Apr 21, 2016 ยท 9 minutes

This morning I woke up to a particularly strange piece of venture capital performance art in the form of a very long essay by Benchmark’s Bill Gurley.

Before I read it, I saw VC after VC applauding it on Twitter, although not really mentioning specifics. So I buckled myself in for the long read.

One question kept coming up over and over again as I read the essay carefully, making notes for nearly an hour: Who exactly is Gurley writing this for?

There is almost nothing in the entire essay that has not already been written about here and elsewhere over the last year.

  • All numbers keep going up, except exits which have been at historically low levels.
  • VCs had a banner first quarter, raising more for their own funds than we’ve seen in 15 years, despite the most uncertainty over what their portfolios are worth that we’ve seen in recent times.
  • That even the strongest companies will be made weaker by wasting billions chasing market share.
  • That dumb money in the form of SPVs, family offices, sovereign wealth funds, and foreign cash is being “invited” into top unicorns because there is no other money left to fund them.
  • That many high profile unicorns raised money with dirty term sheets, which are essentially a ticking time bomb.
  • That employees should ask their founders hard questions about what terms they’ve already accepted.

Any regular Pando reader-- or reader of most publications covering the ecosystem in depth-- know all of this.

Certainly, every venture capitalist knows all of this. Many of them have also been saying it for much of the last year. They’ve likely been saying it to the portfolio companies, so the essay can’t be news to them either.

So who exactly is this essay written for?

Finally I reached a graph that I suspect contained the answer. In a section on how investors should navigate the current mess, Gurley says early stage investors are essentially in the same boat as founders and employees:

This is because these companies have raised so much capital that the early investor is no longer a substantial portion of the voting rights or the liquidation preference stack. 

Bingo. To those who have wondered for the better part of a year why someone like Gurley keeps complaining about inflated burn rates and unsustainable valuations, even as his biggest investments are the biggest offenders of that playbook, here is your answer: He had no say in any of it.

What I was witnessing -- both in this long essay and the VCs nodding and retweeting it all morning-- was essentially the kind of performance I do when my children aren’t playing nicely:

“See???? Isn’t it great how Daniel Tiger shared his toy with his sister????”

You get the picture that Gurley has sat in every board meeting of every unicorn he’s invested in saying each of these things written in the essay. And because board governance and VC board rights are at historic lows, and early stage investors are now such a tiny amount of capital raised, there is not much more investors like Gurley can do than talk. And now, they are sitting there, watching the best companies of this era put more inflated money on top of more inflated money.

Gurley could have called this memo: How I’ve spent the last year watching great companies sabotage themselves.

And while I’m sure this wasn’t intended, there’s an irony that’s impossible to miss: The biggest and most aggressive culprit of everything Gurley describes is Uber. And Uber is Gurley’s biggest hit.

His chief complaint is burn rates. Uber is spending $2 billion a year just chasing market share in India and China, alone. Those aren’t even the company’s core markets. It’s not even winning in them. No one comes close to Uber’s burn rate even in an era of crazy burn rates.

Another example: IPOs. Uber’s Travis Kalanick and Gurley have already publicly disagreed over whether Uber should go public. So consider this graph:

Go public. In the long run, the very best way for founders to look after their own ownership as well as that of their employees is to IPO. Until an IPO, common shares sit behind preferred shares. Most preferred shares have different types of control functions and most of them have a senior preference over common. If you really want to liberate your own common shares and those of your employees, then you want to convert the preferred to common and remove both the control and the liquidation preference over your shares. Many founders have been erroneously advised that IPOs are bad things and that the way to success is to “stay private longer.” Not only is an IPO better for your company (see Mark Zuckerburg and Marc Benioff on this subject), but an IPO is the best way to ensure the long-term value of your (and your employees’) shares. 

And consider this description of what Gurley calls an almost Madoff-like scheme for getting new money like family offices, wealthy individuals, and sovereign wealth funds to invest. It is precisely the playbook Uber ran with its most recent funding in the US, and its “oversubscribed” round in China (That was only oversubscribed once Uber itself invested one-third of the money.)

From Gurley’s piece:  

If you ask any large family office, they will tell you they are being bombarded with calls and emails offering secondary positions in Unicorn companies. Often with teasers such as “20-40% discount to last round price.” 

He derisively calls these “pre-IPO rounds,” because such shady actors promise an IPO is coming.

Compare that description to the terms Uber China offered last year:

“Dangling estimated returns of as high as 109 percent, the “Project U” offer would put at least 80 percent of the money into shares of closely held Uber before an expected initial public offering in 1 1/2 to 2 years, while the remainder would go into stakes of the company’s separate China arm, according to the document.”

Again, from Gurley:

The main message for investors who are just now being approached is the following: it’s not the second inning or even the sixth, it’s the fourteenth inning in a five hour baseball game. You are not being invited to a special dance, you are being approached because you are the lender of last resort. And because of how we meandered to this place in time, parting with your dollars now would be an extremely risky move. Caveat emptor. 

Lender of last resort: Like perhaps shady the Russian Oligarchs that funded Uber’s last round?

And one of the most telling graphs of the entire piece:

Perhaps the biggest mistake untapped investors will make is assuming that because there are branded investors already in the company, that the new investment opportunity must be of high quality.  

Translation: Just because I’m in this company, don’t assume I think an insanely priced late stage round makes a lick of sense. Don’t say I didn’t warn you.

You get the feeling that Gurley is so sick of saying all these things and his companies not listening that he wants to just have it out there permalinked in the world so that he can point to it when, eventually, at some point all of this unravels. It’s his way of not totally going down with that ship, as a guy invested in many of the worst offenders of what he describes.

Towards the end of the essay, he says that even the best entrepreneurs are made worse by too much capital, that even the best companies can be hurt by this playbook. Like, perhaps, Uber:

Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.

He ends with this.

More money will not solve any of these problems — it will only contribute to them. The healthiest thing that could possibly happen is a dramatic increase in the real cost of capital and a return to an appreciation for sound business execution.

Investors like Gurley who were smart enough to see the potential of the largest and highest valued unicorns years ago are at the end of their ropes. They’ve warned against a correction. They’ve tried to talk the Valley into a correction. They’ve mocked “tourist” late stage investors. They’ve tried to slow down funding cycles. But the market just isn’t correcting in any meaningful way. Median valuations were up in the first quarter. Total funding dollars also ticked up.

It’s almost impossible to spin venture funding in the first quarter into a crash, even as exits are getting even worse than they were in 2015. He says at the beginning of the essay that “the fantasy began to come apart” last year. More like Gurley and others have been actively taking a sledgehammer to the fantasy and burn rates are still unsustainable, companies like WeWork (also a Gurley company) continue to raise up rounds at crazier prices.

It’s the tortured manifesto of a brilliant early stage investor, “lucky” enough to have gotten in early in the top companies of this era, who is just sitting by watching in futility as they continue to make capital decisions that he describes in this essay as nothing short of reckless. If his own words are to be believed, he is watching his own best performing companies erode their own potential.

As I read and read, I kept looking for the disclaimer. The “this only works for the best companies” or a caveat to why, say, this strategy makes sense for an elite few companies, but the rest are playing a dangerous game. It never came.

The only thing remotely close was at the beginning of the piece when he says the hope in this era is that there will be enough aggregate unicorn value, that the failings of many individual unicorns won’t matter. He notes that while that might be true, unicorns aren’t an “index,” and not every VC has access to the Ubers or Airbnbs of the world.

It’s a tacit admission that Gurley still believes his own companies-- like presumably Uber, Snapchat, WeWork and others-- will make him and his investors even richer. But until there’s any real liquidity these are the internal screams of a man watching a trainwreck in slow motion, unable to act.