Public Frenzy And Private Caution

Love it or hate it, the stock market is the sentiment machine for the United States. It is our nation’s Fitbit, Apple Watch, mood ring, tarot card, and more for getting a pulse of our economy today and a glimpse into what shareholders believe the future could bring. In the midst of America’s struggle with the COVID-19 pandemic and the induced economic coma set through government policies of sheltering in place and social distancing, we all know what has happened — an ice cold shock to consumer demand, unemployment levels not seen in over 50 years, and concerning uncertainty in everything from government policy, kitchen table issues, and public health. Yet, week in and week out, we see the stock markets holding their own, in some weeks gaining back points, and public market investors seeing opportunity while jobless claims hit 8-figures and rising.

What is going on, and what does it mean for startups? I’ll briefly try to explain the former, and dig into the implications for the latter.

Briefly, my impression of the U.S. stock market during this pandemic is as follows: The federal government is printing more money; there is massive stimulus into the economy, as well as cheap loans to protect payroll; interest rates are cut to zero; computers and algorithms are on the hunt for beta, executing trades, shorts, puts, and more; perceived value is shifting to digital technologies, cloud, streaming, in-home entertainment, collaboration tools, and more; there are glimmers of scientific hope with a race for a vaccine, increasing knowledge of frequent comorbidities, and recent hope with a therapeutic drug; and, institutional investors are not just observing consumer behaviors in different countries when governments re-open economies, but also going state-by-state in the U.S. and modeling what economic activities could recover as soon as June or July.

Public market investors have a lot of advantages in such a calamitous time. These days, besides huge pools of investable capital, they have access to global data, they’ve been following the 10-year plus bull run fueled by a massive technology revolution alongside globalization, and they can take advantage of the government’s recent moves with respect to monetary and fiscal policy. Perhaps most powerful, they can move in and out of investment positions with the flick of a switch or the tap of their phones. Howard Lindzon pointed out that even after years of holding Disney, one of his favorite stocks, he was quite bearish on theme park revenue and sports, so moved into Peloton.

All of this, of course, brings us to private markets, and specifically the world of starting new ventures and the venture capital firms that finance them. Unlike their public counterparts, private early investors have been considerably less active. Despite what you read on Twitter about being open for business and optimism for the future, there is an abundance of investment caution across the top tier of venture capital firms. The reasons are mostly obvious to those who understand the mechanics of these vehicles, as well as the patience required to hold illiquid assets for 7-10 years, and sometimes longer.

But, the key point for observers and especially hopeful entrepreneurs to understand is this — while the stock market gyrates up and down, the market volatility combined with layers of economic, scientific, and public health uncertainty create an environment where VCs have very little incentive to buy illiquid assets at this specific moment, especially when those relationships are so long-term, when the economy is frozen, and when prices have not stabilized. Whereas a public investor can go in and out of Disney based on today or tomorrow’s consumer sentiment, a VC has no such flexibility. Pegging a valuation on an early-stage startup today only to have to re-price it a year from now is not only not fun (and hurtful to the company’s morale), it may not be good investment judgement. This is why we’re seeing investors cutting smaller checks (seed rounds) and piling into known winners (like Stripe or Figma or Airtable, etc) — the pricing on the latter is more or less aligned with their long-term bullishness on digital transformation and collaboration at work, while the former represent smaller dollars and less intense commitments.

It is this key fault line — liquid versus illiquid — that makes venture capital in private markets react wholly differently than public market investors. VCs are taking a 3-, 5-, 7-, and 10-year view on economic fundamentals. That we will be flirting with 30% unemployment. That consumers will clutch their wallets and purses tighter. That massive sectors like travel will be brutally beaten up. That our society may not simply “re-open,” but more likely go through periods of “The Hammer and The Dance,” where the hammer is government-mandated SIP and social distancing, and the dance is our flirtation back into society in controlled, slower, and more cautious ways.

In the previous decade, as VC firms scaled, they tended to cut their first check a bit later (not always) than in previous eras — this makes good sense. It is not uncommon for a VC cutting a $10M check to want to see 1-2 quarters of data before making the investment. Similarly, they may be waiting to see 1-2 quarters of public market stability in pricing before being fully back in business. To be clear, they are still looking at deals and investing — allocating capital to winners in their portfolios, making seed investments in teams they know — but it’s the in-between, that new relationship that has a bit of data, the team is raw and unknown, and the manner in which these deals were prosecuted has been upended, not to mention a looming price readjustment that’s potentially on the horizon.

Ultimately, the VC calculus right now is very different than what’s happening in the stock market. As we go in and out of The Hammer and The Dance, public market investors can follow suit, buying up and dumping stocks on an hourly basis. For VCs, each wave of The Hammer and The Dance presents increased uncertainty and shakier economic foundations for the country overall. This is the difference between east and west coast today in 2020. This is Wall Street vs The Bay Area in methodology. Warren Buffett dumps all his airline stocks, while Bill Gates sees his stake in Microsoft continue to balloon. Even for me, as a small investor working to invest very early, I have to balance staying in market (yes, we have invested in the last two months) and understanding incredible founders will start new companies no matter the conditions on the field. But, in the back of my mind, as optimistic as startup investors want to be, we all follow trends for a living, and while the future can always be bright, the near-term presents significant, fundamental, deep economic wounds that may take years to heal, if they heal at all.