TinkTank

Life, by an analyst.

[keyvanfirouzi]

The Post-Money Lie

Let’s say you have a box full of scrap metal and copper, 100 pieces in total. I propose to buy 20 pieces of your box for $100 (20%). This would imply that your box is worth $500 after I buy the 20% ($100 / 20%). Here’s the lie: When I proposed to buy 20% of your box, you agreed to sell me all of the copper pieces (all 20 of them), while you held on to the scrap metal (the other 80 pieces). Only with blood, sweat, and tears (and plenty of luck) the scrap metal and the copper would both turn into gold (alchemy, unicorn love, whatever). Otherwise, the copper remains copper, and the scrap metal remains scrap metal. Effectively, Copper = Scrap Metal + (Blood + Sweat + Tears)*Luck. So saying that I have purchased 20% of your box is a lie, since the pieces that I have bought and the pieces that you are holding are not the same (i.e. apples and oranges, or copper and scrap metal, so using % is an incorrect mathematical expression). If we want to use %, we have to PROPERLY convert the two pieces together (apples-to-apples).

For those who haven’t gone through a fundraising process, the copper (or the 20%) represents Preferred Stock (has some value, mostly keeps value, and has the potential of being something great), while the scrap metal represents Common Stock (the other 80%, nearly value-less, remains valueless, until it converts into something great: big exit).

The good folks at Correlation Ventures have assembled some great information on this. Below shows the return to U.S. Venture Capital. In nearly 2/3rd of instances, the Common Stock will get nothing:

In 50% of those instances where the Common Stock gets nothing, the Preferred Stock gets some of its money back because of its Seniority and Liquidity Preference (through forced acqui-hires, sale, IP spin-off, bankruptcy, board approved dividend distribution, etc). Because of this fact, the Preferred Stock is inherently worth more, just like the copper is worth more than the scrap metal.

Without having to get into the mathematics of it, the VALUE of the Common Stock is generally about 25% of the VALUE of the most recent round of Preferred Stock (given the above Seniority and Liquidity Preference). That means, if the Preferred Stock was worth $1 / share, the Common Stock would be worth about $0.25 / share (the mechanics of this for another post). Inversely, the Preferred Stock is worth 4x the Common Stock.

Back to our original example: Since the copper is worth 4x in VALUE, then dollar for dollar, my $100 is worth $400 in scrap metal. So let’s take this copper-to-scrape metal comparison and turn it into a scrape metal-to-scrape metal. Since I could buy 4 scrap metal pieces for every 1 copper piece, we can get a box where you have 80 scrap metal pieces (from the original holding) and I’ll have 80 scrap metal pieces (my original 20 copper pieces, converted at the 4x value conversion). So with that said, my $100 has effectively purchased 50% of the VALUE in your box. So the VALUE of your box is $200 ($100 / 50%). You can see how the $200 is not equal to the $500 that you had original thought.

It’s important to understand this differentiating factor: In only a few cases Preferred Stock and Common Stock both convert to Common Stock, and only in those cases the VALUE of the Common Stock = Preferred Stock, and ONLY in those instances can one compare them as apples-and-apples to say one is a % of the other. When the original investment happens, the Preferred Stock is not equal to the Common Stock, and explaining them as a % of each other is misleading: It makes the value of the Company seem much higher than it actually is, so founders would be willing to give away more than they should.

So when you hear a Post-Money valuation of $500M, don’t compare it to a publicly traded company with a Market Value of $500M. They are not the same. A Post-Money valuation of $500M is about $200M in actual Market Value.

Hopefully the above explains some of the craziness that is Post-Money valuation.

Note: As companies mature, the VALUE of the Common Stock starts converging to the VALUE of the Preferred Stock (i.e. IPO). In these instances, the Post-Money valuation converges to Market Value.

[keyvanfirouzi]

Tech Bubble-ish

Tech bubble is the talk of town these days. So-and-so raises $100M at a $1B valuation, and people start comparing how many 50-year old companies have valuations less than a 10-year old company. Let’s set aside why that comparison is completely ludicrous, but stick with a very important matter: Valuation.

Valuations are discussed mainly in a pre-money / post-money fashion:

Say a company (let’s call it “Company” cuz I’m creative like that) raises $1M by giving away 20% of its stock. This implies that the post-money valuation is $5M ($1M / 20% = $5M), and that the pre-money value of the Company was $4M (before the investment, or $5M — $1M = $4M). That’s about it. And people lose their shit when they see this and say “$5M FOR THIS!!!!!” This is what is called a % ownership view:

Investment of Preferred + Relative Value of Common = Value of Company

Investment of Preferred = $1M

Relative Value of Common = 80% / 20% * Investment of Preferred = $4M

Value of Company = $5M

Ok, let’s dive deeper a little bit:

When this deal goes down, the Company doesn’t give 20% of its Common Stock. It gives 20% fully diluted shares in the form of Preferred Stock and there lies the MAJOR difference. In a simple capital structure (1 class of Preferred, 1 class of Common) generally, the Preferred Stock:

- Receives its money back before the Common (“Seniority / Liquidity Preference”).

- Has the option to give up its Liquidity Preference and participate with the Common when it sees fit (“Conversion Right” — In this case 1x Cap. Don’t worry about this too much).

The Preferred Stock has a bunch of other rights and preferences, but let’s stick with the big Liquidity Preference for now.

Without having to dive too deep into why (that’s for another post), the value of the common stock is less than the value of the Preferred Stock (mainly because of that Seniority / Liquidity Preference). At the early stages, the value of the Common Stock as a % of the value of the Preferred Stock is about 25% (i.e. for every $1 of Preferred’s value, there are only $0.25 of value in common). This is mainly because of that great Liquidity Preference clause that the Preferred Shareholders get.

Let’s take all of the above as facts. When the Company gives away 20% of its stock, it is actually giving away 20% of its shares as if all of the Preferred Stock had converted into common stock (i.e. fully diluted basis). However, there are very rare cases when the Preferred Stock converts to Common Stock (successful acquisition or IPO). In the remaining cases, the Preferred Stock will remain Preferred, and the Common Stock will remain Common.

In the original example, if we did the same $1M for 20% Preferred Stock, the investors would get 20% in Preferred Shares that are worth 4x the value of the other 80% Common Stock (the 4x comes from the inverse of the Common Stock Value / Preferred Stock Value). So we are now essentially changing the % of Company view to a value-based view. With that said:

Value of Preferred * Preferred Relative Size + Value of Common * Common Relative Size = Value of Company

$1M = Value of Preferred * Preferred Relative Size

Value of Preferred = 4x Value of Common

Value of Common = $250K (since it’s only worth 25% of Preferred)

Common Relative Size = 4x Size of Preferred (80% / 20%)

Value of Preferred * Preferred Relative Size + Value of Common * Common Relative Size = Value of Company

$1M + ($250K * 4) = $2M = Value of Company

So in essence, when the Company gives away 20% of its shares in the form of Preferred Stock it does NOT imply that the value is $5M. The ONLY case where the value would be $5M is when all the Preferred give up their liquidity preference, which happens mostly in the case of a successful exit or an IPO. Since this does not happen in most instances (which ties into why the common stock is only worth about $0.25 of the Preferred) the true valuations are actually quite a bit less than what is published in “pre-money / post-money” terms. Which is why we are not in a tech bubble.

We are in a tech bubble-ish.

[keyvanfirouzi]

Tech Bubble?

There's a lot of discussion about the Tech Bubble these days. Mark Cuban posted not one, but two posts about this recently.

Just so we have a basis for discussion, let's make sure we are on the same page:

Bubble definition:

Trade in high volumes at prices that are considerably at higher variance with intrinsic values (i.e. high volume of prices paid > intrinsic values). 

1. In this first post, Mark's main argument is that there is no liquidity. This may or may not be true, but certainly doesn't fall under the price <> intrinsic value dynamic. Also, the fact that there isn't liquidity is a signal that we are not in a bubble. Had we been in a bubble, investors (private or public) would perpetually pay higher prices for given number of securities, increasing the value, and providing liquidity for previous investors. In that sense, lack of liquidity is a good signal of lack of bubble.

2. In his second post, he asks a series of questions:

"How many people have been pitched an app that is going to be the next big thing?"

My answer: Some people.

"How many people have been pitched to invest in that app?"

My answer: Some people.

"Has anyone not been pitched investing in an app?"

My answer: A lot of people.

Conclusion: Nothing.

I think Mark is subject to a cognitive error called Representativeness Bias, meaning, since people pitch him a lot of tech idea, and since he's on shark tank, and since he is surrounded by other people who are investors or inventors, he is under the assumption that this is happening everywhere. 

So to help him, I wanted to re-visit this question:

1. Is the NASDAQ 100 composite, as a proxy for tech, at the same level as it used to be: 

It certainly seems to be the case! But, like any historical numbers, I think it would be important to adjust this for inflation. So let's do that:

Ok, it seems like we are not there yet, but surely on our way (about ~65% of the way there).

A major item to note is that these are all public companies. In today's day and age of Unicorns, with their massive valuations, it is important to include them in the list. So I pulled the top 26 Unicorns, with their estimated valuations as of 2015, and added them in a linear fashion to the $ equivalent of the NASDAQ composite, on an inflation-adjusted basis (here, the Y-axis has been changed from NASDAQ points to Dollars, and then the valuation of the following companies have been added to the NASDAQ Dollars, based on the year of inception, growing linearly to the total $234B in valuation that they represent. This, compared to the $6T in total value will seem immaterial).

List of Unicorns and their valuation as of 2015

Xiaomi Technology: $46B

Uber Technologies: $41B

Airbnb: $13B

Flipkart: $10.6B

Dropbox: $10.4B

Palantir Technologies: $15B

Snapchat: $10B

SpaceX: $10B

Theranos: $9B

Meituan: $7B

Square: $6B

Pinterest: $5.1B

Snapdeal: $5B

WeWork: $5B

Cloudera: $4.1B

Spotify: $4B

Kuaidi Dache $4B

Pure Storage: $3.6B

Stripe: $3.6B

Atlassian: $3.3B

Bloom Energy: $3B

Jawbone: $3B

Legendary Entertainment: $3B

Moderna Therapeutics: $3B

Powa: $2.7B

You'll see that even with the addition of private companies, on an inflation-adjusted basis, we are not passing the bubble.

I wanted to do one other experiment and look at the NASDAQ-private-company-added-inflation-adjusted-in-dollars graph [i.e. the graph above], next to the number of internet users:

This is an interesting view. It essentially shows that although directionality we are en-route to the 1999/2000 bubble, there are far more reasons (roughly 2.5B of them) for the valuation to be at these levels. Looked at differently, we can think of this in how much was the NASDAQ-private-company-added-inflation-adjusted-dollars per internet user then, and what is it now:

And I think the above graph is the magic of it all. Although prices are high, and a lot of people are making apps or asking for money to make apps; there have been fundamental elements that demand the current paradigm (Moore's law, Search, Mobile, Social, Cloud). I think what Mark is referring to is an increased in unit valuation, and not a bubble; and that is a discussion for the next post.

[keyvanfirouzi]

Two identical companies walked into a bar and said we don't have any competition

Graham Bell and Elisha Gray filed for what is today's telephone on the same day. Bill Gates and Steve Job's implementation of a mouse + GUI, either copy or derivatives of Xerox, were introduced within a year from each other. 

In a time when information is nearly free and moves at the speed of light, it is mind boggling when entrepreneurs claim that "we don't have any competition." 

Competitors are simply everybody pursuing the same final dollars, or solving the same issue.

Saying there isn't any competition is equivalent of saying you don't have a full understanding of the market or the problem. Speaking about competition doesn't make your work less desirable, but it provides you an opportunity to present your Company's strengths against direct and indirect competitors, as well as substitutes. Most importantly, having competitors is a sure sign of showing that you are solving a real problem, in a real market.

[keyvanfirouzi]

Tech Bubble lessons from the 1980's Financial Industry

In the 2010 movie, Inside Job, Charles R. Morris, the ex-lawyer, banker and author of thirteen books tells a quick short-story:

" I had a friend who was a bond trader at Merrill Lynch in the 1970s. He had a job as a train conductor at night, 'cause he had three kids and couldn't support them on what a bond trader made. By, heh, 1986, he was making millions of dollars, and thought it was because he was smart."

During the 1980's, series of regulatory and deregulatory acts and laws allowed for the largest explosion of financial service activity. Bank and non-bank entity merger, securitization, and credit default swaps were a few result of those regulatory decisions. Though the U.S. finance industry comprised of only 10% of total non-farm business profits in 1947, it has grew to 50% by 2010.

Were a 1980's bond trader at Merrill Lynch would contribute many of the growth to personal achievement, it would become shortly apparent that there are many forces at work, and personal achievement and success is only a by-product.

It's much easier to attribute the success of the financial sector of the past four decades to large mergers, securitization, quantitative trading, deregulation on interest rate oversight, etc, than it is to attribute it to the brilliance of bankers, traders, and corporate raiders.

Is the technology boom of the past two decades better explained by the individual actions of entrepreneurs, technicians, and investors, or the collective effect of Moore's law, API's, open source culture, and smartphones?

The individual greed of actors in the financial sector resulted in one of the greater economic meltdowns in human history (which has been temporarily managed with increase in credit and liquidity, and to many projections, pending a larger economic meltdown to follow). Parallel to this, the greatest potential payout for an actor in the technology ecosystem is solving for Artificial General Intelligence ("AGI"), which would lead to the greatest total meltdown in human history.

Would the individualistic agenda of entrepreneurs, technicians, and investors lead to AGI, or would we sooner (rather than later) realize that the whole is greater than our units?

[keyvanfirouzi]

You DO NOT have to be relevant

Conversation from last night:

New guy: "Oh you're Iranian, I knew a few Iranians back in MIT. Actually, this is kinda funny, when I was studying engineering, one time this guy asked me where the nuclear physics department was as he was new to the U.S., so I pointed him to the department. Then I asked him where he's from, and he said Iran, and in my head, I was like woaaaaa, RED FLAGS GOING OFF!!. hahaha " Me: "Yeah, ha"

No. That is not funny at all. That is prejudice, and you are ignorant. I know you are trying to make small talk and be relevant, but what you just said is the equivalent of "Hey, you are Iranian. I think Iranians are dangerous. Nice to meet you". How is this acceptable behavior? I get it, Iran has bad politics. But I assure you that while those decision were being made, I was at my apartment in Harlem making a sandwich or at work writing an email to the IT department asking why I lost all of my phone contacts when updating my iOS. I don't think minority groups in the U.S. remind white people about their mistakes and bad policies all the time. Anytime I'm at a dinner party, and if asked where I'm from, I have to be prepared to either distant myself from being Iranian, be prepared to defend Iranian policies, or join my counterpart in attacking those policies. I just want to be the sandwich making, lost-phone-contact dude sometimes. I don't know how often I would get invited back to cocktail parties if I walked into a room full of white people and said "Man, that 1953 Coup. What do you have to say about yourselves?"

[keyvanfirouzi]

Maya Lin Wavefield

Elena Koroleva Photography

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Mark di Suvero, mozart's birthday

Elena Koroleva Photography

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 Sol Lewitt, Five Modular Units

Elena Koroleva Photography

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Alice Aycock, Three-Fold Manifestation

Elena Koroleva Photography

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Alexander liberman, Adam

Elena Koroleva Photography

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Menashe Kadishman Suspended 

Elena Koroleva Photography

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George Rickey, Five Open Squares Gyratory

Elena Koroleva Photography

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Alexander Liberman, Adonai,

Elena Koroleva Photography

[keyvanfirouzi]

A (difficult) framework : Swapping equity for employees / partners / investors

You and your friend started a company, and are ready to bring on employee # 3 ("Lena"). Exciting times. Time to loosen the bag and give Lena some equity. But how much? Like other things, there are two methods:

1. Rule of thumb (i.e. "this is what everyone else is doing")

2. Calculation

I'll leave rule of thumb be. That is the forces that is the market.

Paul Graham has done an excellent job at quantifying a framework for this calculation. To me, Paul Graham is God, and I am in no position to judge his work, so I'm going to judge his work.

Paul's suggestion is that if Lena can increase the value of the company by 5%, then it is fair that the company give her 5%. Seems straight forward:

Here's the problem of thinking about this when you are hiring Lena: You've just rolled out the product, and you barely have any customers or distribution channel, and you have not really gone up against the true competition. You may fall into the trap of thinking of "5% increase" in today's terms, and that is quite dangerous (i.e. you would think "well, we have 100 customers, and if Lena can bring in 5 more customers, then we are 5% better". Right? Wrong). Paul's view is that if Lena can increase the value of the company by 5%, then give her 5%. But what is the value of the company? The value of the company is all the hopes and dreams of the future, the ups and downs, the challenges, the potential customer acquisitions, the deals that are going to go through, the bugs that you'll be able to find and fix, the daily motivation of the employees, the ability to grind it through, the shape of the industry, your position in the industry, and, at the bottom, all the money that you're going to make (in today's terms, adjusted for risk and probability). The value of your company is all of that (whatever it is) and you have to be able to say that by bringing on Lena, you'll be able to, on average, do all of those things 5% better, or do at least do one thing a lot of percentages better, so that it increases the value of the whole company by at least 5%. So I introduce graph 2:

In Paul's framework, you have to make a guess about all of the things that make up your company's value (and the bottom-line dollars) with your gut. It would be similar to doing high-frequency quantitative trading with a free e-trade account. The framework is fundamentally sound, but nearly impossible to implement. It is similar to Bernoulli's expected utility hypothesis, in that it helps define and think through a very complex problem, and yet it is quite difficult to get any real value out of it. I'm leaving this thought process for now and returning to it later . . . 

[bijan]

"Be soft. Do not let the world make you hard. Do not let pain make you hate. Do not let the bitterness steal your sweetness. Take pride that even though the rest of the world may disagree, you still believe it to be a beautiful place.”

Kurt Vonnegut, via The Impossible Cool (via bijan)

[keyvanfirouzi]

How many active tech startups are there in NYC?

867 funded startups

Definition of "Startups": 

Angel, 

Convertible Note, 

Equity Crowdfunding

Seed, 

Venture funded.

Source: CurnchBase Monthly Data Extract

http://www.crunchbase.com/

  MAJOR COMMENTS ON SOURCE:

  Startups / VC bury their dead quietly + Be aware of Zombie startups.

  Adjusted to data reported / adjustment to Zombies:

Data slice: CrunchBase reports Company status as: Operating, Acquired, or Closed. Data showing "Operating" Only.

  Assumption: Startups live 21 months after funding. Afterwards, 25% survive, the rest die or exit. Data has been adjusted for these two concerns, even if CrunchBase reports a Startup as "Operating".

  Comment on 2014: The year is not final, and there is an information lag: data may be higher than reported for this year. Data has not been adjusted for this issue.

Further adjustments / considerations:

Data slice: CrunchBase reports Company "Funding Status" as: 

  Venture (30%)

Seed (29%)

Angel (5%), 

Convertible Note (1%),

Equity Crowdfunding (3%)

[Above Considered "Startup" for analysis. Accounting for 69.3% of population.]

Undisclosed (20%),

Product Crowdfunding (0.33%), [Too early to tell]

Grant (1%),

Debt Financing (5%), 

[Above considered "unknown". Could be boot strap (Undisclosed), Could be too large (Debt Financing). Accounting for 27.8% margin of error]

Private Equity (2%), 

Post Ipo Equity (0.45%), 

Post Ipo Debt (0.08%), 

Secondary Market (0.04%), 

[Above considered too big to account for "Startup". Accounting for 2.8% of population.]