I mention Ponzi schemes because, in his first annual letter
, Chamath Palihapitiya
(CEO of Social Capital
and owner of the Golden State Warriors basketball team) highlights an important point about high-cost/high-stakes user acquisition venture funded “arms race” that is happening in Silicon Valley. This arms race is also taking root in Africa as we are witnessing more and more startups (some without revenue, some making losses every year) receiving venture capital funding that ends up valuing them in the millions of dollars. Chamath writes:
It’s not who you think, and the dynamics we’ve entered is, in many ways, creating a dangerous, high stakes Ponzi scheme. Over the past decade, a subtle and sophisticated game has emerged between VCs, LPs, founders, and employees. Someone has to pay for the outrageous costs of the growth described above. Will it be VCs? Likely not. They get paid to allocate other people’s (LPs) money, and they are smart enough to transfer the risk. For example, VCs habitually invest in one another’s companies during later rounds, bidding up rounds to valuations that allow for generous markups on their funds’ performance. These markups and the paper returns that they suggest allowing VCs to raise subsequent, larger funds, and to enjoy the management fees that those funds generate.
Now, I don’t know about you, but to me, and having observed venture-funded startups
for some years, this sounds exactly like a Ponzi scheme. That is, early investors into a tech startup only make their money back when more money is invested into the startup during later investment rounds. They don’t, in most venture-funded startups, make their money from profits generated from customers purchasing the products that the startup sells. Actually, in most cases, the startups make losses for years on end but investors continue to reap returns on their investments as the startup “grows” and more people invest.
A recent example of this is the listing of JUMIA
, an e-commerce company that operates across Africa, listing on the New York Stock Exchange
. For a long time, the Rocket Internet founded company has been struggling to make a profit
from the markets it operates in across Africa. With few exit opportunities available, especially when you’ve absorbed the volume of investments that JUMIA has received from the likes of MTN Group, the only options really left for the “Ponzi scheme” to continue working is for either a much larger company to acquire you (think Amazon) or to list on a liquid and large-enough stock exchange.
There are exceptions in my opinion, and they are family (investment) offices and technology holding companies. Unlike VCs who invest other peoples’ money and earn based on management fees. Family offices and technology holding companies tend to have more skin in the game and thus more interest in actually seeing the startup making real money, not paper valuation.
Perhaps I’m too cynical. Maybe I don’t quite understand how this all really works. My fear, however, is that many an African startup could die prematurely chasing paper valuations at the expense of building things that customers actually pay for.
What do you think?