May 20, 2020

Startups Are a Beauty Contest

One of the hard truths in startups, especially VC funded startups, is that perception matters more than reality. Many people are able to raise vast amounts of money at high valuations on little more than excitement about the prospect of a viable business some time in the future.

Most VCs earn their living from fees, and they earn more in fees when valuations go up, followed by subsequent funding rounds, with larger amounts of capital invested. VCs don’t usually invest their own money, they typically invest other people’s money. Thus, they aren’t really incentivized to see their companies succeed, but rather they want to make their companies appear successful. That is to say, the perception of success matters more than actual success.

This is a topic Keynes wrote about. From Wikipedia:

It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.

This also applies to the entire stock market, which is more akin to a Ponzi scheme than anything. People buy stocks because they think they will be able to sell them for more than they paid for them, at some point in the future.

When companies aren’t being valued based on their current revenue, or dividends, or any other “fundamental” metric, then you’re merely speculating that some fool down the line will be willing to pay more than you for the same magic beans you just bought.

© 2021 Brenden Matthews, some rights reserved.