The Bay Area is in flux, and this has been on my mind for a while. I finally had the time to detail my two cents on how this new structural economic change has enveloped the Bay Area and what it means for folks in the region. See below.
The unraveling of the Enron debacle in 2001 became a symbol of corporate scandals of that era. The effects were so decimating to loyal employees vested in their employers’ retirement plans and public investors, the Federal Government responded with legislation the following year, the Sarbanes-Oxley Act (SOX). Originally intended to protect employees and retail investors from cutting-edge white-collar crime, SOX placed onerous requirements on public companies — so onerous, in fact, it has effectively encouraged some of the most high-growth private corporations founded after SOX to remain private much longer, to tap secondary markets to access liquidity, and to file IPO papers after company insiders and private investors reaped the rewards. The result can be seen most recently in the Bay Area, where reports surfaced this week suggesting Facebook’s IPO was mostly responsible for catapulting San Mateo County past Manhattan in terms of wealth, and as I’ll try to argue, might be indirectly responsible for the risinghouse prices, increased traffic, transit strikes, and bespoke apps Bay Area residents enjoy today. The rent is, indeed, too damn high.
Let me state upfront that I am not blaming Facebook, insiders, or investors. In fact, all actors acted rationally within their rights. Facebook is just one shining example of a trend where the technology sector is the real growth-sector of an American economy which has barely withstood two separate economic recessions within a few years of each other. As a result of money flowing into private technology equities and combined with the restrictions imposed by SOX, new technology companies have enjoyed more access to private capital and have thus been able to remain private longer. While SOX was originally designed to protect the public from “the next Enron,” the unintended consequences of such restrictive legislation dampened the appetite of private shareholders and investors to tap public markets too soon. Unfortunately, one of the most harmful consequences of SOX can be seen through the story of Facebook’s IPO and the wealth that it generated — mostly residing in San Mateo County.
When wealth is created but concentrated in certain ZIP codes, both local areas and the nation’s economy is affected. It all has a cascading effect. With more wealth locked into San Mateo and surrounding counties, the demand for assets rises quickly. House prices skyrocket. Individuals who don’t have enough cash reserved for a down-payment are forced to rent, where competition for rental property creates its own endless race. Contractors rush to meet housing demand, springing up buildings in a boom-time that create noise pollution and closed streets and blocked highway on-ramps, which combines with more and more warm bodies flocking to the Bay Area for the shot to work in the one sector that provides any hope for real, sustainable economic growth. This is why — in large part because of SOX — that your rent is high, why there’s so much traffic and construction, and why it won’t change anytime soon.
There are many, many reasons a great number of people would benefit if private companies operated in an environment where restrictions wouldn’t dissuade shareholders and investors from accessing public markets earlier. Entrepreneurs and investors would have an attractive exit option earlier in their life cycle; entrepreneurs wouldn’t have to rely on “build and shut down” acquisitions to get an exit; employees and insiders wouldn’t feel as much pressure to access liquidity through secondary offerings; wealth-creation would be more spread out and could generate even more jobs; and retail investors would have an equal chance to invest into the next Facebook when its valuation is, say, around a billion dollars versus when its $100B. For a bit of perspective, Google IPO’d after raising a relatively modest amount of venture capital, and Microsoft IPO’d at a $500M valuation — in these cases, the wealth created post-IPO was spread out and technically available to all who could invest in public markets.
Scott Kupor, a Managing Partner at Andreessen Horowitz, wrote a strong piece artfully detailing this view, suggesting over-regulation effectively blocks the entire middle class from participating in the massive wealth creation driven by technological advancement. Over the years, USV’s Fred Wilson has written many great posts on this topic, discussing the nuances of going public early, how public markets can have a harmful effect on company culture, and how potentially distortive the IPO process can be relative to true company value.
OK, so there’s my analysis and argument. I expect many will disagree with my assessment of SOX being the root cause of this, and there are indeed many strong cases to be made that companies should remain private longer. I also believe this is a structural change in the Bay Area — not a cyclical one. It’s easy to dismiss this and say “it’s a bubble” or “this is just cyclical,” but the fact of the matter is that this wealth has been generated and is now kept in the Bay Area — it’s not going away.
Given this, what should folks in the Bay Area technology and startup sectors expect as a result? Eventually, yes, more affordable and micro-unit housing will come on the market, but there’s barely enough transportation infrastructure to handle the increase this will create. In the meantime, here’s what I think we should all anticipate. First, naturally, asset prices will increase, creating all sorts of inflationary pressures, especially on rental inventory. Second, founders should expect to pay even higher wages for talent, and investors should expect founders will want to raise more money as a result. Third, I suspect more and more people will opt to not commute between the Valley and San Francisco as rubbernecking will only increase, so big tech companies will build satellite offices to retain their talent. More private capital will continue to find its way to the Valley in an economy where technology is the only viable growth sector. While I believe things will get sorted out in the Bay Area in the long-term, the immediate term situation currently is and will continue to be disruptive to many. This is just the beginning.
I am not sure what “direct” solutions exist given the limitations of government’s response time. I personally like to see interest in new models emerging as a byproduct of these challenges, many born through frustration and resulting in creative solutions. I enjoy the national conversation around ridesharing and private transportation ignited as a result of the BART strike. I welcome the debate around private shuttle busses ferrying technology workers in and out of a region that can’t provide reliable transportation on its own. I want to see more conversation about the balance between landlord and tenant rights, and to see assets shared according to supply and demand. I hope the economic demand drawing people here will pressure zoning laws to loosen and bring more inventory to market. I want the sharing economy to strengthen inside the fabric of standard economic activity. There will continue to be ideas and realities that irk residents, but this type of “indirect” experimentation is the only way to arrive at a sustainable solution. The region and its entrepreneurs are responding by bringing new products and services to market, and thankfully, are not asking for permission first. The way I see things, this is the only path. Buckle up!