I’m sorry you had to learn this way, that we haven’t discussed this before.

• If your money or
• your friends’ money or
• your Etsy reseller’s money or
• your employer’s money or
• your payroll company’s money or
• your investors’ money or
• your future investors’ money
• your investors’ limited partners’ money
• were frozen this weekend in the Silicon Valley Bank Run,

You might have been working in the financial sector without realizing it.

No sarcasm is implied. It sucked to find out like that.

In fact, if you were working in a pre-profitability or low-profitability company that relied on investment in your future cash flows, you were a packaged and polished product of the investment industry.

This past weekend, several “tsk, tsk” statements pointed to the resilience of companies that grow through customer revenues and were happy and calm because they never raised the capital that introduced them to Silicon Valley Bank. While I personally favor the customer-revenue-first path when it works, it is not really an option for those in biotech, cleantech, and much of healthtech. Before they can earn that customer cash flow, these companies need to invest in technological development and scientifically verifiable evidence.

A Message for the Builders: You Work in Finance

So this message is for the builders of complex stuff. Builders need capital to create something valuable that is aimed at shifting the outcomes in health and our ability to adapt or regenerate our biosphere.

What that means – when you are in a company whose value is in your future cash flows – is that you work in finance, even when you still own most of the company.

It was precisely these types of firms that Silicon Valley Bank catered to: brand new companies with sudden cash inflows and unpredictable future revenue streams.

• SVB provided these companies with venture debt.
• And mortgages.
• And credit cards
• And cash sweep services
• And premium wine banking for founders and investors who wanted to own vineyards
• And credit facilities and investment vehicles for the pro-social ever-helpful venture investors who backed these companies
• And the same products to insufferable puffer-coat-wearing capitalists who led a run on the bank from a group chat

In order to understand the finance industry, you will need an opposable mind.

You are networking with community-minded, thoughtful, and supportive change-the-world investors and founders who want to help each other out.

And you are swimming with cut-throat utilitarian sharks who will cut off their bank to spite their industry.

This set of charts and reflections will help you come to grips with the fact that you work in finance.

1/ You live inside someone else’s asset class  

To gain some perspective, let’s go back to the year 2019 before the recent bubble and crash.

A total of $455 billion was under management by US venture capital funds. $120 billion of these venture capital funds were undeployed during that time. The industry calls these undeployed funds dry powder, which implies kinetic potential. However, this refers to an ancient military tactic used before industrialization, not what happens when not-yet-deployed capital in a venture fund dries up. When markets shrivel, the dry powder goes dormant.

As big as VC folks like to blow up their puffer vests to appear much bigger, they are a small pool relative to other categories of investment.

The size of venture capital can be compared to that of buyout funds, which at the end of 2019 had $1.4 trillion in assets under management, including $560 in undeployed funds. Let’s compare that number to US domestic equity mutual funds, which managed about $8.4 trillion, with active funds controlling $5.6 trillion and index funds $2.8 trillion at year-end 2019.

So small, despite the puffer coat.

[image of Venture Capital industry in a puffer courtesy of DALL-E]

2/ You live in a portfolio. 

Investing in venture capital is a way for pension funds, endowment funds, sovereign funds, and family offices (wealth managers for the wealthy) to access higher returns than they can achieve from bonds, cash, buyout firms, and public equity.

Venture capital and alternative asset classes have seen an increase in funding. In addition to the pandemic requiring mass digitization, COVID stimulus packages, and low-interest rates, there was a massive influx of Venture Capital in 2021. The hockey stick year has come to an end. As a result of inflation rising a year ago, we are experiencing systemic indigestion.

3/ You are expected to aim only for a grand slam

Venture capital has the most investments that lose money but also has more big winners. Buyout funds have more losers than public equity but also have more winners. Only about one-quarter of public stocks lose money.

The above chart comes from a famous analysis by Kauffman Foundation, who demonstrated the power law returns for VC.

Builders who need substantial capital to build their technology before earning revenues will only receive investment from VCs if they can convince them their company has massive potential. To achieve dominance, they encourage you to take risks and move swiftly. They want you to imagine a big total addressable market (TAM).

4/ You will most likely be eaten by a bigger fish

In the early days of the internet, an initial public offering or IPO was the main path to exit, creating the opportunity to sell your company to retail investors as well as the stress of reporting your financials quarterly and managing to more predictable financial results.

In recent years, however, IPOs have declined significantly, and sales to strategic buyers have increased. While we saw a bump in IPOs during the last few years and also an unsuccessful exit vehicle called the SPAC, many of these newly minted firms have failed terribly in the public markets. Yet over recent history, a median and mean IPO return is significantly higher than a merger and acquisition (M&A) exit, and the median M&A exit is for a loss.

I’ll repeat: the median M&A exit is a loss for the investors, which means a loss for the founders. A bigger fish will most likely eat you, and you will probably not make any money.

5/ You are living in an asset class that typically underperforms 

As a result of these distributions, it is not surprising that returns for venture capital funds, and to a lesser extent buyout funds, are skewed. Rather than investing in VC assets generally, the Yale Endowment Chief Investment Officer picked winning VC firms that earned higher returns.

As a Builder, you may be stuck with the lower 75% of VCs who won’t deliver returns greater than the public market. Their investors, those pension funds, endowments, and family offices, would have been better off investing in the public markets rather than in the fund that funded you. That’s why they wear puffer coats and Allbirds instead of Loro Piano sweaters and Bruno Cuccinelli loafers. They need to look successful but often aren’t in the long run.

As a builder who will require capital, but who may not get to work with that top 10% of investors, know that you have to be your own financial thinker or at least get a great mentor that can help you navigate value in the mind of the financial industry in which you work.

6/ You are living in a quantitative AI-driven simulation

While you fear AI takeover—the idea that some kind of artificial intelligence may supplant humankind as the dominant intelligent species on the planet—you can rest assured that this has already happened in your chosen industry, finance.

Using quantitative algorithmic models to simulate how the markets work is the reality you swim in.

With technology reducing trading costs to zero, quants and human traders have been zigzagging for dominance in the market. Nevertheless, this allowed retail investors on Reddit to trade all day, only for the algos to take over again when future cash flows and interest rates need to be calculated.

An algorithmic trade created by a quantitative modeler months ago that shorted Silicon Valley Bank tipped off certain VCs and started the run on the bank before you learned about the risk caused your weekend stress. So now at least you can see that you were in that algo trader’s simulation, Neo.

What to Do if You Realize You are in the Financial Industry 

Suddenly waking up from a good dream, then from a bad dream, only to find out the bad dream was true.

You are delivering on a bet on a future you were expected to create and likely create as a future acquisition so that a pension fund manager can fill a major funding gap.

It will take some time for you to recover from the fact that you thought you were entering a world of makers, doers, and dreamers, but in fact were working for spreadsheet wranglers on Wall Street, and their AI-assisted algos.

Look for bogeymen if you like. You can blame Chairman Powell for raising rates too quickly. We can blame Alan Greenspan for the bubbles by starting quantitative easing. We can blame the clubby world of SVB’s executives and their poor decisions. We can blame the utilitarian libertarian VCs who behaved exactly as they always do and started the run on the bank.

But ultimately, we must understand how finance works if we are to work in finance. Magnetic forces of money, future cash flow expectations, credits and deposits, exits, and IPOs are all things we need to see.

Building takes a lot of time as a builder. If, however, you could extend your building mind as an engineer, designer, or tinkerer to include reshaping the way the world makes money. As of yet, we haven’t designed a way out of this mess.