Sunday, July 17, 2011

Capital markets 2.0

OK, first let me be clear, I was not a finance major.
Much to my later regret, I also skipped accounting altogether. When I completed my MA in public policy at the University of Chicago, I was sent over to the business school where I concentrated in statistics. Thanks to Dr. Miki Gaskow-Green and her patience I ultimately had the opportunity to study with the late Hillel Einhorn.  The little finance I did learn was from Harry Watson in the multiple economics courses he taught within the committee on Public Policy.

A few years later, the mid-80s, I gained a new appreciation for finance when tasked to to creating a relationship profitability model for Citibank in the mid 1980s gave me a whole new appreciation for Finance.  
Fast forward 25 years, and now I can generally follow the complexity of the financial meltdown, grasp derivatives and other secondary market related activity.  

A little tweet I tripped across today, however made me feel a little like Alice chasing the white rabbit down the rabbit hole into Wonderland.  It seems that Sarah Lacy has done a very good job of leading me and other more astute financial market observers to a new reality.  
In this short series Tech Crunch published in March and April of this year, Sarah articulates several new realities. I started with the third article in the series entitled How we all missed Web2.0s Netscape moment. and wasn't quite sure what and where the real story was but ended up with a whole new understanding of the wider financial markets.  For hyperbole I suggest may be we are now in a period of capital markets 2.0. 

Several things fascinate me about these articles and since I don't have the answers I'm reaching out to you. 

What Sarah Lacy noticed and several more astute investment analysts have acknowledged in posted comments, are several macro moves with some interesting, if not serious repercussions.

Diagram of venture capital fund structure for ...Image via Wikipedia
I scribbled the following observations from reading the third post in her series.

1.  If you are going to build a new company, that disrupts an industry use new rules as in metrics to communicate value, don't let the traditional ones define you and your value proposition. This was what Netscape's IPO did and simultaneously changed the laws of gravity around start-ups, particularly when it came to new technologies for which there was no precedent for value. The Market responded learning that in order to go public a startup no longer needed to first be profitable or even have a profit model fully baked.  The buzz and promise of the technology to change the status quo was sufficient to attract significant capital.

2. The emergent lessons from the capitalization of Facebook is again game changing. It's current late stage funding is proving that start-ups no longer need to go public in order to:

  1. Get liquidity for their earlier stage investors;
  2. Stage a huge marketing event; and 
  3. Have extra cash to acquire competitors and keep growing. 

The resulting transformation in the wider public market from Netscape's IPO  democratized investments (author's words, not mine).  But the capitalization of Facebook represents a complete 180, and a conscious avoidance of standards governing public companies i.e. Sarbanes Oxley and Reg Fair Disclosure--

Part Two, really part one 

Hooked, by the this analysis,  I went back to read the initial start of Sarah's series,  Is late stage the new early .

Jason Jones , Founder of High Step capital, commented on Sarah's first post and suggested another avenue for her investigation. 

In the 4th quarter of 2010 approximately 40% of private market sales were completed by venture capital. But here is the interesting thing, about 30% of the private market sales were completed by public market investors (asset managers, mutual funds, and hedge funds).
New questions arose for me. With all the money from both Venture capital and public market investors all being sucked into the private market, what does this mean for normal liquidity?  what are the repercussions for the bulk of the public companies whose shares are being traded daily?

The second article in the series, Benchmark Capital's Stand didn't measure up to the depth of analysis in the 1st and 3rd. I couldn't help but wonder if the bar for returns set by the tech boom  raised the appetite for Venture capital when it spilled over to the street. After all, a rule of thumb for venture style returns are Ten times its invested least that was Benchmark's expectation.  Public companies are beholden to their shareholders and returns are the primary form of accountability, and so it's logical for executive leadership to drive hard to meet near term earnings and focus less on developing longer term value.  In contrast it is precisely the focus on long term and investment in time and resources around innovation that private firms are freer to indulge.  I mean the obsession with short term performance may have as much to do with fear as it does with a complete misunderstanding of what defines value.  Hey if Netscape changed the rules initially and Google also made it clear that it wasn't going to play by the usual standards dictated by the street, Facebook is denying the system the very intell and metrics that move the needles of economic growth.  Or does it do something else?   

Please help me understand, or speculate along with me the implications of these new investment trends.  I had been a pretty firm believer in the financial markets ability to  recognize and reward value and equally strong believer in the need for banking reform. Then I read these short articles  and realize how much of the picture I had missed in my analysis. 

I'm hoping for a clearer followup to appear soon, or counting on others like you to point me to one that I may have missed.   

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1 comment:

  1. While the Google's and Facebooks of the world might be able to circumvent the "normal" market, these companies are huge outliers. My guess is that for 95% or more of the firms "Market 1.0" still applies. As an analogy, most YouTube videos are not viewed by many people at all, very few "go viral".

    That being said, there are a lot more costs to being a public company (SOX, Financial Reporting, Investor Relations, etc.) so firm's that have alternative means might rationally elect to pursue them instead.

    How much easier for a CFO to call up one person to discuss performance candidly than prepare for earnings calls and watching everything they say everday for fear of violating regulation FD?


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