
Pump and Dump: How To Rig the IPO Market with $20M - dualogy
http://wolfstreet.com/2014/08/28/how-to-rig-the-entire-ipo-market-with-just-20-million/
======
api
One of the most depressing things I've heard in my life came from a VC type
around 2007.

He basically told me straight up that working hard to build a real business
with real value was a sucker's game. Every example he'd seen of people making
real money was -- as he put it -- from "equity plays."

By equity plays he basically meant this kind of thing. I started calling it
"hype, leverage, flip." If it were just a lot of harmless hot air that would
be one thing, but what's _really_ happening here is wealth transfer from
honest and productive sectors of the economy and from the long-term savings of
the population (e.g. pensions) into the chip stacks of high stakes gamblers.

Throughout history, gambling has always been one of the favored pastimes of
decadent nobilities. Today's gambling is particularly clever, as it has the
outward appearance of productive work. I cannot help but see today's financial
elite in powdered wigs, and probably merkins too. Guillotines can't be far
behind.

Luckily there are a few honest VCs and angels, as well as a new emerging
financial system built around crowd funding and peer to peer finance. That's
the future. When the guillotines fall -- literally or metaphorically -- the
new distributed financial system will take over in the same way that
mercantile and industrial financial systems took over after the fall of
Medieval feudalism.

------
claudiusd
I'm not surprised to see this coming from KPCB. They have a reputation for
using underhanded tactics and this is just the latest example.

I unfortunately learned about their reputation too late... they pressured my
company into signing a Series A term sheet only to pull it 3 months later (at
the end of the no-shop) after _THEY_ messed up a partnership negotiation.
Needless to say we were out of cash at that point, but luckily we had some
great seed investors who re-upped and a month later we signed a term sheet
with another VC. What a nightmare though.

~~~
dchuk
Can you explain how they went about just pulling the term sheet even after you
guys signed it? Sort of in a nebulous situation with our own investors right
now and would appreciate chatting with someone with a similar experience.

You could also email me at me@dchuk.com if you'd prefer.

~~~
claudiusd
In general, the only "binding" part of the term sheet is the "no-shop clause",
which doesn't let you solicit additional offers from investors, usually for 3
months. It otherwise represents a handshake on terms so that the VCs have time
to perform diligence and produce the paperwork (which is substantial) while
the founders find strategic investors to fill up the round.

Either party can still back out of the deal at any time, and this typically
only happens when something bad emerges during the diligence process. It's
important that startups can trust this fact because agreeing not to solicit
investment for 3 months while (presumably) running low on cash is a pretty big
risk. KPCB broke this trust in our case.

Feel free to email me at the address in my profile if you'd like to chat more.

~~~
spitfire
Thank you for being out in the open about this.

The VC's have a lot of money to run their PR machine, but no one ever hears
the negatives about them. It's important to a functioning market that the
information is out there.

------
_yosefk
Wow! Yardstick Capital at work:

"37signals is now a $100 billion dollar company, according to a group of
investors who have agreed to purchase 0.000000001% of the company in exchange
for $1.

Founder Jason Fried informed his employees about the new deal at a recent
company-wide meeting. The financing round was led by Yardstick Capital and
Institutionalized Venture Partners."

(from [https://signalvnoise.com/posts/1941-press-
release-37signals-...](https://signalvnoise.com/posts/1941-press-
release-37signals-valuation-tops-100-billion-after-bold-vc-investment))

And I thought it was fiction.

------
lquist
This shows a lack of understanding of the structure of late stage VC deals.
These are convertible notes, not straight equity. Also, what is the
liquidation preference on this round? My guess is that this $20M note is the
most senior debt, so if there is a wind down, they get their $20M first. So,
KPCB has hedged some of the downside. And this is the important bit: their
hedge increases as the percent they take in the round decreases. In a
bankruptcy, they could probably at least get $20M out of the company.

~~~
sutterbomb
You seem to be missing the premise of the argument. You're right that they
hedge the downside on this individual deal, but the point is that the upside
for this individual deal is still small for KPCB. So why would they do it? Not
because they're expecting an upside on that deal, but because inflating the
valuation of a darling at a low cost will create a frothier overall valuation
market for their portfolio.

------
chiph
> In numeric terms they have invested less than $30 million since last
> November, meaning that they have been able to leverage an $8 billion
> valuation gain at a ratio of 266:1.

Holy crap.

Reminds me of "Investment Grade Beanie Babies"

~~~
7Figures2Commas
Your "Investment Grade Beanie Babies" are crucial to the Silicon Valley
ecosystem right now.

When these carefully orchestrated valuation maneuvers meet liquidity (and in a
lot of cases _some_ liquidity comes pre-IPO), a lot of the money is invested
back into the Valley. Those with it become angel investors and limited
partners in venture funds, or start and fund their own companies, perpetuating
the cycle.

This in and of itself isn't a bad thing, but anybody living and working in
Silicon Valley should contemplate what will happen when the music stops. Even
if you're just an average engineer with no real exposure on the equity side,
less capital chasing opportunity will lead to fewer startups, and less heavily
funded startups. Fewer startups competing for talent will mean fewer jobs and
downward pressure on wages. Obviously, major companies like Google and
Facebook aren't going anywhere any time soon, but the $1xx,000/year early-
stage startup jobs are going to be harder to find, especially at the junior
end of the market, and the days of being able to jump from six-figure job at
unsustainable startup to six-figure job at unsustainable startup in a matter
of a few days or weeks will be a thing of the past for most.

This could happen two months from now; it could happen two years from now. But
it _will_ happen. Given the valuations we're seeing and the increasing
difficulty with which the Fed is maintaining the status quo, I think one has
to be prepared for the possibility that we're closer to the end of the cycle
than we are to the beginning.

~~~
otakucode
No, most of the money doesn't go back into the Valley. It goes into the
financial services industry and it stays there. Forever.

~~~
7Figures2Commas
First, I never wrote that "most" of the money is reinvested in the Valley. I
wrote that "a lot of the money is invested back into the Valley." Need
evidence? Take a look at any of the increasingly common million-dollar seed
stage party rounds and who the investors are. It's not cattle ranchers from
Texas.

As for the financial services industry ("Wall Street"), this doesn't exist in
a separate bubble. Who led Uber's recent $1.2 billion round? Fidelity. Who
else participated? Blackrock and Wellington Management.

------
debt
Word on the street(in SF) is that bozo investment firms like K9 are
potentially ruining the whole the market by significantly skewing valuations;
basically, _they don 't know what they're doing_.

These firms are like that scene in _Jurassic Park_ when Jeff Goldblum's
character tries to distract the T.Rex and ends up getting thrown into the
outhouse by it. You have potentially valuable companies like AirBnb, Uber,
etc. but the whole market is being skewed by completely outrageous valuations
for products like Snapchat or Lyft.

I don't think it's intentionally malicious(by K9 and other firms) I think they
think they know the value of these companies and that value is really high(in
their minds) when it's really not. It's going to get worse and worse until
pop. But the real ones will survive.

 _The problem is it 's going to affect investment in potentially viable
companies in the future._

Fool me once(2000), shame on you; fool me twice(2015), shame on me.

~~~
davidu
K9 isn't a firm being discussed here. Manu is an awesome guy who helps get
companies off the ground.

------
ChuckMcM
This article seems to forget the 'horrible' Facebook IPO where the stock went
nowhere. Or that companies like Box who were going to IPO and then pulled back
(presumably from a lack of enthusiasm on the road show). Or Groupon, or Zynga.
There are lots of wounds not fully healed out there keeping the IPO market
fairly rational.

That said, the article says Snapchat has raised $160M. If you push them to
take money at a high valuation, you can cut them off at the knees when they
run out of money. No IPO required, just sell off the company to one of the
existing players for your liquidation preference and maybe a small premium.

I will be quite surprised if Snapchat tries to IPO before any revenue, but if
they do make that leap I'll be really interested in watching the market
response. That would be a good data point for bubble/notbubble arguments.

------
squigs25
I want to point out a few problematic components with this article:

1\. For KPCB to exit, they need to find an investor that values the company
more than they do. To find an investor who values an unprofitable picture
sharing company at over 10B would be a difficult task. It will probably be
possible to find retail investors to provide the exit strategy, but the big
tech companies of the world (Google, Facebook, etc.) do not have incentives
for buying out unprofitable poor performing companies with no future. They
have an agenda, and their CEO's are looking for strong future revenues because
they themselves are heavily vested in the companies which they work for. These
are savvy people with a team dedicated to valuing M&A transactions. There is
no good reason for a large tech company to acquire a snapchat unless it thinks
it will contribute to the bottom line, the brand, the network, the IP, or the
scale of the existing business.

2\. There's this incorrect notion that VC firms are somehow not exposed to the
risks of the market. Times are good right now, and if you're a VC firm, you
should be making a profit right now. A typical pump and dump occurs because of
timing effects, insider knowledge, and mass marketing. While you could argue
that an IPO is a "mass marketing", I think that external financial
institutions (hedge funds) are very much looking out for shorting
opportunities. An overpriced IPO is a great opportunity for a hedge fund.
Also, It's worth mentioning that the VC firms which will profit so nicely this
year, are likely to lose 50-80% during a downturn. They are very much exposed.

3\. If KPCB really wanted to profit, why only invest 20MM? This won't make
them much money. The real reason they made this investment is because they're
skeptical of snapchat, but still want the talking point if there is an upside.
It will be a great story for investors, pretty much regardless of how snapchat
exits.

~~~
chetanahuja
I think you may have missed the point of the article. The whole thing about
not really caring about this $20 million but using it to "signal" the wider
market (and thus generate higher valuations on their other investments going
IPO or being acquired) was the whole point.

------
TaoloModisi
The valuation raises as many questions, as the Whatsapp deal did and relates
to the difference between price and value. To justify a 10 billion valuation
on a company that makes no revenue makes nonsense, especially when looking at
the fundamentals (earnings/cash flows, growth and risk). The simplistic
attempt at making sense of the price is to look at the correlation between the
market's assessment of corporate values and each of the measures and you will
see that: 1) Number of users is the dominant driver. The key variable in
explaining differences in value across these companies is the number of users.
The pricing game is not about what you or I think makes sense, but what
traders care about. 2) User engagement matters: The value per user increases
with user engagement. Put different, social media companies that have users
who stay on their sites longer is worth more than companies where users don't
spend as much time. While making comparisons across companies is difficult,
since each company often has its own "measure" of engagement, there is
evidence that markets care about this statistic. 3) Making money is a
secondary concern (at least for the moment): Markets (and investors) are not
completely off kilter. There is a correlation between how much a company
generates in revenues and its value, and even one between how much money it
makes (EBITDA, net income) and value. However, they are less related to value
than the number of users. Snapchat is said to have 100milion Monthly active
users- Whatsapp-hit 600million monthly active users recently, but only had
about 300million users at the time of the Facebook transaction.

------
ojbyrne
Somehow I'm hoping that the most important phrase in this piece is: "The deal,
which apparently hasn’t closed yet"...

------
rokhayakebe
A company does not always need to sell at higher valuation for an investor to
earn profit. It may be very possible to invest in SnapChat at $10B valuation
and still rip a benefit if they sell for $2B.

~~~
HockeyPlayer
Can you explain how?

~~~
rokhayakebe
When someone invest 200M at a 1B valuation (for 10% ownership), remember that
only the $200M are real at the moment. The rest, $800M, is "confidence in the
team + hope in the market." This is especially true when the company makes no
revenue.

So in the event the company sells for $300M, the investor get first get his
$200M out. Then get 20% of the remainder. He won.

------
spindritf
Where's the "dump"?

~~~
jcampbell1
Mom and pop investors who own facebook stock in their retirement accounts paid
$2B to VCs for Oculus VR.

I don't second guess Mark Zuckerberg, as that is a consistently losing bet.
That being said, there is no reason the price should have been $2B. The frothy
prices, mean that a $100M company was priced at $2B and that dumped a lot of
money from Mom and Pop to VCs.

~~~
gtCameron
They have also seen a 78% increase in stock price over the past year so maybe
using Facebook shareholders as an example isn't the best way to make your
point

~~~
dualogy
Yeah but that's the funny thing about pension money going into equities. They
have "seen" the 78% increase but not _realized_ it unless they cashed out
their accounts and retired right then. Wall St / US pension funds turned
everyone into "investors" while mom & pop still think the funky numbers on
their statements are their "savings". I mean I'm simplifying, I'm not a US
subject, but that's what it seems like from afar.

------
rokhayakebe
Question: Why don't founders control valuation if it is exceeding what they
believe to be the true value of their company?

~~~
drewvolpe
They do. If they want to give investors a lower valuation, they can. But why
would they ?

~~~
yumraj
For fear of a down round - but most don't think that far.

Basically let's assume a company raised money on a $10B valuation, and needs
money down the line for a variety of reasons. They will have to make sure that
the future round is at $10B+ which may or may happen, especially if the
company is not flying high at that time. And, if they can't raise at $10B+,
they'll have to go for a down round which can look very bad.

------
danielweber
Levine has a much more responsible review of this deal.
[http://www.bloombergview.com/articles/2014-08-27/levine-
on-w...](http://www.bloombergview.com/articles/2014-08-27/levine-on-wall-
street-ephemeral-valuations)

This existing post is extremely aggressive and over-the-top.

------
jakozaur
New VC model: ignore about that valuation number. Just get X preference (like
4x+).

Then higher valuation works even better for you. Oh Facebook you really need
to pay at least 6 billions, b/c we valued them at 10. Such a great deal. VC
enjoy your 300% ROI.

------
calcsam
Most VC firms also get to value their investments at the value of the last
round of funding, so this creates a paper win for them with LPs. The main
reason why you'd want to do this is if you are raising another fund...

------
fiatmoney
It's not "rigged" if no one can actually sell out at the inflated price.

------
snowwrestler
EDIT: The link has now been updated, thanks HN mods!

\------ My original post:

I was with this piece until it went off the rails, deep into the swamp of
Federal Reserve conspiracy theories.

If you're interested in the title, I'd stop reading this article after about
the 6th paragraph. After that, you're in the swamp.

Or just scoll to the bottom and read the real, original article. (Mods, I'd
recommend switching the link to that article, which is actually about
SnapChat):

[http://wolfstreet.com/2014/08/28/how-to-rig-the-entire-
ipo-m...](http://wolfstreet.com/2014/08/28/how-to-rig-the-entire-ipo-market-
with-just-20-million/)

~~~
api
Conspiracy nuts have a way of being right about the particulars and pretty
astute at spotting trends while simultaneously being bat-dookie bozo about the
overarching mechanisms behind it.

All the surveillance state stuff that the wacky Bill Cooper types were ranting
and raving about in the 90s has all come to pass, often in weirder and more
alarming ways than they predicted. Yet I'm still waiting for my 666 stamp, nor
do I see very much Masonic influence in things.

A conspiracy theorist is kind of an investigative journalist with bad
epistemology and a poor understanding of how the world really works. They see
the smoke and correctly extrapolate the fire, but they think fire is
phlogeston excreted by underpants gnomes.

The reason they're so often right probably boils down to the fact that as
loony outsiders they've got no vested interest in towing the official party
line. So they're able to say really contrarian things and not give a damn.
According to Pravda, stocks always go up. Saying different is not a good way
to advance your career in the Party.

~~~
mbca
Great comment, pretty much agreed on all points. One minor correction -- it's
"toeing the line", not "towing":

[http://en.wikipedia.org/wiki/Toe_the_line](http://en.wikipedia.org/wiki/Toe_the_line)

------
bizocean
give me a break

