But now it is private capital that has been setting increasingly stratospheric valuations on firms that never made a profit and, quite possibly, never will. Last week, SoftBank founder Masayoshi Son had to get up in front of the world and explain how Softbank’s Vision Fund came to lose nearly $9 billion investing in WeWork, Uber and other small ventures. With elegant understatement, he said, “My own investment judgment was really bad. I regret it in many ways.”
But really, it wasn’t just his own investment judgment that’s suspect. The past five years or so have been the era of the “unicorn,” the private start-up valued at over $1 billion, despite the fact that many were still hemorrhaging cash. The idea was (I gather) that you’d fund the huge losses until they had scaled up to market dominance, then take it public and get your billions back. But IPO investors have proven increasingly resistant to the magical lure of unicorns, leaving the private equity funds poorer and the rest of us wondering what the heck is going on in the venture world.
Anyone can make a mistake, and sooner or later, everyone does. But it takes more than one person, or one firm, to produce hundreds of unicorns that are, collectively, valued at almost $2 trillion. That takes a mass folly of fairly impressive magnitude, one that tempts me to say the words “asset price bubble.”
Of course, venture capital has traditionally been a place where you bet a lot of money on a bunch of long shots, in the expectation that a few of them would pay off so handsomely that you could afford to lose money on the rest. But those bets didn’t used to be denominated in the billions, which matters. For one thing, as the bets get bigger, it gets harder to build a diverse portfolio. For another, as Son’s last-minute bailout of WeWork demonstrates, it’s hard to say “Oh, well, you win some, you lose some” with that much money on the table. The temptation to double down, throwing good money after bad, will be almost overwhelming.
Meanwhile, private equity actually has some weaknesses compared with public markets, most notably that there’s no real way to sell a private stock short, so the price gets set by the optimists. Without the discipline of short pressure, many unicorns seem to have gotten stuck in a sort of perpetual adolescence: They kept growing and growing, but somehow never grew up enough to make a profit.
That developmental delay is also a symptom of a broader trend: Firms are waiting longer and longer to go public, a shift for which three main theories have been advanced.
First, regulatory changes, such as the 2002 Sarbanes-Oxley reforms, have increased the compliance burden to the point where many small companies find it too costly to go public. Second, the public market itself is increasingly dominated by large institutional investors, such as pension and mutual funds, that like to buy big company stocks in large chunks — which means firms need to wait until they’re big enough to IPO. And third, it has also been suggested that private markets were just smarter than the public kind, and therefore a better venue for a company that had a bold, unconventional, long-term strategy that would never get off the ground with mom-and-pop investors querulously demanding steadily increasing quarterly earnings per share.
But to this we now have to add a fourth possibility: Private investors are willing to take moronic risks that the staid folks who manage pension and mutual funds would quite properly have eschewed, making them a good target for entrepreneurs whose optimism bordered on mania.
One has to wonder what would have happened to the unicorns if those firms had gone public earlier. Perhaps they’d have settled for operating at a smaller, but profitable, scale. Or perhaps markets would have decided that there was no scale at which they could profitably operate, in which case society might have found more productive use for all those billions of dollars than subsidizing ride-sharing and scooters and office space and takeout for a bunch of urban professionals who very much enjoyed these services but may never be willing to pay what it actually costs to provide them.