Greetings, folks. Let’s take stock of the current environment:
VC is putting money into AI at crazy valuations, numbers that don’t make sense. I’ve talked before about how the value accrual is going to Big Tech (GAMMA), or individual contributors (IC). GAMMA makes bank off of the biggest LLMs, via token consumption, or compute costs, or the compounding internal intelligence that stays within the walled gardens. ICs can exponentially better themselves, but the money goes to the corporations they work for, or their W9s for work they do as “AI experts”. AI startups are going to go the way of Crypto, too much money put into them for the wrong reason (hype). This was the realization I came to after launching an AI company myself. The front-end theory I wrote about is valid, but what I failed to realize is that front-ends are becoming a commodity, either via open source, or straight up voice-to-code app creation. All the money being plowed into AI right now is for compute, and the price is high due to chip shortages and energy prices. Give it 5 or 6 years and US manufacturing will be pumping out H100s, and more renewable energy sources will provide cheaper electricity.
To boot, the majority of the VC bets over the past decade are coming home to roost now in down rounds. In one of my very first articles I wrote about how investors push past 1, 5, 10, and 20 year outlooks while still performing high frequency trading against daily news and quarterly performance against target. To say that X asset, which is valued on a projected 20 year cash flow is worth more or less today than it was last quarter due to whatever bonehead move the CEO did last week is the height of late stage capitalism. That’s not to say there isn’t money to be made in trading the market, but to quote many a sage, “everything is priced in”. VCs have always been out in front of the public markets, but this actually compounds the problem. More risk = more reward, so the constant search for alpha becomes a fool’s errand when probabilities of success approach zero.
A lot of the private market stuff stems from what can colloquially be coined as “fake business”. VCs giving money to friends to start companies that are doomed to fail, and getting paid huge custodial fees for managing them. The AI company I started had exactly one competitor, which received $20M from A16z because the two co-founders were from Stanford. I am not lamenting our success, because we did not quite get our hats in the ring, rather pointing out an obvious flaw in the system.
VCs get some cash upside no matter what via custodial fees, as do the startup founders and employees, but it is the LPs and investors who end up paying the cost. Jobs are created on the back of wealth, as per usual. Critics of capitalism often disregard the risk that investors have to undergo to secure an equity stake in organizations. Lest we forget when that risk proves to be too high the money gets burned at the stake.
So the investors get torched, but VCs still get a paycheck, as do founders and startup employees. It is important to remember that all of this is not available to regular citizens however because the jobs are reserved for those who have degrees from the top universities. I am not degrading those who graduate from top schools, but we all know that these schools as most know have become cyclical nepotism silos, reserved for the wealthy. And while many deserving students get in, perform, and graduate, you are still left with a degree that can be described as “weak signal”. Sure, it is still signal nonetheless, but one could argue that such signal degrades over time through the aforementioned cyclical nepotism.
This creates a safety net for the wealthy. The only way to crack into this world is to create outsized value, such as starting a billion dollar company. This is why capitalism is great, but it is also an example of why we don’t have true capitalism.
Some more hard truths: we are in a high interest rate environment for the foreseeable future, and there is a lot of private financing that was done under ZIRPs that will be coming due in the near future. Private Equity firms are going to have to refinance at much higher rates, but shant they be able to afford it will have to default, or sell off assets for pennies on the dollar the way that VC is right now. I’ve talked in the past about how Public Markets > Private Equity > Venture Capital > Crypto are the increasingly speculative derivative assets classes away from true alpha, and we are seeing that peel-back in real time as each one of those classes collapses in reverse order. Does this mean that public markets are due for a collapse after PE sees a downturn in early 2024, while VC sees its downturn now, and Crypto saw it months ago? Possibly. I did predict there would be a “second bounce”, but per youge, I think I had my timelines condensed.
Note: if you are new to this newsletter you should know that my denunciation of Crypto is purely on its speculative nature. I have written about how the Degen culture is inherently anti-Defi, and that SBF/FTX going under was a positive for the space. Crypto’s enduring use case is regulatory arbitrage, and I do think there is a burgeoning development with AI self regulation afoot. If (big if) AI tokens, or GPU/TPU compute gets regulated, cryptography plays a role in underground, open source AI development. I don’t personally think this is likely, as I do think AI may have reached the top of its S-curve, but with the SEC already waging war on Crypto as securities, the stage is set for some sort of illegal (but perhaps moral) future financial fiasco.
So where is an investor to place his or her hard earned money in such turbulent times? It is here where we must remember that the largest transfer of wealth in history is upon us. As American Baby Boomers pass away, they are leaving colossal fortunes to their heirs, benefactors, or the state. Expect death and estate taxes to be a topic of interest in the next several presidential elections.
These assets set to be turned over are in the form of real estate, investment portfolios, and good old fashioned cash flow positive businesses. Just the type of businesses that have been elusive for so long. Despite massive valuations of both public and private unicorns, many have not been, nor will ever be, cash flow positive.
So, how do you get a piece of these assets that make up a fair portion of the US economy? Well, time is of the essence. Do you want ol’ Phil who owns a chain of gas stations to leave the business to his good for nuthin son, or do you want to swoop in there and make him an offer he can’t refuse? Cash isn’t cheap anymore, so a 10x revenue deal to Phil might sound mighty sweet right now. At 70, 75, Phil might have 30 good years left in him. Might as well compress as much of that revenue into NPV as you can and let Phil ride off into the sunset to spend his days doing whatever the hell Phil wants. Plus, with the handy assistance of AI, you can level up these businesses like they should have back in 1985 when Excel was first released.
Does this take actual diligence and not some quick scan of a resume to see what school a startup founder attended? Yes. Do you have to deal with actual humans and actual atoms and actual businesses and customers and COGS and low margins and non-zero overhead? Yes. But you have business managers for that. And they will be good at math, and experts in digital, and marketing savvy, and they will be tapped into the largest increase of intelligence that the world has ever seen. That’s why if you’re an investor, and you’re looking for alpha, and you’re tired of swinging for the fences in a non-ZIRP environment, it’s time to look internal like a Buddhist, and see the United States for what it is, in all its glory.