An article about economics, investment and ITV (sans Coronation Street)

Last night I went to an event with fancy people. This was not because I am fancy, but because my boss (who is fancy) couldn’t attend and he graciously gave me the opportunity to go (something he may regret if he reads this article).

At this event, I heard three interesting things. One of which was incredibly exciting, the two other points… well… not so much.

The One Incredibly Exciting Thing:

Amongst the sea of Patagonia sweater vests and beige chinos talking about ticket sizes and IRR, there was a shining light. The CEO of the London Stock Exchange, Julia Hoggett. She gave a great example of using capital on early-stage (risky) ventures and how important it is for overall economic growth. She also went on to elaborate on the ITV project (no, not the TV channel — took me about 8 solid minutes of her explaining it to realise that it had nothing to do with broadcast television (probably why I don’t work at the LSE)).

You can read about the project here: https://www.ft.com/content/b0459742-30cc-4857-ab91-ace215ba6deb

It’s awesome. It’s exciting. It’s a combination of the private and the public and it will change the world. Or just the UK. Or just London. Anyway, something will be changed.

The Other Two Things:

Before I elaborate, I think it’s important to say that I have little to no knowledge about economics or investment strategies of funds — in fact, I googled “IRR” before I used it above. But, this is social media, which means the only credentials I require to give an opinion are a username and a password (I happen to have both, although I can’t often remember the latter).

The first of the two things (which is technically the second of the three things — keep up):

A question was asked at the event about how good businesses can raise funds in this market where their investors don’t consent to it because the raise is on a “down round” (i.e. the share price of the potential raise is lower than the share price of the previous raise leading to higher amounts of dilution for existing shareholders/investors).

The room was silent, with puzzled and concerned faces (including my own, because I was still trying to figure out the ITV thing).

Now, don’t get me wrong, it’s a good question. However, the strong irony is that most (if not all) of the people in the room are likely the very investors who aren’t providing the consent required because they don’t want the dilution that comes with a down round.

My concern is that I don’t actually think that the people in the room realised that the issue, and the obvious answer to said issue, was in their collective power to solve/address.

The argument that many investors use when justifying why a founder should be diluted significantly during a round is because, well, 1% of a valuable company is worth infinitely more than 100% of a dud. And that’s a good argument.

So, to double up on the irony, that very same logic applies to the funds who don’t provide consent to a down round. Yes, you overpaid for your shares in a previous round (but that’s your fault — see below), but that shouldn’t hamper the company from obtaining further funding to survive a volatile market. And the founders shouldn’t be punished for it, either. Even if you are diluted…. 1% of a valuable company is worth infinitely more than 100% of a dud.

The last thing

During the same conversation above, a statement along the lines of the following was made:

“We are seeing a lot of companies not ‘growing into’ their valuations of 12 or 18 months ago”.

Two things concerning about this statement:

1. How on earth do you “grow into” a valuation? The valuation at the time of the investment is a value negotiated at arm’s length and it represents the value of the business at that time — not it’s future or potential valuation. If the value you paid isn’t the actual value of the share you obtained, that’s more of a “you” problem than the business’ problem and you should probably have a chat with the person who did all the fancy maths on that Excel spreadsheet.

2. The statement smells a lot like “shifting blame”. What do I mean? Well, 12 to 24 months ago valuations, especially in the tech sector, were insane. Huge multiples in the teens were being applied and businesses were raising significant amounts of capital. Now, one reason for those inflated valuations was likely competition. Everyone wants the next unicorn on their books, and if you didn’t offer a 15x multiple, then someone else will. It was a seller’s market. However, the very investors who had a large part to play in the inflated valuations now use phrases like the one I quoted above. It’s funny because I have no doubt (having been on the Company side negotiating these deals from a legal standpoint) that if a founder said…

“Well thanks, Jim. I love the optimism and that valuation seems awesome! You know we aren’t revenue-generating yet, right? Nor do we have an MVP or any market fit. Anyway, just wanted to say that even though we are agreeing to a £50,000,000 valuation based on figures I pulled out of my butt, that’s definitely a value we see ourselves growing into in the next 24 to 2861 months vs what our value is now”

… the investor would’ve (or should’ve) said “Thanks, but no thanks”.

So why is it shifting blame? Well granted no one blames the business they invest into for a market downturn, and no one blames the investors either (I don’t think). But the inflated valuations based on little to no substance are the fault of the investors, not the businesses. If someone offered you £1,000,000 for a flat worth £250,000 you wouldn’t say no — you’d say “Thanks (sucker)”. Imagine if the purchaser then turned around and said, “I’ve now tried to sell this flat, and I can only get £250,000 for it — how dare you sell it to me for £1,000,000” — you’d sail away laughing on your new yacht (assuming yachts are £1,000,000 or less, I have no idea).

And yes, I know, the flat example is about purchasing something and this article is about investment — which is different. But I like that example and it makes sense, so stop trying to poke holes in things.

So, I guess my point is… it’s much easier to say “Oh well the market sucks and the business didn’t grow into its valuation” than to say “We’re pretty bad at maths and made a mistake”.

Anyway, that’s all.