Premium: Venture Capital Is Killing Itself

Soundtrack: Spinnerette — A Prescription For Mankind

About fourteen years ago, the government made a mistake that would allow tech companies and venture capitalists to conspire to legally scam millions of retail investors, simultaneously depriving them of good information and spuriously inflating the valuations of every major tech IPO of the last 14 years.

On April 5, 2012, President Obama signed the Jumpstart Our Business Startups (JOBS) Act under the auspices of it being “too difficult” for small businesses and startups — though overwhelmingly the latter — to access capital, all while reducing reporting requirements in ways that mostly helped venture capitalists fund and startup founders run businesses in reckless and destructive ways, all sold as a good thing for society.

In simple terms, while the JOBS Act (which was passed with rare bipartisan support) allowed companies to raise more money from more people, it also incentivized companies staying private for longer by eliminating a rule from the 60s that required companies of a certain size — above 500 shareholders and $10 million in assets — to report as if they were public.

Per Casual Finance:

In 1964, Congress implemented a rule to securities law called Section 12(g)...[which] said that once a company of any real size had 500 shareholders, it had to start reporting like a public company. This acted as a trigger that pushed private companies into a public reporting regime - the same way a public company reports its financials, a private company would have to file quarterly reports, an annual report, and an update every time something big happened - which was a huge deal for startups, because startups pay people in stock. Every employee who got shares instead of a bigger paycheck was one more shareholder on the way to 500.

As Casual Finance notes, this is the rule that pushed both Facebook and Google to go public — because if you’re going to have to report like a public company, you may as well have access to the public markets:

Back in 2010, Zuck flat out said it. "We aren't planning to go public anytime soon." Then he continued by saying “I tend to think that being private is better for us right now because of some of the big risks we want to take in developing new products.

And Facebook didn't need the money. They were the hottest startup in the world and everyone wanted in…which is how, in January 2011, Facebook announced it had just raised $1.5 billion privately.

But in that same announcement, Facebook said it expected to pass 500 shareholders sometime that year. Which meant they would have to start publishing their financials "no later than April 30, 2012."

So Facebook was about to get the worst of both worlds.

They were about to have to put their numbers out in the open for every competitor to be able to read, just like a public company. Without any of the upside of actually being a public company. Like a large infusion of equity capital and having liquidity for your stock.

So in 2012, Facebook took their stock public.

The JOBS act, amongst other changes, made it so that you could have up to 2,000 shareholders (but no more than 499 “unaccredited” investors) and, crucially, changed the rules so that employees were no longer counted in the calculation, effectively removing any chance that most startups would ever have to deal with reporting like a public company ever again.

The rationale was that having to report like a public company required audited accounts, adding an "unnecessary burden” to fledgling companies, even though “fledgling” here meant “companies worth hundreds of billions of dollars on paper” that absolutely could afford an auditor. Those pushing for the bill also believed that these requirements unfairly punished companies for awarding stock grants, and that public reporting was tantamount to “exposing trade secrets,” as if there was literally no amendment that could’ve been made to anticipate these problems other than “removing reporting anything of any sort.”

However minor this change might have seemed at the time, the net result was one of the largest private valuation bubbles in history, because there was (and is) no longer any incentive for a company to go public before it’s “ready,” with “ready” defined as “as much value has been drained from the company as humanely possible.”

As Casual Finance noted, when Microsoft went public, it had a market cap of around $500 million, Google $23 billion, and Facebook $100 billion, with their total market capitalization as of writing this sentence sitting at around $10.29 trillion. Anyone investing in any of these IPOs in the first five to ten years of their existence had a chance to multiply their money, because you were able to invest before the companies became massive multiconglomerates with multi-trillion dollar market caps, in turn creating value for millions of households that “took the risk” on investing on an earlier-stage company.

These three companies are used as the poster children of why you should invest in a new tech stock — that you’re getting in on the ground floor, with the reward for the risk being that you’d have the chance of a massive multiple.

Except that doesn’t really work if the companies wait as long as humanly possible to go public.

The reason that Microsoft, Google, Meta, Amazon and all the other famous names in “big IPOs that made early investors a lot of money” was that they had to go public before they’d reached the height of their valuation.

And crucially, their valuations are decided by market forces which, while deranged and emotional, at least are somewhat guided by the underlying financial picture of the company.

Today’s startups have their valuations defined entirely based on the whims and fancies of a venture capital sect that makes up a multiple they’re comfortable investing at. That’s how Instinct, a zero-revenue “AI agent” that you text to do stuff, is somehow worth $10 billion — because investors from Sequoia Capital, Benchmark, and Coatue had been willing to give it $1 billion for 10% of the company.

These inflated valuations drain the vast majority of potential opportunity that any investor might have, effectively transferring all the risk for the company’s future onto the public markets while offering very little in return. The days of thousand-percent-or-more returns are long dead, despite every single IPO selling itself on this eventuality, like SpaceX did when it proposed it had a $28.5 trillion total addressable market.

Anthropic’s upcoming IPO has the company demanding a $2 trillion valuation, equivalent to both Meta and SpaceX, based on flimsy promises of $200 billion in annual revenue years in the future and a $30 trillion total addressable market. It is, to quote New Constructs, presenting risks and is positioned to be a far bigger ripoff of the US capital markets, and exists only as a liquidity mechanism so that early investors can multiply their dodgily-valued early investments by selling their shares under the scummiest possible terms.

Anthropic and OpenAI’s IPOs pose a genuine threat to any investor that dares entangle themselves with unprofitable, unsustainable AI companies promising the world (or the world’s destruction), all sold under the auspices of potentially buying into the next Facebook, Google or Microsoft. In reality, the kind of growth you’d need from these companies to reach anything close to the returns of those early-stage tech investments would require them to have trillions of dollars a year in revenue and market capitalizations of $20 trillion or more — an impossibility that nobody seems to want to discuss.

Yet these rotten incentives have also led to a massive valuation bubble in startup valuations writ large, with the AI bubble being the inevitable result.

By allowing private companies to avoid the reporting strictures of the public markets, financial regulations incentivize a kind of venture welfare, keeping companies that cannot borrow money or otherwise sustain themselves through cashflow — you know, bad companies — alive for longer than is natural, never forcing them to become real companies that can survive, with every trip to Sand Hill Road bumping the valuation up further, making any IPO or acquisition much harder to stomach.

This wasn’t as much of a problem when venture capital was pumping up software companies and flogging them to the markets or dimwitted private equity firms, but has become a critical situation for the legions of cashflow-negative AI companies with aggressively-inflated valuations.

In a pre-JOBS environment, many of these companies would’ve wilted in sunlight, and, I’d argue, been forced to run businesses that could stand on their own two feet. Instead, as I discussed in last year’s Enshittifinancial Crisis, these companies are more venture-dependent than any other hype cycle in history, and because venture is so excited about the potential, they’re investing at bigger and bigger rounds, creating the largest valuation bubble in the history of technology, including the Dot Com Bubble.

Today I am going to aggressively advocate for reforms — if not an outright repeal — of the JOBS act, and call for serious legislative efforts to bring the private markets to heel.

My argument is simple: the current system is built to incentivize rich and powerful people inflating private assets with spurious valuations, harming retail investors, reducing the available capital to good startups, and incentivizing the continued development of bad, unsustainable companies. Venture is no longer a trustworthy vehicle for investment, nor can venture capitalists be trusted to value startups any further.

The JOBS act did the literal opposite of what it intended to — fewer tech companies went public, and those that went public did so at oversized valuations pumped up by venture capital, using retail investors as exit liquidity under the flimsy pretense of “getting in on the ground floor.” We are placing outsized trust in a handful of extremely rich and disconnected people and their ability to pick winners, despite the fact that the majority of venture capitalists are fucking terrible at doing so.

For over a decade, venture capital has inflated the value of startup after startup, then been surprised again and again as these companies didn’t work out, with the vast majority of “successes” — SpaceX, Snap, Airbnb, and Uber — mostly existing to dump their horrid bags on an unsuspecting public.

And by repeating the same cycle — inflating companies based on hype and ever-growing valuations — venture capital is setting itself up for a collapse.

Today I’ll explain how it’s happening, and how we might fix what’s left in the end.