Gavin Baker+ Your Authors @GavinSBaker Husband, Becky Painter. CIO, Atreides Management. Former PM, Fidelity OTC fund. investorfieldguide.com/baker/ No investment advice, views all my own. Dec. 07, 2019 2 min read + Your Authors

1) High valuations are arguably more dangerous to founders and employees than investors. No room for error.

If Magic Leap – an impressive company - had not raised at such a high valuation, it would be in a much better position today.

 https://www.theverge.com/2019/12/6/20998796/magic-leap-two-ar-headset-prototype-layoffs-low-sales-sundar-pichai-board 

2) Investors generally own preferred stock with liquidation preferences and anti-dilution rights that protect them. Founders and employees own common stock at the bottom of the pref stack. Investors will also normally be more diversified than the founders and employees.

3) High valuation generally correlated with a big raise. The big raise often gets spent, because the high valuation creates pressure for the next round, which drives unnatural decisions and a higher burn in pursuit of growth to justify an even higher valuation. Tough treadmill.

4) Some founders justify taking the high valuation by saying that they are going to drive competitors out (especially common logic in “winner take all” internet marketplace land) and then rationalize. In a world of capital abundance, this is absurd. I have *never* seen it work

5) A high valuation for the #1 player makes it easier for the #2 and #3 players to raise money. Exact opposite of the intended effect. One “capital cannon” just attracts others and unit economics get destroyed. Also habituates consumers to discounts, coupons, etc.

6) The habits that are formed as a result of running a large burn are hard to change. Habits are as powerful for companies as they are for people. Hard to go from growth at all costs to financially disciplined. Hard to raise a lot of money at a high valuation and not spend it.

7) Burning cash isn’t always bad. Often unavoidable early. Possible to be laser focused on unit economics and financially disciplined while burning cash.

When is a burn too high? Subjective, but I think most know it when they see it and correlated with big valuations.

8) Am already way past broken record status on this, but until a company generates $1 of FCF, they are at the mercy of markets and dependent on “the kindness of strangers.”

Markets are fickle but will always come back to valuing FCF as they are right now.

9) Obviously means that most companies with high valuations & large burns are in trouble if they need to raise in near future. Hello structure.

And unfortunately, the sharkiest investors are most comfortable with structure which is terrible for employees.

10) More transparency about metrics at later stage, semi public co’s might help employees make better decisions. Instead of seeing a big up round as a positive signal, might be seen as the risk that it actually is some of the time. Might also bring more rationality to the mkt.

11) Obviously difficult to create more transparency today, but nonzero chance that regulators step in - presidential candidates are already discussing the unfairness of employees owning common stock vs. investors owning preferred stock. Among many other similar topics.

12) Magic Leap tech and vision are quite cool btw. Cannot wait for AR to be a widespread reality.

Also feeling quite triumphant that I kept this to only 12 tweets as I do believe brevity is the soul of wit and it’s obviously not a strength of mine. 😃


You can follow @GavinSBaker.



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