The plunge we've seen in tech stocks has had a predictable effect on private tech valuations. After 12 years of basically up only, we're now seeing a widespread retrenchment among VCs and their portfolio companies, who are being urged to conserve cash and hunker down. So what's really going on? And is there more than simply multiple compression? To learn more, we spoke with tech investor Tyler Tringas of the Calm Funds about the state of the market. Transcripts have been lightly edited for clarity.
Points of interest in the pod:
The obsession with avoiding down rounds (2:29)
Why VCs go “unicorn hunting" (3:12)
Why “go big or go home” logic still rules (7:46)
Why big rounds misalign incentives (18:03)
The rise of rolling funds (25:53)
Changes coming to employee comp (34:22)
Tracy: (00:11)
Hello, and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe: (00:15)
And I'm Joe Weisenthal.
Tracy: (00:17)
Joe, it is brutal out there.
Joe: (00:19)
Yeah. It really is wild. It's relentless. It's compounding. There's a lot of fear I guess, due to elevated inflation, people are really sort of feeling like we're in a sort of no man's land, at least with respect to the last several decades of how the economy worked. People don't have confidence that anything's working, so people are dumping stuff and they're buying dollars.
Tracy: (00:43)
Yeah. We are recording this on June 13th. Black Monday is trending on Twitter.
Joe: (00:49)
It seems like a little exaggeration...
Tracy: (00:52)
It's early in the day, so we'll see what happens. But what I will say is on Friday, I think the S&P 500 was down 2.9%, something like that. And it has been just incredibly painful for a lot of stocks out there, but tech stocks in particular.
Joe: (01:10)
Yep. Tech stocks in particular, as everyone knows, have gotten crushed. And then of course, that feeds in a very linear way to private tech companies. And of course, we've had this big private tech boom VC, all these startups and everything, and every late stage private company aspires to IPOs. So if the IPO window is plunging or falling, then that hurts their values. And every mid-stage company aspires to be a late-stage company. And every early-stage company aspires to be a mid-stage company. So there's no way to avoid the sort of follow on effect. Individual companies can do fine. But as a whole, what we see in the stock market, I think pretty straightforwardly translates down into the less liquid, riskier private tech companies.
Tracy: (01:51)
Right. So you would assume there's some effect, but obviously because a lot of these companies, while all of these companies are not listed, you can't actually see what's happening to their valuations in real time. So we can look up the S&P 500 or, you know, Amazon or Alphabet or whatever, and see what's happening. It's a little bit harder with some of these startups.
Joe: (02:11)
The only thing you can do, you know, you can see VC returns and what they tell their investors, but even still the only time you often like, get a true, like mark as in mark-to-market, I think is when they do a raise and of course, no one wants to actually do a down round raise, so you never actually get it…
Tracy: (02:29)
This is the irony, right? When valuations are going up and people are doing repeated fundraising rounds at higher valuations everyone issues a press release and talks about it. And then when things are going in the other direction, it's just silence and crickets. So I'm very pleased to say that today we are going to try to figure out what's been happening in the world of venture capital and startups. We're gonna be speaking with Tyler Tringas, he's the Founder and General Partner of Calm Fund. So Tyler, welcome to the show.
Tyler: (03:00)
Hey, thanks so much for having me.
Tracy: (03:02)
Tyler, maybe just to begin, can you tell us a bit more about Calm Fund? What is it and how does it differ from a typical VC firm?
Tyler: (03:12)
So we are an early stage investor in technology companies. So in a lot of ways, we look a lot like a VC firm in the sense of we invest early, we partner with the founders, we provide community mentorship, resources, all that kind of stuff. And we're with them kind of the whole way until they eventually either exit the company or IPO.
So we share a lot in common in terms of the structure. Where we differ is we are one of the only funds doing early stage tech investing with a different thesis than the traditional venture model of, basically you could call it like “unicorn hunting,” right? Looking for, you know, $10 billion outcomes.
Our model is based around the idea that you can now for maybe the first time in tech investing's history, you can invest pretty early stage in companies that are substantially de-risked and going after slightly more niche opportunities where it's just not the same kind of risk profile as a traditional kind of venture, you know, winner-take-all kind of model and you can build an entirely different sort of approach to portfolio construction around that.
Joe: (04:23)
So can you explain why the typical VC approach is, as you say, unicorn hunting and of course for years, it's been like “Yeah, well, you know, nine of 10 of our portfolio companies are going to fail, but one of them is going to be the next Airbnb or Uber or Facebook.” And that's the game, it’s like, you just gotta hit one. Why has that become, especially over the last decade, but probably before, how did that become the dominant strategy that so many firms settled on?
Tyler: (04:55)
The very simple answer is that's the strategy that worked, right? In the sense that, you know, people sort of reverse engineer the portfolios that were very successful and they looked back and they said, “Hey, you know, it turns out we had this power law distribution where, you know, almost all the returns came from, you know, our biggest winners getting into Airbnb or Uber, that sort of thing.” And nothing else really mattered.
So what we should do is really shift our strategy to be completely focused on maximizing our chance of getting, you know, one or a few of those huge outlier returns in our portfolio, because that's what's worked for the best venture funds in the past. The maybe slightly more theoretically sound version of that is just when you have very, very high risk ventures, which is what venture capital is built to do, right?
It comes out of the semiconductor era of building, you know, massive factories and launching semiconductor products and things like that, where you had huge upfront costs, high risk, no real ability to predict sort of market demand. You needed to be compensated for that risk with very, very, very outsized returns, at both the company level and at the sort of overall fund portfolio level, right? You needed to make sure that you couldn't just generate a 2X fund, you needed a 5X fund or something to really move the needle. And so you needed 100X outcomes to get to that 5X. So that's the general, I guess, history of that approach.
Joe: (06:26)
It's interesting, Tracy, you know something we've been talking more and more about on the podcast, this idea of like capital investment coming back and actually spending, and then thinking about all these companies over the last 10 years, what capital did they really need? Like for software, they didn't need to build a chip foundry.
Tyler: (06:44)
I was just going to say, this overall dynamic, I call it the peace dividend of the SAAS wars. So the idea of like a peace dividend where, you know, you just are left with all of this kind of infrastructure and stuff after the kind of bubbly phase of things. And you get to use all that stuff for free. And so now yeah, you're right. It's like these software companies that are going to market are really not, they're not venture opportunities in multiple respects. And one of which is, they're just not that capital intensive before you can start to de-risk and see if people actually want this thing.
Tracy (07:17)
Well, presumably a lot of the money just went into trying to gain market share, right?
Joe (07:27):
And become a monopoly.
Tracy (07:28)
Right, that was it. But, okay, here's my big question based on that. I can't imagine anyone going out and sort of saying explicitly that they're unicorn hunting in the current environment, it just doesn't feel like an environment conducive to finding those types of companies and getting the funding for those types of companies. So what are venture capital firms, traditional VCs doing right now?
Tyler (07:46)
I don't know if they would agree with the premise of your question to be honest. I think a lot of venture funds still think that, you know, the fundamental sort of approach is more or less the same. I mean, they're still looking for those kind of large outlier returns, especially if you're investing early stage and their view is just ‘Hey, you know — I think maybe Marc Andreesen kind of said this a while back and it's become kind of an ethos throughout the industry, which is that — you know, there's only a few huge outlier companies that matter every year and your job is just to try to get into those.’
And, you know, the valuation you do it at doesn't really matter. It's all about making sure that you get into the Coinbase or whatever the thing that's gonna generate a 100X or 500X return for your fund. I don't think that that approach has changed a ton right now for the traditional early stage venture funds who've been at it for a while.
Joe: (08:43)
So what are they doing right now though? So you have this like incredible 10 years, which the strategies have just worked so well and so beautifully. And you mentioned Marc Andreesen and I think it was A16z that started around 2009, essentially like right at the bottom of the last crisis, so just like truly an incredible decade. Where do things stand out in terms of like strategy on June 13, 2022?
Tyler: (09:17)
Well, I think the dominant strategic consideration right now for VCs has a little bit less to do with what's happening exactly now and about what's happened over the last few years, because, you know, like you guys were talking about in terms of private valuations, there's a bit of a one-way ratchet, right? Where once you invest at a company at a particular valuation, there's really a humongous amount of incentive not to generate a down round, not to raise more capital at a lower valuation and lock in that sort of negative return.
Joe: (09:47)
Stocks go up and down. Why do players in private markets do everything to avoid a down round?
Tyler: (09:58)
I mean, kind of like Tracy alluded to, there's a real sort of ‘Heads I win, tails you lose’ dynamic in private valuations, which is just, you know, when they're going up, you're able to report those ‘paper returns’ to your LPs as markups, right? So you're sending these updates to your LPs saying, “hey, you know, our fund is now worth 2X what you invested. It's worth 2.5. Now it's worth 3X”. And those are all based on those up rounds, right? Each time a new priced round happens, you mark your existing ownership up. And there's just a lot of sort of incentive not to want to send a quarterly report that says, “Hey, we're now a 2.2X fund versus a 2.5 because we took a really big markdown.”
It's just part of the overall psychology, I think, between, you know, venture funds and their LPs, which is that those returns always go up and you're going to really stand out as an anomalous sort of thing for them, if you're one of the few funds in their portfolio that's marking sort of negative returns for a particular quarter or year.
So that's really it. It's like, there's just a lot of incentive to really navigate around that, to try and either convince the company to completely shift gears and, you know, cut their burn rate, lay off staff, start to focus on profitability so that they can “grow into those valuations.” Maybe they would never have gotten there in the typical sort of 12 to 18 months, but if they can extend their runway to three years, well, then they can spend that three years getting to the point where they can raise at least a flat round or an up round or there'll be a lot of incentives to sort of structure around a down round because, you know, if somebody comes in and says “Hey, I wanna invest more capital in this company, but you know, his last valuation was sort of bananas. We're not gonna invest at that.”
Your options are: You can either do the down round, right? You can say, fine, let's find a new price. Or you can add in all kinds of liquidation preferences and special terms and things like that to keep the nominal headline price the same or up and everybody is kind of happier that way. There's also the dynamic of employee options, right? There's sort of a little bit of a dynamic there where employees don't wanna see the headline valuation going down because their stock options are, you know, on a strike price from the last round and things like that. So a huge amount of incentives to not accept the reality of lower valuations.
Tracy (12:34)
So can you talk to us a little bit more then about how lower valuations or down rounds, how those actually come about? Because as you say, there are so many incentives to keep the valuation up as much as possible. And then the other thing that tends to happen is because these are illiquid markets, it feels like you could sort of resist the new pricing for quite a while. What is typically the process or the trigger that will lead to a lower valuation for a startup, for instance, is it just the company can't get any money without taking a lower valuation and they need the money? I'm just trying to understand exactly like what the trigger is that will have one company accept a lower valuation versus another that's able to hold on for longer.
Tyler (13:21)
Yeah. So the first thing is that it's very, very rare. So we're basically trying to generalize about an incredibly small anecdotal data set. It seems to me, as I think about the few instances I've heard of this, the most common scenario would be when a sort of new investor of a completely different archetype wants to come in and get involved.
So this would be like when you would see sort of PE or hedge funds and things like that get involved, because if you are an investor in technology companies regularly, and this is your business, you know, you really just are highly incentivized to make sure that there's not a down round. In fact I wrote a little thread to founders, basically talking about how if you are running a company that just raised a very high valuation venture round, you are sort of misaligned with your investors.
They're quite incentivized to want you to sort of really double down and go big or go home. Like doing a down round is kind of like the worst option. They would rather you either sort of gut it out and somehow hit the metrics that you need to raise an up round or just fail.
And so there's a lot of counter incentives to what would be the sort of rational strategy, which is to try and, you know, pivot to profitability, even though you are seeing some folks start to sort of preach about that as well. You know, there's a ton of incentives against it and you would probably do it if you had no other choice. And you know, you got an offer from some sort private equity entity or something like that to do a bridge round, where it can kind of be justified by ‘Hey, we're working with these folks because they're just different types of investors.’ So of course there's going to be worse terms with it, but it's a real negative signal in the industry.
Joe: (15:27)
Can you talk about, from your perspective, so your investments are, you're not taking the unicorn hunting approach because as you've said, you believe that it's possible to invest in relatively early-stage tech companies but that don't have like high downside risk. And so that actually, you're not just trying to have nine go to zero and one goes to a hundred billion or whatever it is. That being said, I'm sure, you know, some of the same macro stresses are gonna apply to every company, so can you talk to us about like, the advice you are giving? Is it the same as like, you know, because every VC puts out these memos — cut cost, you know, this is the time, profitability, etc., but can you talk about what those conversations are like beyond just the sort of like the press release memo, tweet thread level?
Tyler: (16:14)
Sure. Yeah. So to be clear, the reason that we think our thesis works is less about any kind of change in the validity of the venture capital model and more just about the ground sort of shifting under everyone's feet where a lot of software and kind of software-enabled — like e-commerce and things like that, SAAS, all these kinds of products — they sort of shifted out of the venture profile, where they just became de-risked like we were talking about before. So it's more just that there's this segment over here that we think, you know, at least our strategy is valid, if not more applicable to these opportunities because they're not as capital intensive and quite frankly not as risky. It doesn't change the fact that, you know, if you wanna build factories in space or launch rockets, you know, that are reusable and all this kind of stuff, you really do need to still go on that traditional venture capital approach, as long as you're really having those winner-take-all dynamics at the other end.
But in terms of like the conversations we are having with companies, honestly our overarching message has been sort of stay the course. We were sort of fighting a little bit of against the tide for the last couple of years as capital became really easy. So even founders that were maybe not really a fit for traditional venture were getting term sheets and saying ‘Hey, this guy wants to give me $6 million. Should I take it?’ And we were saying, well, you know, maybe, but you know, you're going after a fairly niche market…
Joe: (17:42)
How much did the appeal for these founders to take that, how much was it affected by opportunities to cash out early, some of their shares, some of which even … and probably the opportunity to make life changing amounts of money in a relatively early round?
Tyler: (18:03)
Yeah, it's a really good question. We have not seen that very much in our portfolio in part because, you know, most of our companies are optimizing for being capital efficient. The vast majority of them have not raised additional capital. So we haven't seen a ton of that, but you did see quite a lot of that going on in the market the last couple of years. I think it's a real function of the fact that the entire venture community for the last two years was just getting completely squeezed. And there was just a supply and demand dynamic going on where there was just an oversupply of capital relative to the number of real venture scale game-changing opportunities, or at least the perceived set of those. And so there was this competition to compete and to offer better terms and to offer more attractive kind of secondary sales for the founders.
And you saw some sort of truly crazy stuff. I think the first one that kind of hit the news was Clubhouse. Early on the founders took $2 million off the table and everyone was like, ‘oh man, like they're barely, you know, they barely launched and they just raised this huge third round in however many months and the founders took $2 million off the table.’ And that was news. And then later, over the last couple of years you saw, you know, founders taking $5 million, $10 million and $200 million off the table.
Joe: (19:27)
Wait, who took $200 million off the table as a founder?
Tyler: (19:31)
Fact check me on that, but I believe it was reported that the founder of Hopin, the virtual conference software.
Joe: (19:38)
I never even heard of them.
Tyler: (19:39)
Yeah, they got probably the biggest Covid boost of maybe any company, maybe Zoom aside, where they basically run virtual conference software. And they're on one of the steepest valuation trajectories I think anyone has ever seen. They went from kind of, you know, very low seed round to $6 billion valuation over the course of Covid — less than two years. And I believe it was reported that the founder took $200 million or more off the table.
Joe: (20:12)
Amazing. Good for them. Good for them.
Tyler: (20:16)
I mean, it's hard to blame people for taking it, right? I mean, it's hugely misaligned with your employees who certainly were not offered that same level of liquidity, you know, and now have a bunch of their stock options locked up at this kind of like very high evaluation. And we'll see what happens to those. I think, you know, we're going to see a huge wave of employees see millions of dollars of equity wiped out.
Joe: (20:42)
There it is. Hopin founder in June, 2021 — this is according to the Financial Times — nets a hundred million pounds, so $130 million or something in share sale. Okay. Amazing. I had no idea. That's good for him anyway. Sorry, Tracy, what were you gonna say?
Tracy: (20:56)
Well, sorry to press on this, but just on valuations. Okay, so in an up cycle, you have this pressure on valuations and lots of money competing for the same thing. And so prices tend to get squeezed even higher. And actually we spoke to Howard Lindzon about this back in February, but you also had particularly big players, like SoftBank, who would come in and squeeze a company much higher than it would be otherwise. What happens on the flip side of that? When everything starts going down, is it, you know, people hold on because their incentive is to hold on and avoid booking these companies at lower valuations, or does like a bunch of money get pulled and the cycle is even worse on the way down?
Tyler: (21:45)
Yeah. Good question. I mean, there’s a bunch of different effects going on all at once right now. So maybe the biggest one is the pullback of the multi-stage hedge funds that got into VC over the last couple years. So notably Tiger Global and Coatue were two hedge funds that built very large technology practices and raised dedicated funds for that sort of thing.
And they were deploying billions of dollars into the space up and down, everything from seed rounds to Series A to late stage. And that was one of the primary things. If you think about like the marginal demand in the supply curve for start valuations, they were really providing a large portion of that marginal demand, where they were the last people who would come in at 2X the price of the next best offer.
And so that was doing a lot of the work to really push up those valuations. It's been sort of reported that, and certainly seems to be the case, that those folks, they're not dedicated venture funds. They're sort of, you know, multi-stage cross-sset hedge funds. And so they do seem to be pulling back quite a bit. So I definitely think you'll see that dynamic play out where you know, they basically won't be coming into these rounds and marking them up in a huge way. In terms of what happens I think we're gonna see a bit of a delayed bloodbath to be honest. There's an ability to sort of just hold on and wait it out. You know if the company has raised at a 10X the valuation, and they have 11 months’ runway in the bank, you know, what do you do?
Well, it's going to be such a trivial amount of money relative to what people invested that you don't just like return the funds. You just kind of try to make it work. You just kind of hang on and and see if you can get lucky and hit that inflection point and maybe raise some more capital or maybe the market turns around. But if things stay as they are, I think over the rest of the year, you're gonna see a lot of high-flying late-stage companies, maybe even the ones that just did big rounds of layoffs and things like that, to try and stay alive.
Joe: (24:06)
You know, Tracy asked about the Softbanks and you of course mentioned the Tiger Globals and all those, but then the other phenomenon, and again, this is something that we chatted with Howard Lindzon about is in March, 2020 when the pandemic hit and everyone was at home and very quickly asset prices started going up and Zoom started taking off, that actually, you had this situation where like everyone became an angel investor and everyone started like, ‘Hey, let's do a zoom meeting. We don't even have to fly to meet you anymore. Let's chat for 15 minutes. And also maybe I have a Substack, so I could promote your company and my investment.
You have all these, like FAANG rich people. Facebook, Google, Amazon employees who probably have maybe a few million in the bank or something and want to cut $50,000, $100,000 checks. Can you talk like how big of a phenomenon was that and how much that new money or inexperienced money had an effect on competition and valuations?
Tyler: (25:19)
You're right. ‘Everybody has a venture fund now’ was the kind of joke. And everybody just started doing angel investing. AngelList the platform for angel investing really contributed to this, where they launched a pretty neat fund product that allowed your Substackers and things like that to really easily and cheaply spin up a venture fund. The rolling funds.
Joe: (25:47)
Did that work? I never looked up like, how did the rolling funds work and talk to us about what that effect that had?
Tyler: (25:53)
Yeah, rolling fund was basically AngelList did this whole productized version of a venture fund where traditionally you'd have to pull in, you know, lawyers to do your docs and you need a fund administrator to do your backend and tax people to do your tax and all the stuff that we have to do. We have a team of 30 people that we fractionally use to sort of run our fund. AngelList said, ‘Hey, if you wanna do traditional venture investing, we'll do the whole back office. And by the way, we'll also make it really, really approachable for individuals to be LPs in your fund’ — LPs are the limited partners who invest the capital into your fund — by basically setting it up to where it's more of a subscription product. So you can actually just invest, you know, $10,000 a quarter, and it's a fixed, you know, flat number.
You can make it up down every quarter that you want can change it. So it just added a lot more flexibility that I think brought in not just a whole bunch of new funds, but also a huge new influx at least in volume (maybe not in total dollars) of LPs from folks who had, you know, done really well in crypto and done really well in their stock portfolios.
And they decided to diversify a $100k of that into you know, a venture fund from someone that, you know, they admired on the internet. There was sort of a bottom-up effect where there was a huge increase in the volume of capital out there chasing opportunities. But the thing is like, these are not price setters, right? So a lot of these funds that were set up, you know, they're writing relatively small checks and they're also not sort of super experienced VCs.
And so when they go into a round, all they wanna do is find an already priced and mostly full round, you know, and put their $50K or $100k into that round. And they just kind of take the price as that's somebody else's problem. But the problem is you had this top down effect, which is all of these huge multi-stage funds getting involved. And that's the hedge funds, as well as some of these really, really big funds like Sequoia, Andreessen Horowitz, these kind of folks, they were the ones in many cases coming down and setting the price at, you know, seed or series A, some of these early rounds. So you have these angels coming in with lots of new cash, and they're saying, ‘Hey, we wanna get into this round, but we don't wanna set the price.’ And then you have something like Tiger coming in and saying, ‘cool, like we'll set the price, no big deal.’
The problem is those two groups are completely not aligned with each other. And in fact, they're actually selling different products to their LPs. The angels and the venture funds, they're trying to do the traditional thing. They're trying to put in their $100K and get a 100X outcome on that. They're looking for those real outlier returns. The very large funds had essentially become, even though nominally, they would be sort of venture funds. They were basically growth, private equity, right? They were raising billions, do multibillion dollar funds. And the way that you move the needle on a multibillion dollar fund is when you put, you know, $50 million, $100 million into these companies at late stage, and then they IPO at 3X. And that's how you generate your sort of reasonable growth equity type of, of returns, right?
And those would be your sort of like 2X to 3X kind of outcomes, not your a 100X outcomes. And what these huge funds were doing is they were basically viewing the seed rounds and the series A rounds as just kind of optionality, right? They were going in and they were buying the options sometimes explicitly in the form of pro-rata, which is I invest in your seed round. And I have special terms that say, you know, ‘I get to invest more and more at each subsequent round.’
And then sometimes just kind of implicitly just by saying, ‘Hey, look, you know, we led your seed round. So let us lead your A and B and C and all that sort of stuff.’ And so you have these large players who are not really that concerned about the price at seed, because that's not their game.
But they're the ones setting the price and so the people who are trying to make all their returns on this difference between the seed round valuation and the ultimate valuation. Now they're investing at four-times, five-times, 10-times higher than they were just several years ago. And so their returns are, if all things are equal, unless the world kind of magically changes and everybody IPOs at 100X higher, you're just going to have, you know, a 10X, 5X, you know, 2X lower returns at seed. So that was like one of the big dynamics right there, which was that people who were basically nominally VCs, but were actually running different products that were more like private equity, were the ones setting the price. And then you had this huge influx of new capital that was just very happy to go along with price, just to get a piece of the action and put capital to work.
Tracy: (31:04)
So this was actually gonna be my next question, but I'm so used to thinking of Silicon Valley at this point as like, you know, aggressive pricing, lots of cash pouring in, the sort of excesses of venture capital. If we get a big downturn in the market, would you expect to see some of that behavior or some of the way that the industry is structured and incentivized start to change?
Tyler: (31:32)
Yeah, for sure. So some of the stuff that you maybe are thinking of in terms of just negative unit economics and things like that, I don't know how much those will go away. You know, if you're in a winner-take-all market, sometimes it does make sense to underprice your product and grow really, really fast. So there's always gonna be incentives for that.
Some things that I think definitely will change is a lot of the stuff around the way that the competition for employees has sort of evolved where, you know, competition structures for senior engineers are just absolutely eye popping. I don't know if you've seen any data there, but you know, you have folks just getting, you know, $600K base salary and $400K a year in stock options and all this kind of stuff for sort of mid-level engineers.
Like just really, truly bananas offers going on on top of, you know, tons of perks and all kinds of stuff like that. So I do think you'll start to see a pretty significant softening in terms of the competition for employees. It's hard to sort of cry crocodile tears for really, really well paid tech employees, but they are gonna suffer the brunt, I think, of this with, pretty significant losses the value of their stock options, as well as probably you know, much less competitive offers as they were able to kind of sort of jump from Big TechCo to Big TechCo, kind of doubling their salary every two or three years. I think that that's something that you'll see pare back quite a bit.
Joe: (33:11)
Yeah. You know, I want to actually press further on that. It almost seems to me — and I don't know if this is true — but one might speculate that in a sense, even employees of startups essentially start taking an angel investor mindset. If you think that equity in a startup is going to potentially 10X or 100X or potentially, you know, you're thinking like you have multiple options for where you're gonna go work, because you're a talented engineer and you start thinking like, “well, which one is gonna be the 100X or which one is gonna be the 10X” and actually like make a fortune on some of this early stage stock.
But I'm just like wondering if you can talk a little bit more about how this relationship is going to change and, you know, even at FAANG level if the assumption no longer exists that stocks automatically go up, how does this change how people think about their own careers?
Tyler: (34:20)
I think the folks who are at, you know, Google and Amazon, it's a little bit above my pay grade to say much about how that dynamic's gonna play out. But you know, because I just am not really that familiar with how public market prices affect employee compensation, things like that. But in the private market, this is really acute.
I think you're right, that there was this similar “everything goes,” YOLO mentality over the last few years with employees as they were evaluating their comp packages. And you know, one of the things we're seeing is a realization from a lot of folks where basically if you were issued a ton, maybe millions of dollars worth of stock options at some of the kind of crazy valuations in a private company that we saw over the last, you know, couple years, you actually, not only do you need to mark those down a little bit, you know, like if you have a public company, you actually might need to mark those down to zero.
And the reason being, if your company lays you off in private markets, you often have this very difficult and silly rule where you have a 90 day option exercise window, right? And so you need to, not only, if you get laid off to even retain any of that equity, you actually need to go out and buy it. You need to either have the capital or borrow it to buy that.
Joe: (35:40)
You might need to pay taxes on it if the price that you're buying it at is above the price your the options were listed at?
Tyler: (35:48)
Exactly. I mean, it's so financially sort of onerous that very few employees, you have to already be someone who had a previous exit or something and have, you know, many tens of millions in the bank to be able to, it seems to make the bet.
Joe: (36:00)
And then like with the execs, they like give them a deal. It's like, oh, well, like we'll give you a year or, you know, you could keep your, and it always seems like very, very cruel to the employee level.
Tyler: (36:12)
It's really bananas. And then you layer, so it's difficult even in normal times for it to work. And then you layer in the fact that, you know, the company just raised at a $5 billion valuation and, you know, the whispers in the private markets are that it's worth, you know, $900 million. And so now you have to make this bet to buy that equity and then gut it out and wait and hope that at IPOs at, you know, over that $5 billion valuation that your options are issued at, right? And it doesn't work exactly that way, but that's the basic dynamics of it where you're making this fundamental bet on the company that just laid you off in order to sort of get your equity and you're even seeing sort of, you know, and so basically all that adds up to most of these folks are just gonna walk away from that equity, right?
It's just not ever gonna be valuable. And in fact saw recently there was an extreme example of this with Bolt, which is sort of a famously high flying -- some would say overvalued -- company. They sort of came up with this “solution” for this, which is that they would actually loan their employees the money to go ahead and buy that equity so that they would own it.
So they wouldn't have this 90 day option exercise window. The problem is they're then taking out personal recourse loans. These loans have the rights to go and seize their employees' assets, from the company to own this equity. And if there is a down round right, or something like that, their loans are gonna be underwater and they're gonna have personal recourse against that. It's absolutely crazy. And there was a feature recently of at least one employee because they did that — and then a couple months later they announced a big round of layoffs — and so there was at least one of an employee who took out, you know, six figures of debt to buy that equity then got laid off and now has 90 days to pay it basically to come up with that money and to buy it. It's absolutely crazy.
Tracy: (38:21)
Oh, wow. Well, okay. So on this topic of leverage, so this is a question I have about, I guess the market overall at the moment. Like how much leverage is actually embedded in the system, especially as we see, you know, crypto prices go down and, and things like that. But, when it comes to venture capital, I mean, there was an article that Bloomberg published last week, I think it was about the D1 hedge fund borrowing billions of dollars in order to purchase stakes in private companies. How much of that is going on? Like how much leverage is embedded in venture capital, such that when valuations start going down, it could become problematic?
Tyler: (39:04)
I think very little, the largest sort of venture funds, you know, the Sequoias and Andreessens of the world, don't really use leverage. You use sort of convenience products in terms of like capital call lines of credits and things like that. Just basically kind of bridging the gap between when you invest in a company and when you call the capital from your LPs. But the vast majority of traditional venture players are using, you know, no debt. So I think it would just be, you know, the few folks, you know, coming from the sort of hedge fund world and that sort of thing that might be using leverage. But I mean, it's kind of crazy because they're not cash flowing assets. So you really are taking a very, very high risk bet by levering those up. And traditionally, most investors in the space are not doing that.
Joe: (39:55)
You know, I'm curious, you mentioned the crossover funds that came from the hedge fund world. And of course the preeminent one that everyone talks about is Tiger Global. And it seems to me that, you know, as you mentioned, they're not really VC in a sense, they're not really hedge fund in a sense, they're sort of late stage private. You know, if you think of like a hedge fund, that's like, ‘Okay, like we're gonna pivot to energy investing this this quarter because the macro environment changed.’ It seems to me like, you cannot do that with a late stage growth investing.
You are all in on one strategy and you can't just like pivot. ‘Hey we're value investors this year. We're oil investors this year/’ Like, you're all in. What do you think is like, how important had those entities become to the overall startup ecosystem and what do you see as like the future of them? I mean, I think Tiger is down 50%, extraordinary amount of money lost, especially when you think, probably, think about the inflows that came in in recent years, huge dollars up in smoke. Does that model come back in the downturn or does it get rethought?
Tyler: (41:05)
Yeah. I mean, also bear in mind that, you know, those headline lost figures that are being reported for Tiger. That's their public markets right there. That's not even factoring in all the venture investing that they've done for all the reasons we've been talking about. There just haven't been down rounds. So you have this dynamic whereby you have these realized losses on your public portfolio and unrealized losses on your private portfolio.
And it's a real tough situation. I think this is going to be a bit of a one-off anomaly. My macro kind of basic view is that for the last couple of years in these zero interest rate environments, you had these really, really vast pools of capital. These just, you know, sovereign wealth level kind of pools of capital that were sitting on hundreds of billions of dollars and just sort of frantically looking for anything that would generate yield. Because there was just nothing, right? Bonds were useless, kind like everything was just useless. And, you know, if you need to put $10 billion to work and get some kind of good return on it, your options were just incredibly limited. And I think into that space stepped in a couple of hedge funds who said, ‘Hey, yeah, we can put [it to work].’ I mean, I think Tiger invested an entire multi-billion dollar fund in less than a year. They said, ‘Hey, we can put that money to work.’
Joe: (42:26)
They did like a check in day, right?
Tyler: (42:30)
Yeah. And just very large checks as well. But I think it was a, I have to look it up, maybe it was a $3 billion or a $6 billion fund that they deployed in like under a year or plus or minus a year. And that was the product they were selling right. At the end of the day, you know, all funds are selling a product to their LPs and the product they were selling was, ‘You know, we are gonna take huge, huge pots of money. We're gonna absolutely fire hose it into technology companies at the late stage. We have a bunch of people who have some venture experience.’ So like I said, we're gonna be investing early to get that optionality, to put a lot more capital in later, but ultimately they were there to serve this, you know, this demand for some amount of yield in a very uncompetitive market.
And that dynamic is changing right now, right? Like if you look at the public markets now, you're like, ‘Hey, actually there's probably quite a lot of yield to be had here.’ And interest rates are going up so maybe bonds are gonna be more attractive and stuff like that. So I think that while the model is not necessarily going to be like disproven or abandoned, I just think the demand for it is going to get dispersed across a whole bunch of other assets. And I really doubt that we'll see multi-stage hedge funds raising more, seeing more further, incredibly large, kind of late stage tech funds doing what they've been doing over the last couple of years.
Tracy: (43:51)
You know, Joe and I started the conversation talking about how, when things are going badly in the public market we kind of see just how badly, because we can pull up a chart and watch the line go down. It's a little bit trickier with the world of startups and private equity and private money and venture capital and things like that. What, in your opinion, is the best thing to watch out for to try to gauge how bad things are getting?
Tyler: (44:19)
It's a good question. I mean, the one interesting dynamic here, which is that valuation is going down, but software companies are still doing very well. You can even look in public markets, you see these companies that are ‘Hey, we got, you know, another record year for, you know, revenue is up, you know, losses are down, etc.” Like the fundamental business of most technology companies.
And we see that in our portfolio as well, even at the earlier stage that we're investing in, you know, companies are not affected by this kind of macro change in terms of their underlying business. It's purely a question of the fact that the same assets are being repriced much, much lower. And so I guess the thing you want to look out for is basically just that squeeze, right? Where an otherwise good business that is actually still growing and still getting closer to product market fit and still growing their customer base and all that sort of stuff.
They just you know raised too much. And so they have to hit certain, you know, growth trajectory targets to raise their next round. And they just kind of have to do that, but there really aren't leading indicators for this kind of thing, because you're just so incentivized to just try to hit those hurdles up until the last possible second. And then you say, oh, we couldn't raise a round. You know, like you saw that with with Fast recently where, you know, the week before they were talking about all their plans and everything, and it's like, you're trying to create this forward looking, you know, up and to the right curve and the perception of that, until you just can't raise the capital and then you shut down. So it's gonna be a lot of surprises, I think.
Joe: (46:04)
So real quick question. I have two questions. One is a short one. You know, you say like the fundamentals by and large look strong, would you say this is distinctly different from the Dot-com Era, in which sort of infamously, all these different dot-coms, they were each other's customers, so to speak. And so one company would raised a bunch of VC and then take out a bunch of ads on Yahoo.com or whatever. And so they were sort of all the same, like, would you say that phenomenon just is not as significant when you look at the underlying business quality of, you know, some of these software companies?
Tyler: (46:39)
I think it's far, far less prevalent. You know, especially if you look at a portfolio, like within our portfolio, we are primarily investing in SaaS companies and those SaaS companies are usually selling to different verticals or industries. So we're really sort of diversified across, you know, the underlying customer base of our portfolio companies. You do have a little bit of the circularity there. I think I saw, it was kind of a jokey headline or something, but it was like somebody launches a fintech for fintechs. So think fintech is one area where you do have a little bit of that circularity where, you know, everybody is everybody else's customer and they may all sort of go down simultaneously. But there's a lot less than in the Dot-com Era.
Joe: (47:26)
I just have one last question and that is conversations with LPs. My understanding is when you raise a multibillion dollar fund, I don't think they get all the money wired to them right away. And then over time they collect from the LPs who have made these commitments. How strong are those commitments? And you mentioned that there are alternatives and that maybe part of the issue going forward is going to be like, no, late-stage growth is not the only place to get returns. And so how do you see like the relationship evolving between funds and their LPs in this environment?
Tyler: (48:04)
I think this is going to be one of the most interesting dynamics to play out over the next kind of 18 months. And I'm really not sure which way it goes, which is the fact that you will hear a lot of folks commentating on the venture markets say, ‘There's never been so much dry powder.’
You go out and you raise a billion dollar fund. You don't get it wired. In fact, you get almost none of it wired to you. You go out, you make commitments to invest in startups, and then you call that capital from LPs. And you assume that they're going to be able to fulfill those commitments. And so people are sort of adding up those headline fund sizes and saying like, ‘wow, there's just a ton of uninvested funds out there,’ but it's not literal piles of cash sitting around waiting to be put into startups. It's commitments from LPs.
And those LPs are under a lot of pressure right now. They're diversified across public markets, maybe crypto, etc., they're seeing liquidity squeezes. And so, you know, hopefully they're doing their job and good risk management and they have a ton of capital set aside. But I do think there's going to be a very interesting sort implicit and explicit negotiation between fund managers and LPs that raised or you know, had committed very large funds right now to sort of say, ‘Hey, you know, maybe let's slow down the pace here a little bit.’ You know, coming from the LPs because these are long term relationships. Yes they did sign a limited partner agreement that obligates them to meet your capital calls.
But also you want to keep them around investing in you for the next, you know, 20 years. And like now is not the time to really put the squeeze to them and say, you know, you committed this capital. We have to invest it, live up to your end of the deal or else. There will be some amount of that, but it's going to be very interesting to see how that plays out. And I think there's a real risk that there's actually not nearly as much dry powder as everyone is predicting because of this dynamic where LPs are going to really push back and say, ‘Hey, like, let's slow this pace down a lot. Let's deploy this over three years instead of one year.’ That sort of thing.
Tracy: (50:19)
All right. Tyler Tringas of Calm Fund. Thank you so much for, uh, for joining Odd Lots.
Tyler: (50:24)
Thanks. It was awesome.
Joe: (50:25)
Yeah, that was great Tyler.
Tracy: (50:26)
Thanks. Thank you so much.
Joe: (50:27)
I learned a ton from there.
Speaker 4: (50:29)
Thanks guys. That was really cool. So, yeah.
Tracy: (50:45)
Joe, I thought that was a really interesting conversation. And one of the things I really like about it is, I guess Tyler's emphasis on incentives. And like I mean, obviously in traditional finance, in public markets, there are different players with different incentives, but I feel like that's just magnified in venture capital. And I feel like when you look at the ecosystem of how it works with the funds and the LPs, everyone has slightly altered incentives. And so it leads to these interesting dynamics, like the ones that Tyler was describing.
Joe: (51:17)
So many things that he described that I hadn't really thought about or understood until he articulated them. But for example, obviously if you're the founder of a startup that can raise at a $5 billion valuation and take a hundred million dollars off the table early in your career, that's really great. But it is really problematic for employees that potentially have years and years and years before they're going to see any liquidity on their equity. And in the meantime, maybe they want to switch careers and have to buy back their stocks. So, you know, that's just one example, but also do you really want to like call your LPs right now and tell them they have to pony up the cash?
Tracy: (51:57)
Uh...
Joe: (51:57)
That's gonna be sort of a awkward conversation at a minimum.
Tracy: (52:01)
Yeah. I guess like the older I get, the more experienced I get in the financial industry, I just think everything is ruled by people not wanting to have to make that one phone call.
Joe: (52:10)
It is, right. Everyone loves cash at key times and no one loves a call where they have to give up cash.
Tracy: (52:15)
It's all about the phone calls.
Joe: (52:18)
The other thing that I thought, well, there were numerous things, you know, the unholy marriage between the sort of like Substack AngelList VCs at the low end or sort of like, let's do the VC thing. And then accept basically being price takers for the sort of like big funds, was like a really interesting dynamic. And you could just see how someone in the middle or someone who's like a kind of normal VC, that's not one of these mega funds, but also not someone who's just sort of like spun up an AngelList fund in April, 2020, would get really squeezed, as he put it, by this sort of huge influx of cash coming into the market.
Tracy: (52:58)
Yeah. Well, I, I guess, like, it's just gonna be really interesting to watch the next year or so I imagine.
Joe: (53:05)
Yeah. He used a good term, the “delayed bloodbath.” I thought that was really, we don't really know yet how this is going to play out, but everyone has an incentive to keep the numbers up nominally.
Tracy: (53:18)
Right. And this is the classic thing about illiquid markets, right? When things start going badly, it can take a while for that to play out because people have the ability to resist some of the pricing pressures. But not forever. So the timing of it is also going to be interesting, I think
Joe: (53:35)
Totally. Lots more to talk about on this topic.
You can follow Tyler Tringas on Twitter @tylertringas.