Asset Volatility

I was thinking about some parallels between my floor trading business, and investing in startups.  There are a lot of parallels believe it or not. Idealogical investors get crushed and miss opportunity.  You have to find flow.  You have to be open to lots of ideas.  Once you make a decision there is no looking back, but you do have to consistently interpret the market and readjust when necessary, or the opportunity arises.

The one thing that traders have a hard time realizing when they try to angel invest is liquidity, and capital allocation/preservation.

There is zero liquidity in angel investing.  It’s a roach motel.  If the company works, you can make money.  If it fails, you are guaranteed to lose.  There is no “buying at a $2M valuation and selling at a $10M valuation”.  In angel investing the math lays out pretty clearly.  You press your winners and cut your losers fast.  It’s more like option trading where you roll for duration.

One thing I am empathetic to is founders.  Investors can assume risk over many companies.  It’s not diversified risk in the classic sense, but it gives you more chances to make money.  Founders are putting it all on one company.  They are assuming much more risk than an investor.  They should get paid for it.

When I traded, I owned a seat.  You could lease them too, but I owned.  The commission break for owning vs leasing gave me an incentive to buy one.  Seats fluctuated in value.  It was always nice when it was more expensive than the day you bought it.  But, it could go against you too.  I remember in the mid nineties, seats went to just about $1M dollars.  I had paid a little over $500k for mine.  You could lease them out for $5k per month.  It felt pretty good in the morning to see higher and higher bids, even though I had no intention of selling it.  In 1998, seats went to the low $200k’s in value.  People thought exchanges were going out of business.  That hurt, and friends of mine sold into the panic.

Seats are never going to be worthless like a startup will be.  But, if you are going to be in the business you have to participate in that market.  Same with startup investing.  If you want to participate, you have to accept the volatility that comes with the valuations.

I wrote a post about Snapchat the other day.  I don’t think this will be the first time we see write downs.  It’s going to reverberate through the whole food chain of startup funding.  The days of the $6M-$10M seed round valuation should start to be in our rear view mirror, thankfully.

But, what if you are the CEO that gets hit by the write down?  This is an entirely different problem.  It all depends on why you are being written down.

In Snapchat’s case, it’s a response to the public markets.  Snapchat is still executing.  They are turning out a great product.  Someone’s private analysis given the other information they have caused them to write them down.  Snapchat’s CEO can explain that pretty easily to their employees.

What happens next depends on where options were struck and the internal culture of the company prior to the write down.  If options were struck at the higher price, you are guaranteed to have a morale problem.  People lost money, and might feel hopeless that there is no way for them to get it back.  You run the risk of losing them to another company.

This is why company culture should focus on customers, building great stuff of value and not the stock price of the company.  The stock price will take care of itself if they build great product.

What if you were going out to raise money?  You thought you were going to get one valuation and instead there was a rude awakening?  That all depends too.  If it’s a down round, figure out exactly why it’s a down round.  Facebook had a down round in 2008.  They could blame it on the external market.  What you need to know is if the down round is caused by something you can control.  If that’s the case, fix it.

If you go out to raise money and your valuation isn’t what you thought it would be, but it’s still an up round, no biggie.  Take the money and build the company.  Ask a lot of questions about how they got to their number.

When I traded, there were a lot of times I just accepted less profit on trades than fighting for an extra dollar.  The risk/reward ratio had changed.  It was much better to have money in the bank than turn a winner into a loser.  The emotions and feelings with each circumstance are far different-and they can influence decisions down the road.  The trader shorthand for this concept is “Pigs get slaughtered.”

I believe markets are on the cusp of a big psychological change.  Get used to the volatility of asset prices because for a while, no one is going to know exactly how to price them.


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