drop.

In venture capital, you’re looking at money seven years from now when you invest. In a scenario where interest rates are at 6%, 7%, it is very expensive to lock your money, for the opportunity cost.

To compensate for this, venture capitalists should expect higher returns, which means they would only support the best companies, and at a lower market value. So, for sure, this new financial climate will bring adjustments.

But at the same time, since Google went public in 2004, tech companies have been on an extraordinary streak. Therefore, they spread across the world. My opinion is that prices will adjust. The valuation value of startups will have to be lower, but there will be a lot of people wanting to invest in venture capital. It won’t be like 2000, when Nasdaq crashed and Silicon Valley kind of went to sleep for three years.

The “winner takes all” model must follow gift? In the future, this model may be less dominant. In businesses that have a network effect, the more people you serve, the greater the margin of return. It’s different from the classic model, where the cost of production goes up as you produce more.

In marketplaces and networking businesses like Facebook and Google, the more people use them, the smarter they get and the more useful they are to the customer. On Amazon, you can choose from millions of products, and the cost of putting one more thing up for sale is almost zero. So these networks have a penchant for the winner-take-all model.

But if you go back to a world where venture capital backs companies that are producing hardware, like electric batteries for cars, there can be less strong network effects. There will still be some winner-take-all effect because whoever has the best technology is likely to dominate the market. And if one company dominates, others will try to follow because the margins will be fat for the leader.

You already said that unicorns [empresas iniciantes avaliadas acima de US$ 1 bilhão] are the problem, and that the best way to deal with it is to prevent the creation of bubbles in the market. Do you have any suggestions on how to prevent blisters from forming? Bubbles have existed throughout the history of finance. We won’t get rid of them completely, but there are government failures with unicorns.

The qualities that a founder needs to start a business are not the same as those of running a mature company. Often you have a leadership change at some point. But unicorn founders have been given a lot of power, through super-voting stocks. And there are investors who do not want to exercise governance or a seat on the board. Thus, unicorn founders are untethered and spend capital as if it were water. And people don’t say the king is naked.

At WeWork, that didn’t happen until they went public. When you become a public company, there will be experts and journalists who will look carefully at everything. Then everyone says “that was ridiculous”. But nobody says this before because the owners of the shares are not exercising governance and supervising the founder properly. This is part of the mechanism that could reduce bubble formation.

Still on unicorns, what’s your analysis of the blitzscaling model today? Could we have more cases like Uber, which spent a lot of money to dominate markets by offering discounts to customers? For budding startups, especially software startups, having speed is appropriate. The faster you scale, the more you’ll get margin returns. Venture capitalists put money in and give startups six or nine months to get off the ground, and you need to be quick to see results. So it’s a good thing, it pushes companies to be ambitious and get things done fast.

But there are many examples of companies that have gone too far. Blitzscaling can be a problem sometimes. In America today, when people repeat Mark Zuckerberg’s phrase, “move fast and break things,” they do it to laugh at him and Facebook. But I don’t think so.

As for breaking things, it depends on what you break. If you release version 1.8 of your program and it’s not good, you just tinker with the code and fix it quickly. If you’re making hardware and you have to build a factory, then fixing the mistake will be more difficult. And when Facebook gets big as it is, it has global consequences. Breaking things can mean breaking society. And you don’t want that.

How can governments, like Brazil’s, act to attract more venture capitalists? The first thing is to have the government invest in training, technology and people. Support students who want to learn science, technology, engineering and math, and support people who are going to start technology companies.

The second thing is to think about intellectual property rules. It is important that when something is invented at a university, it is possible to license the technology and create a company with it, so that the university receives some royalties. But that can’t be too restrictive, because we want companies to be profitable.

If they are very, very profitable, that will, of course, increase inequality. But at the same time, there’s a clear pattern: every time a new unicorn comes along, the people who have worked there from the beginning see the experience of growing up, which is really exciting, and then they want to do it again. Then you start another company, help someone else do it. Or become an investor. So, every unicorn created in Brazil will be an accelerator for the world of technology business.

And one more thing: if you make the details of things more similar to the US, it would make it easier for venture capital companies to go to Brazil. These people have a lot of experience in Silicon Valley and they know what they’re doing. They can help companies in Brazil grow and sell within the US. So standardizing things in the American way would be a good idea.

And what governments Should not to do? Governments often want to put money straight into risky investments. This has been done in many countries, and the most successful example is Israel, where the government has given money to create venture capital funds, on very generous terms. It was a great subsidy.

The interesting thing is that they stopped doing that very quickly: once the venture capital firms were successful, they said, “ok, you’ve learned. Now you can do it yourself.” And this is very important. In Europe, the government puts a lot of money into venture capital, in a way that messes things up for private capital, because there’s all this government money, which doesn’t necessarily have to have a high return. It is not very healthy money, because the government does not have the same experience in advising the entrepreneur. So you have a lot of bad investments and bad companies.

It’s a good idea for investors to take all the risk in the beginning. If they lose, they lose 100% of their money, and taxpayers pay nothing. So investors have a strong incentive to allocate capital with good entrepreneurs, think hard about which startups to support, and work hard to help them grow. If they fail, they are left with nothing. Everything is fine. This is capitalism. But if they succeed, they have to pay taxes, but not too much, because they took all the risk in the beginning.

In the US, venture capital firms pay zero in taxes. Taxes are paid only by partners who put money into the partnership. There is no double taxation. And there are capital gains taxes. Something between 25% and 30% looks good to me.

Do you have any advice for the reader who has never invested in venture capital but is interested in doing so? It’s an expensive investment. You put the money in a fund, which will be run by professionals who understand technology. They find all these people who want to start businesses and they say no to most of them. This fund will charge expensive fees, like 2% of capital a year and maybe 20% of profits.

If you have limited savings, there are probably better things to do. The first rule of thumb for individual investors is to try to pay less fees and taxes. Another is to spread your bets, and venture capital can be one of them. If you have a lot of reserves and are rich, it would make sense to put some money into venture capital. Otherwise, I wouldn’t do it.

X-ray

Sebastian Mallaby, 58

He studied modern history at Oxford and made a career as an economic journalist and author of books. He was a columnist for the Washington Post, editor at the Financial Times and head of The Economist’s Washington bureau. He is a senior fellow at the Council on Foreign Relations.