So, if I’m following: Banks are lending to private equity firms to fund purchases of businesses.
Many of these businesses are SaaS which means their valuations are tumbling.
It seems possible that valuations tumble so much that the private equity owner no longer has any incentive to operate the business, bc all future cash flows will belong to the bank. What happens in practice then? Will banks actually step in and take operational control? Will the banks renegotiate terms such that the private equity owners are incentivized
to continue as stewards? Or, will they prefer to force a business sale immediately?
> Banks are lending to private equity firms to fund purchases of businesses.
Yes some businesses are SaaS but here's the real problem: Many businesses' sole purpose is _leveraged buy-outs_ which really is the devil in disguise.
It goes like this: A VC specialising in veterinary clinics finds a nice, privately owned town clinic with regular customers and "fair" prices, approach the owners saying "we love the clinic you've built! We'll buy your clinic for $2,500,000! You've really earned your exit!".
So now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books_. So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly, ~~burn out personnel~~ slim operations accordingly, and any surplus that doesn't go to interest and amortization goes straight to the VC.
> now the VC lends the money from the bank, buys the clinic, and here's the important part: _they push the debt onto the clinic's books
This mostly correctly describes a leveraged buyout (LBO). LBOs are done by LBO shops, a type of private equity (PE) firm. Not VCs. (VCS do venture capital, a different type of PE.) And LBO debt isn’t “pushed” onto the company’s books, it’s never on the sponsor’s (LBO shop’s) books in the first place to any material extent.
Private credit, on the other hand, involves e.g. Blue Owl borrowing from a bank to lend to software businesses, usually without any taking control or equity. It’s fundamentally different from both LBOs and VC or any private equity inasmuch as it doesn’t have anything to do with the equity, just the debt. (Though some private credit firms will turn around and lend into a merger or LBO. And I’m sure some of them get equity kickers. But in that capacity they’re competing with banks. Not PE. Certainly not VC, though growth capital muddles the line between what is VC and other kinds of PE or even project financing.)
> And LBO debt isn’t “pushed” onto the company’s books, it’s never on the sponsor’s (LBO shop’s) books in the first place to any material extent.
Doesn't the LBO shop still need to pay off the debt, technically speaking? AFAIU the company's assets (hospital in OP's example) are used as collateral in a credit agreement between the LBO shop (as the hospital's new shareholder) and the bank. But unless I'm mistaken, this is not exactly the same as the debt being on the hospital's books and the hospital having a credit agreement with the bank. (For an increase in debt on the liabilities side of the balance sheet there would have to be an equal increase of assets on the other side. The hospital didn't receive the cash, though, nor does the hospital suddenly own itself.)
LBO firm will create a new company called Acquisition Co. ("AcqCo") and put $500K of cash into it (equity). The Blue Owl will lend $2M to AcqCo (debt). AcqCo uses the $2.5M to buy the vet clinic. AcqCo will use cash flow from vet clinic to pay Blue Owl loan interest. If AI makes vet clinic lose revenue because customers treat Fluffy's ear infection at home, then Blue Owl and LBO firm are in trouble.
So the debt isn't "pushed" and it's not risk-free as the original comment said... also not Venture Capital. Lots wrong in that comment.
It's not risk free for the companies involved. Limited liability protects private assets which is the original motivator behind all of this. And yes, there could be alot of book cooking going on to extracting liquidity. Over here, we call them locusts, not PE and externalizing risk is kind of their job.
This is the general leap, wealthy dynasties do. They scale up from a regular (family) business that provides services (eg. the clinic) to eventually transition into investors with lesser or indirect motivation of providing services/goods.
Sure, it should say PE not VC. But it was pretty accurate. The PE firm won't be on the hook for much of the debt. The nano-debate over the word "push" is probably obscuring more than it's revealing.
If you work in a PE shop you’d know it’s not riskfree and that the PE firm also puts their own money up plus money raised through LPs (hence “leveraged”)
> PE firm also puts their own money up plus money raised through LPs (hence “leveraged”)
This is not true. PE firm individuals put their own money in a fund, which also has LPs money. That fund is used to acquire businesses and in order to fund a transaction they use both equity (capital from that fund) and debt (loans from banks) to fund the transaction. The debt is the "leverage" part of the equation...hence leveraged.
The lender generally has a positive EV, but variability is high. The interest rates on leveraged buyouts are high, and the lender has priority over everything but taxes. If the company can stay afloat for a while, the lender probably got made whole and then some, even if the full loan never got paid back.
It’s the same as buying a house. I want to buy a house for $1.2m. I put down $200k and borrow $1m. The bank determines the value of the house. My equity absorbs a 20% drop in prices, so the bank is fairly protected. Businesses are different because they really can go to $0. Banks will need more collateral and/or make many different types of loans to dilute the risk.
Any one loan may be risky, but in aggregate the rates compensate for it.
They pay you 0-4% for the money in your checking account and lend it at 1-3% points higher. As long as they have a big enough uncorrelated portfolio, they make easy money.
And if the whole portfolio tanks all at once, the whole industry gets bailed out.
The latter. Big Banks lend to private equity because the profit is good and they are large enough to absorb the variability.
The public hates it because they see highly visible bankruptcies. They don't see the success stories, or the businesses successfully carved up for more value than the sum of their parts
> Why does Blue Owl borrow from a bank to lend? Why would it need investors if it borrows from a bank?
Leverage. They raise money in their public funds. And then they borrow, typically around 50% of their capital, to amplify returns.
Note: “Private credit lenders won’t lose money before private equity firms do. That’s how the capital stack of companies work: Equity is the first in line for losses. Before lenders like Apollo Global Management, Blue Owl Capital or Ares Management lose a dollar on their loans if a portfolio company fails, the private equity owners will already have been hit” [1]. Leveraging the senior debt is actually less risky than leveraging the underlying equity. (Though obviously they compound when done together.)
For the gp: the other side of the risk/reward coin is that private credit has limited upside. They're going to get the margin between the private 6/7/8/9/10% loan and their funding source + admin. Whereas PE can go “to the moon” if things work out.
I think the free market response is that another vet with fair prices will show up, but A) that's a waste of everyones time and very inefficient and B) a real grass roots business takes time and passion, somebody to start it, buy in from the community etc.
That work had already been done. To throw it all away for VC or PE to squeeze the life out of it and by extension the community, that's just sad, and a net negative for society. I don't really care about who to blame, the PE or the business owner who sold, the process is destructive.
The business owner is in a job that takes a huge amount of their life, with a suicide rate four times higher than average.
People accuse veterinarians of being in it for the money, the same day another owner decides to euthanize their dog because they don't want it anymore. While an angry owner on social media is rallying pitchforks over something that the vet can't even respond to due to privacy standards.
I have no sympathy for PE that's wandering around our lives, destroying the actual purpose of businesses to extract profit from everyone they can.
Waste and inefficiency is real. As unpalatable as it is, cleaning up the mess of decay often requires brutal methods. That begs the question, is waste and inefficiency socially undesirable? Maybe not. Maybe not on certain scales or in isolation. But waste compounds.
A certain amount of inefficiency or slack is necessary buffer in any system to reduce brittleness. When a problem occurs, a system that is running with 50% slack can recover more easily than a system with 5% slack.
See Germany's rail network, where almost every time-slot is occupied by a train, and then one train is delayed, and the system collapses with nobody getting to their destination on time for the rest of the day, until the overnight buffer.
In queuing problems, queue length (which means latency) is inversely proportional to slack time. If a network link is running a 90% capacity, on average there are 10 packets queued up and a packet that arrives will have to wait for 10 packet transmission times. At 99%, 100. At 99.99%, 10000. And if you try to use exactly 100% of your network link, the expected queue length is infinity, and the expected latency is infinity, which will not occur in practice because sometimes it will exceed available memory and packets will be dropped, even though utilization never exceeded 99.9999...%.
> So all of a sudden the nice town clinic has $2,500,000 in debt, raise prices accordingly...
From a financial engineering perspective this is wrong.
Both equity and debt have costs of capital. Debtholders expect interest, capital holders expect RoE. The money going to debt interest is money that would previously have gone to equity, but now does not because the equity is replaced with debt.
Crucially, the costs of debt is lower than the cost of equity because of the interest tax shield. Therefore, the vet clinic now requires less revenue to maintain or even increase its return to equity.
Technically true, but RoE expectations from a PE firm are typically a lot higher than from the original owners of a small business.
And the LBO model is much less resilient to economic headwind. Let's assume a 25% EBITDA margin business, with most costs fixed (like the clinic example). Unfortunately revenue drops 20% because of external factors. It would maybe have a tiny profit left, tax would also be tiny and there is no interest to pay. The shareholders receive near zero, absorbing most of the problem for a year waiting for times to get better.
Now the same business, same reported EBITDA, but paying a large interest sum every year to the bank. If revenue drops 20% they can't pay their interest, and banks don't just wait for next year. Now the business has the restructure, agree with the banks what that looks like, or face a bankruptcy risk.
While the new PE shareholder has a better RoE due to leverage in the upside scenario, the business (and the PE) could be completely cooked in a downside scenario. For the PE this is a calculated risk, they optimise the overall portfolio. But for the employees and customers this isn't a great scenario.
> the vet clinic now requires less revenue to maintain or even increase its return to equity
The small-town vet would have probably accepted a lower RoE. More critically, they’d have been more willing to absorb shocks to said RoE than a lender will to their debt payments.
Small businesses are notoriously bad about calculating RoE; bookstores that own a building that would rent for way more than they ever make in a month, etc.
The free market solution to this seems to be making it easy / easier for competitors to arise. Then, when private equity does this, the customers, and workers, just hop ship to a competitor that's better managed and the original clinic goes under.
I don't expect this happens in reality though. In general the things that happen in a healthy free market are NOT happening in our society.
This completely discounts the work involved to find service providers you trust. I spent a long time finding a Doctor I trust, finding a Vet I trust, etc. I don't want a "free market" solution where I need to switch providers every 6 months because some rich dude is being a dick.
This is the problem with so many market focused solutions. They discount the burden put on the consumer.
Participating in a market is work, the only way a market (or life in general) works is if you hold your counterparties accountable.
> I don't want a "free market" solution where I need to switch providers every 6 months because some rich dude is being a dick.
Nature does not have a mandate that good quality services and products be available at low prices at all times. The rich dude being a “dick” was a tired vet owner who wanted to sell their equity, just like anyone else who sells their SP500 shares or their house.
The only thing that can be done is encourage government policies to ensure more sellers exist.
If the market is healthy, there will already be two or three providers in town instead of one that has any sort of monopoly, and the LBO won't be lucrative to begin with.
In a perfect world we'd have antitrust enforcement all the way from the top of government down to the municipality, so that this kind of behavior could be curbed. But I bet few cities bother to try at all.
You’re confused because you are treating free-market and capitalism as the same thing.
Capitalism is about who owns the assets, free markets are about how they are transferred. They don’t require each other. State owned enterprises can participate in the free market, an example are municipal utility companies. Private enterprises can operate without a free market, an example would be Lockheed Martin, whose defense business is mostly cost plus contracts.
The US hobbled the free market with deregulation since the 1980s. We encourage monopolies with strange reactionary legal precedent, use tax and other policy to establish price floors on residential units and health procedures.
The behavior that these firms are able to carry on with in veterinary, dental, dermatology, hvac and plumbing is anti-competitive and predatory.
Fewer businesses. But that aside when people say regulations are costly without providing specifics typically they are upset they can't rip off the public, pollute the environment or perform other acts to the disadvantage of the population.
They're not so silly as to have any personal or professional liability, they probably spin up a special purpose vehicle or llc to hold the bag if it all goes south
It’s analogous to a mortgage in a non-recourse state. If the borrower defaults the bank (or non-bank lender) gets the leveraged company, but can’t usually go upstream.
Ohhhh a live one! Sir do I have a wonderful bridge in Brooklyn to sell you! :)
Fun fact: banks fund this sort of nonsense constantly. I've asked about this before: why they do it. They must be making money I just don't know how. The LBO guys pay themselves massive management fees and dump the debt on the company so they walk away scott free.
My wild guess was the banks offload the eventual IPO onto investors and so make their money on the IPO fees and funneling their own clients the dead-man-walking shares. But I honestly don't know.
> wild guess was the banks offload the eventual IPO onto investors and so make their money on the IPO fees and funneling their own clients the dead-man-walking shares
The banks get paid back their debt when the next PE fund buys the company or the company pays it off. Unless an IPO is being done to pay off debt, which it never is, the mechanism you describe doesn’t occur.
The list of companies imploded by LBO/PE is quite high though. Why do banks keep lining up to fund such deals? They must be making money somehow. These companies aren't worth much in liquidation. Are they able to extract enough value during the dead-man-walking period to make it worthwhile? Especially for retail or similar deals where the bank isn't going to foreclose on a bunch of real estate or assets worth selling.
I was not saying this is how they make money - I was saying I honestly don't know. If you do know please share. I would love to understand why the banks are so keen to fund what looks to my eyes like super shady vulture capitalism. We start with a profitable company and end with a smoking husk. The Wall Street guys are doing it to steal as much value as they can before it all blows up. Someone is eating the eventual loss. Who? Or are you saying the majority of these deals don't end up with the company being eviscerated?
The usual arrangement for an LBO is to saddle the bought company, the vet in this example, with the debt,or spin off a secondary company from the vet with the poorest assets and most to all of the debt. It's all a scummy business.
This is exactly what happened at a SaaS company I previously worked at. It was an awesome company with ~1500 employees, turning a small profit. Private Equity comes along, buys it with ~$2B in debt. Sticks the SaaS company with a $100M+ annual interest payment. Round after round after round of layoffs ensued. Then interest rates went up... and it got even worse.
I think they are under 500 employees now. They basically laid off almost all of engineering and hired 100 new contractors in India to completely rebuild the entire platform in Node.js, as if the language it was written in was the problem. So glad to be far from that dumpster fire.
Really disappointing to see a great company gutted by some private equity people who almost certainly got their bonuses before the shit hit the fan.
I don't understand: Who's lending the $2B in situations like this? Wouldn't they be worried that the above situation (company gutted, then going down the drain) is going to play out and they won't get their $2B back? Or is that the root problem with this whole YC submission: banks are being hit by defaults because of this exact problem?
It's from the rapid exploitation of an asset. If I have a cow, I can milk the cow or kill the cow. If a cow costs $1, maybe I can get $5 worth of milk over the cow's lifespan, or I can kill the cow immediately and get $2 of meat. The man with $100 who buys all the cows in town and kills all of them doubles his money in a short timespan, but now there's a shortage of both meat and milk next season.
That is the exact problem. The people who put up the $2B thought they were safe - after all they were putting up money to buy a successful profitable business.
Problem is they didn’t really understand the business and trusted the PE guys to keep running it well…
This was driven home to me at SaaS company with > $80M ARR when the new CEO was parachuted in by the PE owner said in an all-hands "and we're close to cashflow positive when we account for our interest payments..." How can a software company generating this much subscription revenue NOT be making money? When it's servicing the > $500M the PE firm used to buy it. The rest of the playbook was boringly predictable: cut costs, sign multi-year enterprise deals, sell before the current fund's horizon and hope the music doesn't end.
As a result I prefer the naked greed of VCs where everybody - VC, owners, employees - knows the plan is IPO because at least it's transparent compared to the dirty lies a lot of PE pushes.
It's the destructiveness that gets me. It's a perfectly good company, employees are happy, consumers are happy, profit is being made, it's sustaining itself... Then they come and just literally destroy all that.
This can't be good for society. I wonder why it's just not criminalized somehow.
> It's a perfectly good company [...] I wonder why it's just not criminalized somehow.
Not-an-expert here, but I think part of the problem is that it's hard to draw a nice legally-enforceable line that would distinguish when it's a "perfectly good" company versus one crying out for intervention.
For example, suppose a company is floundering because of executive mismanagement, outrageous compensation to the C-suite, etc. In that case, someone could LBO in, fix things up, and then sell the revitalized thing later and make a modest profit while improving the world.
The way I see it, it's literally simply the PE paying the existing owner for the privilege of squeezing the value out of the business and its customers in the short term (or in the ideal/theoretical case, running it more sustainably and making higher profits). Management's job becomes to extract high profit in the short term, not to keep the company running profitably.
So, logically, selling to PEs/operators who are known to do this is basically the owners selling out and taking the cash. The consequences are clear to anyone who's been watching.
I saw another model where the PE buys a hospital. They sell the land under the hospital, everyone gets a cut, then they spin out the hospital. Now the hospital has to pay rent on the land it sits on.
It seems like almost every decision made is for short term gain, at the cost of long term viability.
If the VC borrows money from the bank and lends it to the clinic, the clinic is not on the hook to the bank. The clinic is on the hook to the VC and the VC is on the hook to the bank. Which means that if the clinic goes under, the VC takes the loss because it still has to repay the bank.
(Edit: To be clear, I agree with the other commenters that none of this is what VCs do. I'm just pointing out that the way this is being described doesn't even work on its own terms. Needless to say, LBOs are not "risk free".)
Nope. The clinic is the collateral to the bank. VC stand to loose nothing.
It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This can be done in about 6mo to 1 year process with some companies. The initial out of pocket expense is small and paid back very quickly.
I also forgot. Sometimes they will take the newly owned company and merge it. During that process they extract more money and load more debt onto the remaining entities, again making the VC money.
In some cases they can even get huge tax benefits by loading the company with debt which offsets the tax bill of the final entity.
When these transactions are done, within the span of a day multiple companies are created and merged and absolved.
> The clinic is the collateral to the bank. VC stand to loose nothing
This is actually a case where using the correct terminology clarifies.
VCs don’t do LBOs. Private equity firms do. When their deals go bust they lose the equity they invested. That equity is the first layer to take a loss. When that happens, the lenders—whether they be banks or private credit firms—take over the company, often converting some of their previous debt into equity.
There is a lot of risk in LBOs. It’s why they have such a mixed record.
PE includes buy-out (leveraged and not) and VC transactions. PE is typically any medium to long term equity investment not traded publicly on an exchange. Even this is cloudy now that the PE firms themselves are going public.
LBOs are also not a black and white classification, at least not the way they were in the Gordon Gecko 80's, with varying levels of target-borne debt financing specific to the deal. So while I agree "VCs don't do LBOs", PE does both LBOs and VC deals, with the PE firms doing their own style of fund and deals.
> this is cloudy now that the PE firms themselves are going public
The public or private status of the manager has no relation to private equity being cloudy. Out of all of the delineations, PE is a pretty sharp one. VC is PE. Private credit is not. It’s private debt. Not equity.
> It does not happen overnight. But what happens is after they take control of the clinic or company they change the sales model to boost reoccurring revenue, this then allows the clinic or target company to take loans out. Because they look good on paper. The company then pays VC back when then pays bank back.
This was the missing bit for me. Thanks for taking the time to explain!
The PE sales pitch is often that the target company can benefit from expertise management and/or there is value locked in it that can be captured. Both of these claims are... marginal? Studies around the "expert management" claim tend to show this is not true, based on pre/post returns, but it's hard to account for the long term, because PE also tends to focus on sales with very specific characteristics & time horizons (and associated cost savings) that benefit a 5-7 year fund that sells the portfolio company (wait for it) around years 3-5.
Which is a long-winded way of saying the bag holders are anyone invested in the long-term success of the company: 1. employees, 2. customers, 3. owners (i.e. the next PE fund) when the music stops, i.e. what we saw when interest rates went up impacting debt financing, and (real or not) AI-eats-SaaS impacted valuations. I'll add 4. "the public" if the company is big enough, with various levels of goverment and employment, taxes, etc. lost but I think it's more the smaller organizations in aggregate that hurt at this level than any specific company.
An acquisition like that would have non-compete restrictions. And often the previous owners don't get 100% cash, they would receive part as shares in the new holding company.
Yeah, they thought about it well on how to shackle, extract and leave a husk behind. What about the clinic's long term success? Not in their plans, they just want to extract cash from the customers as fast as they can. I'm sure that if people organized well enough and change their mindset they'd find workarounds to these financial engineering scums.
About eight years ago I had a chat with a physician in Texas, who had a several year old private clinic that he was planning to sell within a year to an investment firm, and it wasn't the first time he had done this. I expect all those urgent health care clinics that show up follow a similar path.
I mean, just getting new management, improving efficiency and raising prices of any business is… normal business?
Whether a PE firm decides to buy it and do the same isn’t some nefarious act or special in any way, it’s just new owners.
Let’s say your neighbor has a lawn mowing business but wants to retire, says they’ll sell for $50,000. You think great! You could run the business better, plus the old man hasn’t raised prices since 1990! But you don’t have $50k, only $30k, so you borrow $20k from your brother. Congrats, you just did a leveraged buyout.
And no, it’s not risk free revenue (I think you mean profit?) because it clearly might go under and PE firms need to pony up some of their own cash too plus money raised through LPs.
So yes, PE funds are probably overvalued right now and there are a lot of PE funds getting rich off management fees while not providing promised returns...but this comment is so wrong I don't know where to begin.
First, VC stands for venture capital, which is a subset of private equity that does zero LBOs and doesn't even acquire any businesses. VC funds buy equity in startups, and take on zero debt to do so. You have your boogiemen totally confused.
Second, the entire point of a PE fund that uses a leveraged buyout strategy is that they need to sell the acquired firm at a profit to make any returns to the fund. LBO funds don't 'cashflow' businesses, and saddling a business with a bunch of debt is antithetical to that purpose anyways.
Third, this is not "risk free revenue." It's a high risk strategy to use the debt to increase the value of the business by improving operations enough that you can sell it for a profit to the fund. If you saddle a company with debt and DON'T increase the value of the business beyond the debt you took on, the PE fund will not be in business for fund 2.
The risk-free revenue while the fund is alive comes from the management fees that investors in the fund pay (usually 2%, which is way too high IMO, but has nothing to do with the debt or the acquired businesses).
Please do not write confident sounding comments about things you don't understand, it spread misinformation and makes the internet a worse place.
It is absolutely possible (and even likely!) that a bad PE fund was the cause of the issue you're talking about. But there is also a media hysteria around PE, and a lack of understanding among the general public of what it is.
It's just as likely the business that was acquired was already failing or unsustainable to begin with (hence why the owner wanted out at low multiples). LBO funds don't acquire promising businesses at 5-10X revenue like tech companies do, they usually buy businesses at low multiples that are past their prime or failing in an attempt to revitalize them (with debt, since you can't raise capital by selling equity in a failing business).
Obviously this will not always work out great, given the trajectory of target companies was already not great to begin with. Momentum is the strongest factor in all markets.
The problem is, Private Equity has become a conspiratorial catchall boogieman and scapegoat for every problem under the sun, so it's hard for me to assess without further details of the situation.
Nit: beta is the strongest factor in all markets. Which is actually relevant for the success for PE funds in general, as a rising tide lifts all boats and people taking on debt to finance equity generally post outsized returns in bull markets.
Anyway, the rest of the stuff you're saying I agree with.
Yes, beta is the overwhelming source of returns. I was referring to factors in the sense of the University of Chicago research on market inefficiencies (where momentum is the strongest factor for inefficiency).
If you buy a “factor-weighted” etf the idea is it’s tilting you into those “factors” away from pure beta like buying whole market.
PE you could argue is largely just leverage plus an illiquidity factor play, since if PE just returned beta (which these days it might!) you’d be smarter to buy the S&P500 with equivalent leverage and not pay crazy fees.
Background: I work for a PE-owned company and I have friends in PE (associates up to MDs).
On your second point: LBOs aren't the only tool in the toolkit, and it's not as popular as it was decades ago, so I would lean towards the parent simply conflating "buying an ownership stake in a business in some capacity using other people's money" with the strict definition. Regardless, yes PE firms need to figure out how to get 20%+ IRR throughout a short timeframe (usually a 5 year holding/funding cycle) -- however this is through any means necessary. Philosophically, it's about increasing efficiency of operations and growing the business. In practice, it's financial engineering because PE firms do not have the operational skills to make any value-added changes to firms besides driving costs down.
Saddling a business with debt is reductionist. I've seen absolutely nonsensical financial structures that make no sense for a layman, but in practice end up "using the business' finances to 'own' (beneficially) the business" (see: at the most vanilla, the strategy of seller financing in SMBs). No this is not technically "putting debt on the books" but it is in all practical respects a novation/loan transfer that can leave the purchased co financially responsible for servicing any debt that was used in its purchase.
On your third point: what I wrote above can be used as context. It's not risk free revenue, frankly it's very risky unless you're in an inflationary environment where your assets will grow regardless of your business operations solely because the overarching economy is growing and you're riding a tailwind. However, it again boils down to financial engineering. It's not as simple as assets - liabilities = equity. The calculations used to determine valuations are so ridiculously convoluted. The amount of work that goes into financially analyzing businesses and finding "loop holes" that can justify higher prices is the core business model. The debt factors into it, but there's ways to maneuver around it through various avenues.
For example:
* debt-to-equity conversions (reclassification of debt as equity)
* refinancing
* sale-leaseback (selling company's assets to a 3rd party and using that money to pay down the debt, then leasing the equipment back)
* creative interpretations of what is actually debt (e.g. reclassifying real debt as a working capital adjustment or a "debt-like")
* dividend recapitalization (a nasty trick of loading the company with debt, paying that out as a dividend to the holdco, then selling the company at lower enterprise value. They still extracted value for their LPs/investors, despite the exit being lower)
* separating the debt from the operating company into a different holding company that services the debt
Why can't they find something more interesting to do with their lives? They are wealthy enough to do anything and they choose to keep hoarding more and more.
This is just wrong. VC is not PE. The Vet example is really a bad trope. For every bad deal there are many others you never hear about. PE firms are not making money by simply buying everything up. The business still has to maintain and grow.
VC is most definitely a form of Private Equity, though it's not the limited-partnership deal model that we often see in SaaS, or Vet Clinics, or Housing, etc. Yes, they need to grow but PE firms don't invest directly. They have funds with relatively short time horizons that want 2 things: 1. cashflow during the fund lifetime and 2. equity growth so they can sell the assets in the fund prior to the end. PE firms will sometime flip portfolio companies to their next fund but this is frowned upon because the investors are sophisticated and recognize the valuation conflict of interest. The PE business depends on repeat business for selling their funds; the best are always over subscribed and never go shopping for investors, while the rest are marginal forever.
Did not read all of it. Yes, it is a form of private equity. Of course. You missed the context. The post kept saying VC is buying a vet shop. In that context they meant private equity. VC is not the same as what they meant to say, PE.
I absolutely believe you on the facts, and it all sounds very disgusting, but here's what I don't understand: customers and staff alike no longer like the clinic. Won't that be a huge boon to competitors, essentially ruining the VC's investment?
I get that it's not so clean cut with something as equipment- and licensing heavy as the veterinarian sector. But I've heard the same story exemplified with pizza parlors instead. Won't all the good staff take all the loyal customers and go elsewhere very easily in that case?
Private equity is a huge inflation driver. I'm thrifty, and for years I enjoyed a $10/mo phone provider, ~$12.39 with taxes. I even evangelized this carrier with some young parents who were struggling to get financial traction while paying off student loans.
Our affordable plan came to an end when the rates tripled! Turns out a private equity firm bought the company, jacked the rates on every customer, and sold it off again. This was not a fundamental cost being passed on in slightly increased fees -- it was private equity extracting millions from the people who can afford it the least. Across my financially optimized life, I see this happening repeatedly.
Personally, I can afford a more expensive cell phone bill. But I would imagine that many who have a $10/mo plan do not have many other options. I would like to punish the banks who are funding attacks on consumers. If by no other means, then by letting them fail.
It’s not private equity’s fault, it’s the continued imposition of increasing taxes and government-mandated fees:
“The wireless market has become increasingly competitive. The result has been steady declines in the average price for wireless services. Over the last decade, the average monthly revenue per wireless line has fallen from $47.00 per month to $34.56 per month. Unfortunately, this price reduction for consumers has been partially offset by higher taxes.” - Tax Foundation (2023)
Taxes coincidentally causing a 3x price change right when private equity buys a company is quite unlikely. Especially since I doubt every other company has tripled their prices.
Every other carrier hasn't tripled their prices - this one unnamed and unsourced company did. You can get a $10 or $15 cellphone plan right now, so his claim is false, or that PE company has magical powers to completely outprice the otherwise competitive mobile phone market.
However, "Taxes, fees, and government surcharges make up a record-high 27.60 percent of the average wireless services bill... Since 2012, the average charge from wireless providers decreased by 29 percent, from $47.00 per line per month to $33.36 per line. However, during this same time, wireless taxes, fees, and government surcharges increased from 17.18 percent to 27.60 percent of the average bill, resulting in consumer benefits from lower wireless prices being offset by higher taxes and fees".
> Banks are lending to private equity firms to fund purchases of businesses
Not quite. Private credit is to debt what private equity is to equity. (Technically, any non-bank originated debt that isn't publicly traded is private credit. Conventionally, it's restricted to corporate borrowers.)
So bank exposure to private credit generally means banks lending to non-banks who then lend to corporate borrowers.
You'll find plenty of talking heads on YouTube right noe claiming exactly this. Time will tell if private equity is actually wound up as tight as housing was in the GFC.
I don't think you're wrong if the following holds true: Before the housing bubble burst, banks lent funds to countless borrowers who couldn't, ultimately, afford their mortgage payments (because the banks didn't do their due diligence when underwriting the loans). This was widespread across pretty much every bank and mortgage banker. Not sure of the actual percentage of borrowers who, when all was said and done, had no business getting a mortgage for a house or condo, but suffice it to say it was well into the double digits percentage-wise (there's much more to this than simply banks and borrowers with Wall St. playing a major role in the collapse, but just keeping things simple).
In this private credit situation the analog for the banks are these private credit funds that have raised the capital they've lent from institutions and high-net-worth individuals (as opposed to banks, which have funds from consumer deposits). The analog to the individual mortgage borrowers from 2008 are actual companies.
To connect the dots, if the private credit funds were like the banks pre-2008, where due diligence was an afterthought, then this could turn out to be similar. So the real question is: are the borrowers (businesses in this case) swimming naked? Or do you believe the private credit funds when they say they actually conducted a good amount of due diligence when extending their loans? Once you know the percent of the companies that are naked you can evaluate whether this could/would end up similar to 2008. Nobody knows that yet, even, I suspect, the private credit funds themselves.
Yes, instead of banks lending sub prime mortgages directly, it's as if they are lending to private equity groups who are then lending rather undiscerningly. Within the last week, we now have Blackstone, Blackrock, Owl, and Morgan Stanely limiting withdrawals on private credit funds. Not a good look...
Even the best due diligence can't do anything if a crisis (not necessarily banking-related, a Middle East might just do the trick) starts manifesting itself and now many of those businesses have issues in paying down the debt they owe.
Late to reply here, but, yes, agree generally, though I don't think what these private credit companies are being accused of falls into that category (i.e., I think they're being accused of playing fast and loose with their due diligence, which was baked into their competitive advantage over the banks themselves. The competitive advantage being "we'll close quickly" without all the fuss a bank would require).
I've had quite a few conversations with someone who claims to be in the know about this situation (though, really, I don't think they're any more in the know than anyone!) and they swear up and down it's all a misunderstanding, which, cynic though I may be, immediately makes me think the accusations are at least somewhat true.
"I did my due diligence but didn't anticipate these risks". Doesn't sound like due diligence to me. Not having a plan to unwind your position if SHTF doesn't sound like due diligence to me. You can argue it any way you like but it boils down to "The money was good and I didn't think the worst was gonna happen".
I agree with this and tend to think due diligence needs to not only account for the regular course of business, but also for the exceptional circumstance. You'll never be able to accuse someone of not thinking of the exceptional UPSIDE circumstance, of course. The problem is the complete ignorance of the exceptional downside. That said, your parent is right that you can't really do due diligence on "war in Iran." Instead you something like "ok, if there's a shock to the system and 20% of our loans default what does that mean for our business?"
My comment was mostly against the idea that due diligence is a silver bullet, it isn’t. Of course that it can “catch” the most egregious cases, like outright fraud, but, again, no due diligence process can read the future.
> This is just another form of that "shadow banking" system isn't it?
Private-credit lenders are literally shadow banks [1]. But I'd be cautious about linking any shadow banking with crisis. Tons of useful finance occurs outside banks (and governments). One could argue a classic VC buying convertible debt met the definition.
That said, the parallel to 2008 is this sector of shadow banking has a unique set of transmission channels to our banks. The unexpected one being purely psychological–when a bank-affiliated shadow bank gates redemptions, investors are punishing the bank per se.
> So bank exposure to private credit generally means banks lending to non-banks who then lend to corporate borrowers.
Isn't this similar in spirit to the infamous (according to Western media) Chinese shadow banking market? There are articles [1] more than 10 years old talking about the collapse of China because of that practice, but it looks like the US is all too happy to do a very similar thing. I also wonder how big of a market we're talking here, as I was too lazy to check. A few hundred billions? $1 trillion? $2 trillion? More?
In at least the US and EU but probably elsewhere, the asset categories of banks are tightly regulated as well. They can have transient ownership of anything but there are hard limits on what portion of their assets can be indefinitely tied up in nonbanking businesses that they are operating on their own behalf.
Wouldn't they still owe interest to the banks on the money they borrowed, as well as the money they borrowed? I mean if all the money I make goes to the bank to pay off my mortgage my solution is not quitting my job, even though life is not very good under that situation.
Imagine you got a loan to buy a bunch of laundry machines to run a laundromat. But your laundromat earns $8,000 a month, and the loan payment is $10,000.
You can decide to sink $2,000 of your personal money into the laundromat every month, or you can give up.
The author keeps saying, over and over, that the reason this is a good bet is because "the downside is capped and the upside is asymmetric" as if that's some ground-breaking realization.
Sorry, but obviously the downside is capped. The downside of virtually any marketing investment is capped at the cost of the media buy...And, the upside being "asymmetric" isn't some saving grace. What matters is the likelihood that you actually realize that asymmetric upside. And, nowhere in the article does he talk about Ro's estimated success likelihoods or actual outcomes.
In short, he's basically saying:
- I made a bet
- It costs me something ("capped downside")
- There's a potential payout ("asymmetric upside")
- I have no idea whether this is positive expected value
The downside isn't really capped as in most cases there's a big dev effort to prep for an event like that. Plus a lot of spend on the day of the event to deal with the surge. This can easily be in the millions as well, in direct cost as well as in opportunity cost
This is also kinda wrong because the downside can be a lot more than your marketing spend if people really hate your ad. Just look what happened when Budweiser decided to send a personalized Bud Light can to a transgender person. For the Superbowl specifically, I can't imagine the "Search Party" ad helped Amazon sell more Rings.
Yeah but this is footnote territory. The idea of a cap is more appropriate for most advertisers. There’s a minor chance you miscalculate and the cap dissolves. It kind of goes without saying as that always applies, possibly can have high magnification if too far off the mark.
Or Gillette. Or Jaguar. Wrong sort of advertising can provably destroy your brand image among your consumers. Social media helps to amplify things in both directions. So you really need to know your audience's current mindset. Or wrong move could lead to losing lot more than just any money and manpower spend on the ad.
If they really only raised $1.7b, per Crunchbase, then this seems to me like a very good outcome for everyone involved except its late stage investors. And, even for the late stage investors, they're breaking even.
No. The last two investment tranches will get back their money, based on 1X liquidation preference. Employees who joined in the last 5 years if they got options are fucked. If they have RSUs then they will take a fraction of their equity.
It sounds like investors got out okay, but employees got fucked big time. It's a terrible exit and Brex waited too long until their growth stalled.
Yes, and it goes to the same people that the first 1.7B goes to.
The order of operations is not "everyone breaks even, then we start distributing profit".
The order of operations is "people with preferred stock (i.e. investors) get all their profit, and then employees get whatever's left over".
The fact that the amount of investment money put in is less than the sale price is meaningless. If you are an employee with options at a strike price of $5, and the common stock price is now $2, you're screwed.
All the investors before 2019 got multiples of their investment.
So series B is worth about 250M and series C is worth about 625M. Series C-2 is worth about 1.5B. Series D is worth 425M and Series D2 is worth 300M because of LP. That's a total of 3B.
That leaves 2B for everyone else. Most employees are going to get fucked big time, especially the ones after 2019. They will get a small fraction of their RSUs and all their options will be worthless, if they had options.
> the company re-cap'd employees at a more realistic valuation a couple years back. So looks like all employees benefited here which is a major win. Respect to the founders for looking out!
I assume if you put in 100 mn at a 12 bn valuation in the last round, you're either getting 100 back at 1x pref or you're screwing over the common even more?
Considering the 12bn round was back in 21, I'd expect most of the employee base to be taking a haircut on the value of their options.
Words are cheap. I really wish there was a way to incentivize authors like this to put their money where their mouth is, before seeking attention for their ideas.
Shorting a security means risking exponential losses if the stock you're shorting continues to increase in value. As the saying goes: the market can stay irrational longer than you can stay solvent.
If so, keep in mind that it's contingent advice. The question was how to profit from predicting an AI bubble popping [or something along those lines]. The answer is shorting Nvideo (assuming your prediction also includes a timeline).
It's always a way to lose a massive amount of money if you're wrong, so the advice is also contingent on confidence level.
I'm not trying to be facetious here, but I think it's very naive to assume you get to "profit from predicting an AI bubble." In theory, maybe, but in reality you will lose money. Shorting is never the solution... it's a very niche tool for very niche group of investors.
When retail guys talk shorting, it's very hard to take them seriously.
Retail guys generally think they can time the market based on vibes, rather than specific insider-y info. But if you (retail investor or not) have that specific insider-y info--something resulting in justified, high probability, time-bounded knowledge about a future change, shorting can be the rational decision.
What's your complaint about this article? I wish there were a way to incentivize comments to put effort into specific criticism, before seeking attention for their ideas.
I'm not aiming this at GP specifically, but there seems to be a culture around gen AI that the burden of proof is on sceptics, not the people claiming we're about to invent God
It's possible to notice a trend while still having the wit to realize you can't precisely time that trend well enough to profit from it. Another example might be, "Trump is increasingly old, feeble, and incapable of doing his job... but I'm not sure how that will translate into how long he's able to keep the job. It's possible that he could be a vegetable at some point and still POTUS."
Demanding that people gamble with their often limited finances to prove a point orthogonal to the one they're actually making feels disingenuous and dismissive to me.
It's not orthogonal. And you will find people will change their mind when forced to put a little money on the line.
"Team X is definitely winning, I'm certain". "So you'll offer me 1000-1 on the opponent?". "No". "6-1?", "No". They often realize they are about 65% certain at some point. And they often aren't being hyperbolic, they are just not thinking clearly.
There was a point after which the outcome of WWII was obvious and inevitable, but could you have timed the ending to within a week or two based on that knowledge? Should the inability to precisely time something imply that the arc of its future can’t be obvious?
Clearly not. Does the fact that few of us know the date of our death imply that we might live forever?
You've misunderstood the point. It's not about being exactly right. It's about thinking clearly about the probabilities of different events. In your case, you explicitly call out that it's difficult to know the exact timing - so if someone had offered you even money for some particular week, you'd say no. If they offered you 100-1 for said week, it's a great bet, even if you lose.
Surprised to see this upvoted because the takeaway is completely incorrect, and based on the anecdotal evidence of one advertiser.
As someone who spends seven figures every month on Google ads, what’s much more likely to be happening here is that the individual advertiser is either getting outcompeted or they’re executing ads poorly.
Google ads revenue in the US continues to grow every quarter. And, since advertisers will generally invest in ads until the last dollar is break even, it’s likely that the total value advertisers unlock through Google ads is growing as well. Whether that’s true or not, the notion that value generated for advertisers is “dead” is absurd.
Your experience is 100% compatible with the linked article: the seven-figure spender is presumably running a much higher margin business and can scale narrowly profitable ads much more effectively. The natural equilibrium for a perfect ad market is for the ad spend to be exactly equal to increase in revenue: a perfectly efficient market with no profit for the advertiser. Google (and Meta et al) are so good that for many SMBs they are completely cornered at the zero-point: spend as much as you can just to stay in the same place financially.
> The natural equilibrium for a perfect ad market is for the ad spend to be exactly equal to increase in revenue
Not quite, the equilibrium is when marginal ad spend results in no change to profit. The ad spend at equilibrium should result in increased profit compared to no ad spend.
I just Googled "kids magic show in Durban" and his ad showed up in the top slot (sorry if this post has swamped your ad bill); and as a bonus, the Gemini AI blurb also touted him: "For kids' magic shows in Durban, look for local entertainers like Big Top Entertainment..."
Doesn't seem like the issue is he's being outbid by international conglomerates with million dollar budgets. Maybe the kids magic show market has cooled in South Africa? Or users have left Google? Curious what we are to conclude here.
Google ads are very time & location dependent, the fact that it's showing to you might be a bad sign since you are most likely not close to Durban and this seems like an ad you only want to run locally.
Yes our ads were geo-fenced when I had them on. We have always had a good web presence, I think the conclusion is that nobody looks for services on Google, and our reliance on it above other channels is now no longer viable
Everybody looks on Google for services; or ChatGPT googles/bings it for them. Still the same.
We had a 10x jump just last month for my own company.
For bigger company I consult with we had stable revenue last 2 years even though search traffic declined by 50%, our Google ads still perform the same. In general buying intent still seem to come through Google, only 10% via GPT.
It will become more and more, but a full drop in 3 months means something else is wrong.
I run a small software business and I know various other people who run small software businesses. We are all pretty much agreed that that Google Ads have been less and less profitable, year or year. Most of us have now given up on PPC ads.
And equally I know many people running non software businesses whose experience is the complete opposite of yours and Google ads has and continues to drive the majority of their revenue.
I expected them to start seeing a hit or significant decline by now, and even told them as such but in what I honestly find surprising, it’s not come to pass.
I've run Google PPC on-and-off for 20+ years. It's definitely way harder to make money with them now, and the complexity is now through the roof, which makes it way harder for a novice to optimize their campaign. I steer small businesses away because it's too easy to screw up and lose your shirt on PPC without professional help.
I spend a small amount on Adwords and that is pretty much it. I gave up on Bing PPC. Facebook Ads aren't suitable for my market. Linked Ads ar too expensive. I tried Reddit Ads, but that was a disaster. See also:
What about sites like bitsdujour? I get an email with deals from them every so often (that I subscribe to) and have spent money on licenses after finding software that I liked.
The question is, why has this post been massively upvoted?
It contains zero useful information. Just somebody struggling with AdWords and they don't know why. Not helpful.
I have to assume the vast majority of upvotes are based on the title alone, assuming it's about Search? A large proportion of top level comments are about Search too. Depressing.
Massively? I can't know. I read the article and upvoted 1) because it suggests a rocky road ahead for Google and 2) because, as you may have guessed, I dislike ads, dislike Google's complicity in ads, and so am happy to discuss.
I happen to in fact think we have reached an inflection point. Whether "Google is dead" depends probably a good deal on where they go now.
I am fairly confident that the answer is that most people vote based on the title/headline without ever clicking through. I am likely guilty of this as well sometimes. It takes discipline to avoid this behaviour.
> We find that most users do not read the article that they vote on, and that, in total, 73% of posts were rated (i.e., upvoted or downvoted) without first viewing the content. [0]
In this case, my guess is that people are noticing less and less utility from Google search, and that was why they voted like they did.
This same phenomenon is what gives newspaper editors far more power than the journalists, as it is the editors who not only decide the stories to be covered, but even more importantly, they decide the headline. Most people just scan the headlines while subconsciously looking for confirmation of their own biases.
I tried to find that paper via google search first, and I failed after 3 different searches. I then opened my not-important-stuff LLM, chatgpt.com, and found it in 3 interactions, where in the 3rd I made it use search. Chatbots with search are just so good at "on the tip of my tongue" type things.
Google is in such a weird position because of their bread and butter legacy UX * scale. This has to be the biggest case of innovators dilemma of all time?
Google.com has "AI mode," and it tries to intelligently decide when to suggest that based on a search query. I could have likely clicke AI Mode on google.com once it gave me a crap SERP response, and used that to find the same thing. But, I instinctively just went to chatgpt.com instead. I am not a total moron, I use gemini, claude, and gpt APIs in the 2 LLM enabled products that I am working on...
However, just last week I noticed that the AI mode default reply for some queries was giving me just horrible AI mode replies. Like gpt-3.5 quality wrong assumptions. For the first time I saw google.com as the worst option. I cannot be the only one.
I think that I might understand the problem. Google has the tech, but as a public company they cannot start to lose money on every search query, right? The quarterly would look bad, bonuses would go down. Same reason ULA can't build Starship, even if they could and wanted to. However, OpenAI can lose money on every query. SOTA inference is not cheap.
Basically any online shop with decent volume / revenue is going to be spending 100s of thousands if not millions of dollars a month on Google ads. (Not just Google Ads, also Facebook ads etc.)
It used to be possible to get by with "organic" search traffic and some SEO... but google search looked completely different back then. Now when you look for something it's an AI box, products (google merchant) ad box, ad (promoted results) box, ... then there's a couple of (like two) results that are "organic" (whatever that means these days) and that's it. And we all know that when you want to hide something, you put it on the second page of google search results. So the space for doing online business "ad free" has been squeezed out over time.
And the K shaped economy is totally true in this ecomm space. These days say 15% of your revenue gets eaten by ads, but you also have say 50% higher revenue overall. At some point it becomes a margin game and the bigger players will start squeezing out the smaller ones because the biggers ones can operate on tighter margins (making up the difference with volume) which the smaller ones simply can't afford. The difference in operating costs of an eshop that sells 10000 items a month is not that different than that of an eshop selling 100000 items a month (i.e. not 10x, more like 2-3x). But selling 10x items gives you the volume you need to be able to lower your margins and put the difference into ads.
BTW all of this is handled by professional online marketing people with increasingly widespread use of AI so there's no room for the small players to make it big while not being optimized to the gills. This is why most small advertisers are seeing small or negative returns while Google and Meta are making tens if not hundreds of billions in ad revenue... The ads work, but the amounts you need to spend and the optimization level you need to have is in a completely different galaxy than it was 10 years ago.
> As someone who spends seven figures every month on Google ads, what’s much more likely to be happening here is that the individual advertiser is either getting outcompeted or they’re executing ads poorly.
Outcompeted by who??? He's a performer offering local entertainment. I highly doubt that people searching for "entertainer in durban" are getting ads for Cirque du Soleile.
His ad is probably on the first page for that search term; the problem is more likely that no one is looking at that first page anymore.
> Surprised to see this upvoted because the takeaway is completely incorrect
It's the standard actually. Hot takes get more votes and hot takes are usually wrong. Experts have non-controversial opinions, which are boring (so no impulse to upvote), and there are 1000x more non-experts with blogs. Add to that HN culture which values contrarian-ness. So HN front page blog posts are almost entirely incorrect, but spicy
As this incident unfolds, what’s the best way to estimate how many additional hours it’s likely to last? My intuition is that the expected remaining duration increases the longer the outage persists, but that would ultimately depend on the historical distribution of similar incidents. Is that kind of data available anywhere?
To my understanding the main problem is DynamoDB being down, and DynamoDB is what a lot of AWS services use for their eventing systems behind the scenes. So there's probably like 500 billion unprocessed events that'll need to get processed even when they get everything back online. It's gonna be a long one.
I wonder how many companies have properly designed their clients. So that the timing before re-attempt is randomised and the re-attempt timing cycle is logarithmic.
In short, if it’s all at the same schedule you’ll end up with surges of requests followed by lulls. You want that evened out to reduce stress on the server end.
It's just a safe pattern that's easy to implement. If your services back-off attempts happen to be synced, for whatever reason, even if they are backing off and not slamming AWS with retries, when it comes online they might slam your backend.
It's also polite to external services but at the scale of something like AWS that's not a concern for most.
> I visited the Berlin Wall. People at the time wondered how long the Wall might last. Was it a temporary aberration, or a permanent fixture of modern Europe? Standing at the Wall in 1969, I made the following argument, using the Copernican principle. I said, Well, there’s nothing special about the timing of my visit. I’m just travelling—you know, Europe on five dollars a day—and I’m observing the Wall because it happens to be here. My visit is random in time. So if I divide the Wall’s total history, from the beginning to the end, into four quarters, and I’m located randomly somewhere in there, there’s a fifty-percent chance that I’m in the middle two quarters—that means, not in the first quarter and not in the fourth quarter.
> Let’s suppose that I’m at the beginning of that middle fifty percent. In that case, one-quarter of the Wall’s ultimate history has passed, and there are three-quarters left in the future. In that case, the future’s three times as long as the past. On the other hand, if I’m at the other end, then three-quarters have happened already, and there’s one-quarter left in the future. In that case, the future is one-third as long as the past.
This thought process suggests something very wrong. The guess "it will last again as long as it has lasted so far" doesn't give any real insight. The wall was actually as likely to end five months from when they visited it, as it was to end 500 years from then.
What this "time-wise Copernican principle" gives you is a guarantee that, if you apply this logic every time you have no other knowledge and have to guess, you will get the least mean error over all of your guesses. For some events, you'll guess that they'll end in 5 minutes, and they actually end 50 years later. For others, you'll guess they'll take another 50 years and they actually end 5 minutes later. Add these two up, and overall you get 0 - you won't have either a bias to overestimating, nor to underestimating.
But this doesn't actually give you any insight into how long the event will actually last. For a single event, with no other knowledge, the probability that it will after 1 minute is equal to the probability that it will end after the same duration that it lasted so far, and it is equal to the probability that it will end after a billion years. There is nothing at all that you can say about the probability of an event ending from pure mathematics like this - you need event-specific knowledge to draw any conclusions.
So while this Copernican principle sounds very deep and insightful, it is actually just a pretty trite mathematical observation.
But you will never guess that the latest tik-tok craze will last another 50 years, and you'll never guess that Saturday Night Live (which premiered in 1075) will end 5-minutes from now. Your guesses are thus more likely to be accurate than if you ignored the information about how long something has lasted so far.
Sure, but the opposite also applies. If in 1969 you guessed that the wall would last another 20 years, then in 1989, you'll guess that the wall of Berlin will last another 40 years - when in fact it was about to fall. And in 1949, when the wall was a few months old, you'll guess that it will last for a few months at most.
So no, you're not very likely to be right at all. Now sure, if you guess "50 years" for every event, your average error rate will be even worse, across all possible events. But it is absolutely not true that it's more likely that SNL will last for another 50 years as it is that it will last for another 10 years. They are all exactly as likely, given the information we have today.
If I understand the original theory, we can work out the math with a little more detail... (For clarity, the berlin wall was erected in 1961.)
- In 1969 (8 years after the wall was erected): You'd calculate that there's a 50% chance that the wall will fall between 1972 (8x4/3=11 years) and 1993 (8x4=32 years)
- In 1989 (28 years after the wall was erected): You'd calculate that there's a 50% chance that the wall will fall between 1998 (28x4/3=37 years) and 2073 (28x4=112 years)
- In 1961 (when the wall was, say, 6 months old): You'd calculate that there's a 50% chance that the wall will fall between 1961 (0.5x4/3=0.667 years) and 1963 (0.5x4=2 years)
I found doing the math helped to point out how wide of a range the estimate provides. And 50% of the times you use this estimation method; your estimate will correctly be within this estimated range. It's also worth pointing out that, if your visit was at a random moment between 1961 and 1989, there's only a 3.6% chance that you visited in the final year of its 28 year span, and 1.8% chance that you visited in the first 6 months.
> Well, there’s nothing special about the timing of my visit. I’m just travelling—you know, Europe on five dollars a day—and I’m observing the Wall because it happens to be here.
It's relatively unlikely that you'd visit the Berlin Wall shortly after it's erected or shortly before it falls, and quite likely that you'd visit it somewhere in the middle.
No, it's exactly as likely that I'll visit it at any one time in its lifetime. Sure, if we divide its lifetime into 4 quadrants, its more likely I'm in quadrant 2-3 than in either of 1 or 4. But this is slight of hand: it's still exactly as likely that I'm in quadrant 2-3 than in quadrant (1 or 4) - or, in other words, it's as likely I'm at one of the ends of the lifetime as it is that I am in the middle.
> while this Copernican principle sounds very deep and insightful, it is actually just a pretty trite mathematical observation
It's important to flag that the principle is not trite, and it is useful.
There's been a misunderstanding of the distribution after the measurement of "time taken so far", (illuminated in the other thread), which has lead to this incorrect conclusion.
To bring the core clarification from the other thread here:
The distribution is uniform before you get the measurement of time taken already. But once you get that measurement, it's no longer uniform. There's a decaying curve whose shape is defined by the time taken so far. Such that the estimate `time_left=time_so_far` is useful.
If this were actually correct, than any event ending would be a freak accident: since, according to you, the probability of something continuing increases drastically with its age. That is, according to your logic, the probability of the wall of Berlin falling within the year was at its lowest point in 1989, when it actually fell. In 1949, when it was a few months old, the probability that it would last for at least 40 years was minuscule, and that probability kept increasing rapidly until the day the wall was collapsed.
Why is the most likely time right now? What makes right now more likely than in five minutes? I guess you're saying if there's nothing that makes it more likely to fail at any time than at any other time, right now is the only time that's not precluded by it failing at other times? I.E. it can't fail twice, and if it fails right now it can't fail at any other time, but even if it would have failed in five minutes it can still fail right now first?
Yes that's pretty much it. There will be a decaying probability curve, because given you could fail at any time, you are less likely to survive for N units of time than for just 1 unit of time, etc.
> However, the average expected future lifetime increases as a thing ages, because survival is evidence of robustness.
This is a completely different argument that relies on various real-world assumptions, and has nothing to do with the Copernican principle, which is an abstract mathematical concept. And I actually think this does make sense, for many common categories of processes.
However, even this estimate is quite flawed, and many real-world processes that intuitively seem to follow it, don't. For example, looking at an individual animal, it sounds kinda right to say "if it survived this long, it means it's robust, so I should expect it will survive more". In reality, the lifetime of most animals is a binomial distribution - they either very young, because of glaring genetic defects or simply because they're small, fragile, and inexperienced ; or they die at some common age that is species dependent. For example, a humab that survived to 20 years of age has about the same chance of reaching 80 as one that survived to 60 years of age. And an alien who has no idea how long humans live and tries to apply this method may think "I met this human when they're 80 years old - so they'll probably live to be around 160".
> The wall was actually as likely to end five months from when they visited it, as it was to end 500 years from then.
I don't think this is correct; as in something that has been there for say hundreds of years had more probability to be there in a hundred years than something that has been there for a month.
Is this a weird Monty hall thing where the person next to you didnt visit the wall randomly (maybe they decided to visit on some anniversary of the wall) so for them the expected lifetime of the wall is different?
Note that this is equivalent to saying "there's no way to know". This guess doesn't give any insight, it's just the function that happens to minimize the total expected error for an unknowable duration.
Edit: I should add that, more specifically, this is a property of the uniform distribution, it applies to any event for which EndsAfter(t) is uniformly distributed over all t > 0.
I'm not sure about that. Is it not sometimes useful for decision making, when you don't have any insight as to how long a thing will be? It's better than just saying "I don't know".
Not really, unless you care about something like "when I look back at my career, I don't want to have had a bias to underestimating nor overestimating outages". That's all this logic gives you: for every time you underestimate a crisis, you'll be equally likely to overestimate a different crisis. I don't think this is in any way actually useful.
Also, the worse thing you can get from this logic is to think that it is actually most likely that the future duration equals the past duration. This is very much false, and it can mislead you if you think it's true. In fact, with no other insight, all future durations are equally likely for any particular event.
The better thing to do is to get some even-specific knowledge, rather than trying to reason from a priori logic. That will easily beat this method of estimation.
You've added some useful context, but I think you're downplaying it's use. It's non-obvious, and in many cases better than just saying "we don't know". For example, if some company's server has been down for an hour, and you don't know anything more, it would be reasonable to say to your boss: "I'll look into it, but without knowing more about it, stastically we have a 50% chance of it being back up in an hour".
> The better thing to do is to get some even-specific knowledge, rather than trying to reason from a priori logic
True, and all the posts above have acknowledged this.
> "I'll look into it, but without knowing more about it, stastically we have a 50% chance of it being back up in an hour"
This is exactly what I don't think is right. This particular outage has the same a priori chance of being back in 20 minutes, in one hour, in 30 hours, in two weeks, etc.
Ah, that's not correct... That explains why you think it's "trite", (which it isn't).
The distribution is uniform before you get the measurement of time taken already. But once you get that measurement, it's no longer uniform. There's a decaying curve whose shape is defined by the time taken so far. Such that the statement above is correct, and the estimate `time_left=time_so_far` is useful.
Can you suggest some mathematical reasoning that would apply?
If P(1 more minute | 1 minute so far) = x, then why would P(1 more minute | 2 minutes so far) < x?
Of course, P(it will last for 2 minutes total | 2 minutes elapsed) = 0, but that can only increase the probabilities of any subsequent duration, not decrease them.
(t_obs is time observed to have survived, t_more how long to survive)
Case 1 (x): It has lasted 1 minute (t_obs=1). The probability of it lasting 1 more minute is: 1 / (1 + 1) = 1/2 = 50%
Case 2: It has lasted 2 minutes (t_obs=2). The probability of it lasting 1 more minute is: 2 / (2 + 1) = 2/3 ≈ 67%
I.e. the curve is a decaying curve, but the shape / height of it changes based on t_obs.
That gets to the whole point of this, which is that the length of time something has survived is useful / provides some information on how long it is likely to survive.
Where are you getting this formula from? Either way, it doesn't have the property we were originally discussing - the claim that the best estimate of the duration of an event is the double of it's current age. That is, by this formula, the probability of anything collapsing in the next millisecond is P(1 more millisecond | t_obs) = t_obs / t_obs + 1ms ~= 1 for any t_obs >> 1ms. So by this logic, the best estimate for how much longer an event will take is that it will end right away.
The formula I've found that appears to summarize the original "Copernican argument" for duration is more complex - for 50% confidence, it would say:
P(t_more in [1/3 t_obs, 3t_obs]) = 50%
That is, if given that we have a 50% chance to be experiencing the middle part of an event, we should expect its future life to be between one third and three times its past life.
Of course, this can be turned on its head: we're also 50% likely to be experiencing the extreme ends of an event, so by the same logic we can also say that P(t_more = 0 [we're at the very end] or t_more = +inf [we're at the very beginning and it could last forever] ) is also 50%. So the chance t_more > t_obs is equal to the chance it's any other value. So we have precisely 0 information.
The bottom line is that you can't get more information out a uniform distribution. If we assume all future durations have the same probability, then they have the same probability, and we can't predict anything useful about them. We can play word games, like this 50% CI thing, but it's just that - word games, not actual insight.
It's not a uniform distribution after the first measurement, t_obs. That enables us to update the distribution, and it becomes a decaying one.
I think you mistakenly believe the distribution is still uniform after that measurement.
The best guess, that it will last for as long as it already survived for, is actually the "median" of that distribution. The median isn't the highest point on the probability curve, but the point where half the area under the curve is before it, and half the area under the curve is after it.
The cumulative distribution actually ends up pretty exponential which (I think) means that if you estimate the amount of time left in the outage as the mean of all outages that are longer than the current outage, you end up with a flat value that's around 8 hours, if I've done my maths right.
Not a statistician so I'm sure I've committed some statistical crimes there!
Unfortunately I can't find an easy way to upload images of the charts I've made right now, but you can tinker with my data:
cause,outage_start,outage_duration,incident_duration
Cell management system bug,2024-07-30T21:45:00.000000+0000,0.2861111111111111,1.4951388888888888
Latent software defect,2023-06-13T18:49:00.000000+0000,0.08055555555555555,0.15833333333333333
Automated scaling activity,2021-12-07T15:30:00.000000+0000,0.2861111111111111,0.3736111111111111
Network device operating system bug,2021-09-01T22:30:00.000000+0000,0.2583333333333333,0.2583333333333333
Thread count exceeded limit,2020-11-25T13:15:00.000000+0000,0.7138888888888889,0.7194444444444444
Datacenter cooling system failure,2019-08-23T03:36:00.000000+0000,0.24583333333333332,0.24583333333333332
Configuration error removed setting,2018-11-21T23:19:00.000000+0000,0.058333333333333334,0.058333333333333334
Command input error,2017-02-28T17:37:00.000000+0000,0.17847222222222223,0.17847222222222223
Utility power failure,2016-06-05T05:25:00.000000+0000,0.3993055555555555,0.3993055555555555
Network disruption triggering bug,2015-09-20T09:19:00.000000+0000,0.20208333333333334,0.20208333333333334
Transformer failure,2014-08-07T17:41:00.000000+0000,0.13055555555555556,3.4055555555555554
Power loss to servers,2014-06-14T04:16:00.000000+0000,0.08333333333333333,0.17638888888888887
Utility power loss,2013-12-18T06:05:00.000000+0000,0.07013888888888889,0.11388888888888889
Maintenance process error,2012-12-24T20:24:00.000000+0000,0.8270833333333333,0.9868055555555555
Memory leak in agent,2012-10-22T17:00:00.000000+0000,0.26041666666666663,0.4930555555555555
Electrical storm causing failures,2012-06-30T02:24:00.000000+0000,0.20902777777777776,0.25416666666666665
Network configuration change error,2011-04-21T07:47:00.000000+0000,1.4881944444444444,3.592361111111111
Generally expect issues for the rest of the day, AWS will recover slowly, then anyone that relies on AWS will recovery slowly. All the background jobs which are stuck will need processing.
As is the case with most complex problems like this, the correct answer is: it depends.
In this case, it depends on what the crux of your business is. Sometimes the crux is building world-class technology. Sometimes the crux is customer acquisition.
If the crux of your business is customer acquisition, then an exceptional business co-founder will actually be the most important ingredient to long-term success.
This is one of the biggest weaknesses I've noticed in YC's mantra. In most industries, just building something people want doesn't lead to success - you have to excel at customer acquisition also. And, in these industries, as you business matures, you realize that customer acquisition, at scale, is actually the hardest problem to solve.
I think you've just argued yourself out of a position of "it depends." This is one of the few areas where there's no wiggle room. A worthy business co-founder MUST be able to bring something practical to the table, and in my experience as it also seems to be yours, there's only really two ways they can do so:
- Be great at customer acquisition (or at least as the original article says, bring in a "customer waitlist")
- Have or bring in actual funding
If the business co-founder can't even bring one of these two things to the table, there is no justification whatsoever for them to hold a meaningful share of the startup's ownership.
Years ago, I was lying in the grass, having a conversation with a fellow founder, when he noted how, on most days, he would forget to eat lunch because he was so engrossed with his work. I thought to myself, That's ridiculous. Everyone notices when they're hungry. This was just a thinly veiled brag about his work ethic.
Nowadays, I find myself skipping lunch every other day - out of forgetfulness.
> Why pretend to be smart and play it safe? True understanding is rare and hard-won, so why claim it before you are sure of it? Isn't it more advantageous to embrace your stupidity/ignorance and be underestimated?
I wish this were true, and I do think this mindset would be optimal if everyone adopted it. Unfortunately, real workplaces are filled with people who are confident and wrong. As a leader, if your intuition is more accurate than your peers and you care about objective success, it’s important to assert yourself.
Many of these businesses are SaaS which means their valuations are tumbling.
It seems possible that valuations tumble so much that the private equity owner no longer has any incentive to operate the business, bc all future cash flows will belong to the bank. What happens in practice then? Will banks actually step in and take operational control? Will the banks renegotiate terms such that the private equity owners are incentivized to continue as stewards? Or, will they prefer to force a business sale immediately?
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