Early-Stage Capital

Growth versus profit.

High-growth software companies have boomed in the last decade, powered by investors' thirst for capital appreciation. But it might just be that this era is coming to an end, to be replaced by a renewed focus on profitability and yield. Here's how I'm thinking about my investments.

James Green

Nov 23, 2022 • 3 min read

Please note: none of the following is, or should be construed as financial advice, or advice of any kind.

What’s happening with tech companies?

"Big Short" investor, Michael Burry, tweeted in October that "ALL the silliness must go". He pointed at the staggering number of publicly listed "unicorns" in the USA, which have annual losses greater than $100m (2,018 companies, at the time). For a while now Burry has predicted "the mother of all crashes".

A few days ago, the FT wrote about the massive $4.7bn debt that Masayoshi Son owes to SoftBank. Not a great look for someone who is arguably the single most powerful person in the entire world of venture capital.

Recent SPAC figures don’t look great either. According to information in Dealbook, this is what you'd have left from a $10,000 investment in the following SPAC deals:

Skillz (gaming and betting): $235 (-98%)
Cazoo (automotive): $255 (-97%)
Nikola (automotive): $300 (-97%)
AppHarvest (agri): $361 (-96%)
Clover Health (benefits): $447 (-96%)
Canoo (automotive): $524 (-95%)
QuantumScope (battery): $597 (-94%)
Galactic (space): $597 (94%)
Luminar (automotive): $1,517 (-85%)
Ginkgo Bioworks (biotech): $1,601 (-84%)
Draft Kings (fantasy sports): $1,687 (-83%)
SoFi (financial services): $1,805 (-82%)

Yet another article, written by David Heinemeier Hansson, dug deeper into losses in the productivity software space (see below).

It’s no wonder we're seeing such a significant correction in the Nasdaq, and one can't help but wonder if it has further to go.

So what does all this mean?

It may mean that the world has run out of "greater fools".

Capital appreciation versus yield

In simplistic terms, investing is about annualised ROI.

"If I hold this stock for five years, how much money will I make?"

ROI comes in two forms. Either you make money while you hold an asset, known as "yield" (e.g. interest on savings, rental on property, and dividends on profitable shares), or you profit by selling an asset for more than you paid, known as "capital appreciation".

For years, tech investments have been based on capital appreciation. Investors were willing to give up yield on the expectation that, by the time they came to sell, the value of the shares they own would have risen. It was often the same with crypto assets (notwithstanding the yield-bearing DeFi schemes). In times of low interest rates, the appeal of capital appreciation grew further, as yields were comparatively poor.

Greater fool theory

Of course, the problem with capital appreciation, especially with loss-making companies that don't offer a yield, is that it depends 100% on someone else's willingness to pay more - the greater fool.

For many of today's tech companies, the greater fool is the retail investor. For years, retail investors sat on the sidelines, watching and reading about the huge returns being made by professional investors. Meanwhile, these investors kept their darling companies private for longer, locking in the maximum possible gains for themselves and their LPs.

Eventually the companies IPO'd. At that point, the professional investors could sell their shares, and retail investors, recently cashed up by COVID money-printing measures, were finally able to get in on the hype.

The bubble bursts

Eventually, of course, shareholders start to wonder how and when these loss-making companies might deliver a return. Impatience turns to concern, and concern to fear. By the time questions start appearing, the original investors, who helped propelled these companies to such heights, and the banks who managed their public listings, are often nowhere to be seen.

As uneasiness spreads, it's not long before everyone's running for the exit at once.

A new era?

Of course, it's exciting to be an early investor in one of these "unicorns", and it's not like anyone specific is responsible for what's happened. Investors merely rode the wave of opportunity. It just feels like the easy money may be at an end, and the day of reckoning is nigh.

When the dust settles, perhaps we will enter a new era, where investors focus on more patient, more sustainable, and more profitable companies - both private and public. That's certainly where I'll be focusing my investments.

Something tells me, however, it's going to get a lot worse before it gets better.

It was fun while it lasted.

Source links:

Image credits:

– Featured image by Mohamed Hassan.
– Fool by Andrea Piacquadio.
– New dawn by Stijn Dijkstra.