For true fans of free-market capitalism, Monday, Sept. 30, 2019, is a day to celebrate. That was when reality finally caught up with WeWork. After a string of petty, self-dealing episodes by CEO Adam Neumann, which resulted in his stepping aside, the company pulled its S1 filing, effectively ending its chances at going public, at least for now.
A worrisome sign for the tech market? For the economy? Hardly. The stalled IPO is actually a huge win for American business in an era that has become increasingly out of touch with reality. While there is much to admire and like about America’s startup culture—It identifies new needs or better ways of doing things, takes risks and makes things happen, often in unexpected ways—it has also strayed far from its roots.
Powerful, self-interested players—venture capitalists chief among them—have bastardized the startup world, turning it into something often not-so-beautiful and threatening our free market system along the way. By twisting the rules to their advantage, they have become the purveyors of modern-day snake oil, and in so doing they tarnish the honest business people who take care of their customers, employees, investors and communities every day.
Too many young entrepreneurs, for instance, now judge success not by dusty old-school measures like profitability — but rather by the amount of capital they’ve raised. Startup CEOs use “dollars raised” and private money “valuations” as their KPIs. “Secondaries,” “Bridge financing,” and “Rounds A, B, and C” have become the nomenclature of the startup crowd, signaling false sophistication, when they should be focused on “Value,” “Customers,” and “Profit.”
WeWork was the ultimate example of this effect. Softbank’s latest $2 billion investment in the company pumped the valuation to $47 billion. That’s for a company with no profits and a business model that has yet to be tested in anything but a boom economy.
The VCs are hardly alone. They are supported by a network of self-interested lending institutions, business schools and professional service firms looking to make a few bucks, as well as mainstream media outlets who see these young, photogenic CEOs as “heroes of capitalism” who can pop magazine sales and clicks that drive ad dollars (see Holmes, Elizabeth).
This “Venture Capital Industrial Complex” has become a self-perpetuating monster.
Venture capital too often resembles a “pump and dump” stock brokerage scam: each investor buys in, hypes the investment and sells out to the next investor in line at ever-increasing valuations. The ultimate kill, of course, remains an IPO, where valuations can be obscene. The regulatory environment, unfortunately, has created a world in which a growing retail investor base has ever fewer stocks to choose from. According to the St. Louis Federal Reserve Bank, the number of U.S. publicly listed companies per million people stood at 30.0 in 1996 and dropped to just 13.4 in 2016. It’s a situation ripe for abuse.
Crunchbase, which tracks venture capital investments, currently counts 498 “unicorns,” private companies with valuations exceeding $1 billion (September 2019). They roam a universe in which only 1,667 public companies in the U.S. have valuations exceeding $1 billion, suggesting serious unicorn inflation.
A 2016 survey of 889 venture capitalists found that 91% of these insiders believe unicorns are overvalued. There was no difference in the response between the 40% of VCs who claimed to have themselves invested in a unicorn versus the 60% who had not had such good fortune.
Take, for example, the case of Blue Apron. Founded in 2011 by then-28 year old Matt Salzman, who felt the itch to start his own company while working as an associate at, wait for it….venture capital firm Bessemer Venture Partners. He and partner Ilia Papas were classmates at Harvard Business School, and initially raised money for a startup crowdfunding platform for scientists. They pivoted and settled on meal delivery kits, but neither had food industry experience (Papas was a techie). So they recruited a third friend, Matthew Wadiak, who had done catering for his mother in law. Salzman’s former employer, Bessemer, led funding rounds totalling $135 million.
Salzman was triumphant and eager to dispense wisdom. “A lot of people who found companies go out and do it with their closest friend who does exactly what they do and has the exact same background that they have,” he modestly told Inc. magazine in 2015, which added fuel to the fire with its feature, “How Blue Apron Became a $2 Billion Startup in 3 Years.” “We were very deliberate in assembling a team that we thought was complementary.”
Things started going south even before the 2017 IPO, when the stock was valued at $10 a share. It now trades at a split adjusted price of around $0.63 (the company needed to do a 1:15 reverse split this past summer to avoid being delisted by the NYSE).
This story almost ended, as these stories usually do, with the venture capitalists making out like bandits. At the IPO, they sat on hundreds of millions of dollars in gains. But this time they missed their window and mostly rode the stock down with retail investors.
Don’t get me wrong: starting new businesses is hard and high risk. I don’t fault anyone for trying to build something new, even when the effort results in failure.
But we can’t allow the Venture Capital Industrial Complex to keep distorting free markets, leaving behind a wake of destruction in its path, redefining capitalism to our detriment. Thankfully, the market seems to be catching on. It usually does.