E114: Markets update: whipsaw macro picture, big tech, startup mass extinction event, VC reckoning

Jason Calacanis 0:00 All right, everybody. Welcome to the All In podcast. We're back. Thanks to Friedberg and Sacks for moderating the show into the lowest ratings-

David Sacks 0:10 (laughs)

Jason Calacanis 0:11 ... in its history. (laughs)

David Sacks 0:13 (laughs)

Chamath Palihapitiya 0:13 Hold on, hold on. Please give the keyboard warriors that are their bot armies some respite here. They tried their best. It just didn't work.

Jason Calacanis 0:20 They did try their best. They just ... It's, it's okay.

David Sacks 0:22 I think the ratings of the last episode must be a result of Google, uh-

Jason Calacanis 0:25 Yeah.

David Sacks 0:25 ... down-ranking us as a result of our honesty about not wanting to get more boosters-

Chamath Palihapitiya 0:30 So Sacks, you're on the Brigadoon train.

David Sacks 0:31 ... because somebody at Google, some lower level functionary, to push a button-

Jason Calacanis 0:36 Push a button.

David Sacks 0:36 ... to, uh, shadow ban, I mean, visibility filter us.

Chamath Palihapitiya 0:39 It's everything except the moderation skills-

Jason Calacanis 0:42 Yeah.

Chamath Palihapitiya 0:42 ... of the two Davids.

Jason Calacanis 0:42 No way is the moderator (laughs) turning it into Fox Sunday.

Chamath Palihapitiya 0:44 Can't be that.

Narrator 0:45 I'm going all in.

0:46 Let your winners ride.

0:49 Rain Man David Sachs. I'm going all in.

David Sacks 0:54 And I said we open source it to the fans and they've just gone crazy with it.

Chamath Palihapitiya 0:57 Love you, man. Nice.

Narrator 0:58 West Coast queen of quinoa. I'm going all in.

Jason Calacanis 1:02 The reaction I got from our COVID vaccine discussion was, hey, pretty fair and balanced. Like, not in a, in a joking way, but like, actually like, yeah.

Chamath Palihapitiya 1:09 Yeah, the warning on YouTube was pretty benign actually.

Jason Calacanis 1:12 Yeah. It's like, "If you want COVID information, click here. Thank you." (laughs)

Chamath Palihapitiya 1:14 Yeah.

Jason Calacanis 1:14 Okay.

Jason Calacanis 1:15 Let's talk about the market data. The Fed raised 25 basis points. The market obviously has ripped since then. The jobs data this morning was crazy. We added 517,000 jobs, more than 2X December, and well above the estimates of 188,000 jobs. The Fed, I think, is starting to realize they can f- inf- obviously impact inflation and slow down speculative assets, but they're having a very hard time with the labor market, uh, obviously. Labor participation actually is growing. We've talked about that many times here. It's bumped up to 62.4%. We all know it peaked at like maybe 69% during the 2000 time period. Wage growth though continuing to slow, so that is some good news there. And obviously risk-on assets are ripping the last couple of days. Chamath, what's your take on where we are with the market and the Fed's action, which people are starting to believe will be another 25 basis point hike and then maybe staying high for the rest of the year? Did you, uh, hear their comments? You think dovish? What's your take on the market?

Chamath Palihapitiya 2:23 I watched Powell's speech and it was really amazing because in December he was extremely hawkish and he was basically like, "Listen, we're gonna keep rates higher than you like and longer than you want." And that was pretty clear, and the markets reacted. And then not but 35, 40 days later, he essentially said, "We have two 25 basis point hikes left to go," and he's going to try to stick the landing essentially. And even though the rest of the language in his entire speech and the press conference, if you read it in the absence of his body language, so if you just read the transcript, would seem very hawkish as well, but the reality was he basically capitulated. And then the market essentially said, "Okay, we're at the end of this thing." And we've talked about this before, but markets tend to bottom six to nine months before it's clear that you could have done this. And so we're a little bit off to the races in the short term. It's compounded by a couple of other factors. One is that at the end of last year, so many people were tax loss harvesting, which means if you had some gains somewhere else, you sold some things that were losing money so that you could net the two together. You saw a lot of stocks, Tesla was probably the poster child for this, trade all the way down to like $108 a share and it's effectively doubled in the last 30 days, right? So, everybody tax loss harvested. Everybody de-grossed. Nobody was really owning anything. And then when Powell basically said, "We're mostly done," there's been so much systematic buying right now that nobody's really well positioned. To me, this is very similar and eerily reminiscent of the end of 2018 and beginning of 2019. And if you guys remember, at the end of 2018, October, November, December, the markets just fell, and part of it was Powell's gonna raise rates, inflation's getting out of control, et cetera, et cetera. And then we got all this data that said China may be entering a real period of malaise and Powell capitulated. Again, trying to stick the landing. And long story short, he didn't. That was a head fake and the markets just ripped higher. Then we went into the COVID pandemic and all of that stuff happened. So, I think we're about to replay a little bit of that, at least in the next 30 to 90 days. The pain trade is to go up, so that's probably where we're going.

Jason Calacanis 4:48 Here's the Fed fund rates chart from 2000 and into the 2008 recession, and you see just, you know, to Chamath's point in 2019, that little step up to 2%, uh, and then this dramatic step up, uh, that we've been on up, uh, to four and a half or so. Sacks is this where the Fed pauses, you think they cut, and, and what overall effect is this gonna have on venture capital in the startup market, which is super important to us?

David Sacks 5:17 I think we're in the whipsaw economy here. Just a month ago, sentiment was incredibly negative. On this show we were predicting for the year that we were looking at the Fed funds rate going from 4.5% to say 5.5%, two 50 point increases. The belief was that we were gonna have a recession later this year. I think that was pretty much consensus. And now three weeks later, you had a situation in which we got a couple of really good inflation reports, so all of a sudden the consensus changed to, "We're not gonna need to raise rates, you know, to 5.5%, maybe we only get one or two more quarter point rates." And the market just ripped on the belief that inflation was in the rear-view mirror, the problem had been licked, and now we can just kind of move forward. And the Fed seemed to confirm that-... just yesterday with the quarter point rate increase. And now today, we have this wild jobs report with over half a million new jobs. The expectation was only 100,000. And so now all of a sudden people are wondering, "Well, wait a second. Does this mean that labor costs are gonna, you know, go back up, that the economy is overheating, and now the Fed's gonna have to raise more?" So I would say literally from week to week, we're being whipsawed between expectations of, uh, whether inflation has been conquered or not, whether the economy is gonna have a re- recession or not. And I think probably where we're sitting at this moment is you'd have to say that the risks of inflation returning are slightly higher, but the risks of a recession are slightly lower, because with this kind of jobs report, better chance of having a soft landing here.

Jason Calacanis 6:58 It's very hard, in other words, Sax, to have a recession if people are employed, if people are employed.

David Sacks 7:04 Especially when you're down to-

Jason Calacanis 7:06 And we have 50 year, yeah, 50 year low.

David Sacks 7:06 ... 3.4%. Yeah, exactly. So-

Jason Calacanis 7:08 50 year low.

David Sacks 7:10 Right. So I just think that we're in a highly volatile economy and it's very hard to predict the future. I'd say that relative to where we were a month ago, you'd have to say that the odds of us having a soft landing this year are quite a bit better than they were just a few weeks ago.

Jason Calacanis 7:27 All right, Freidberg, when we look at this employment picture, it does seem people are going back to work. It seems maybe indicative of people blew through their savings. We talked about this, you've been harping on and on previous episodes about people doing personal debt, buy now pay later. Is, uh, a possible thesis here that people YOLOed for so long, post-pandemic, Coachella, vacations, et cetera, that maybe they whipped through their savings? It seems like we, we've burned off a trillion in savings or something like that, and the debt's going up, so now people maybe need to go back to work and they're finally capitulating and taking jobs. Do you think that's what's actually happening here?

David Friedberg 8:04 I don't know if I would-

Jason Calacanis 8:05 Just one of those theories.

David Friedberg 8:05 ... classify that. I mean, the, there's obvious, a lot of this stuff is on the margin. The, the one challenge, you know, Larry Summers has been harping on since last spring all the way through the summer and the fall, and, you know, in multiple kind of interviews and publications he's done, he's ex-US Treasury Secretary, obviously brilliant economist, um, that the US needs to have a 5 to 6% jobless rate for five years in order for us to really get to the inflation rate target of 2 to 3% or below 2%. And so, you know, the economists and the macro guys that are tracking the jobs report today are the, I think the indication is we're not there yet, and that the implication of a tight job market is wages go up and wages go up, inflation goes up, and 'cause companies need to charge more 'cause they have to pay more to get talent. And this, uh, obviously continues to support the escalatory spiral, uh, that drives inflation. So that's the, the, you know, kind of downside to the jobs report today that I think a lot of folks are watching.

Jason Calacanis 9:11 The Fed mentioned over and over again deflation. So a- any impact there, Chamath? Do you think we're gonna see prices start to crater? And what impact would that have on the market?

Chamath Palihapitiya 9:21 I think Sax is right. I think the, the marginal risk here is, is for this whipsawing. So we have a period now which is disinflationary, but the problem is if the stock market keeps going up and all of a sudden we have less restrictive monetary conditions, then we're gonna be back at the same place we were before, which is money sloshing around into all kinds of risky assets for more money. You know, there's still an enormous amount of money sitting on the sidelines that has to come into the market now if this thing keeps going higher. So we're in a delicate moment, and if we reignite inflation because all of a sudden more companies have more liquidity that they can tap, right, more money they can raise, more money as a result that they can spend, because we don't have this first inflationary cycle under control, there could be a risk that, that we reignite inflation. And so then, then they have to capitulate, the Fed has to capitulate again and start another hiking cycle. So I think it's a complicated moment. I think all of the smart money in Wall Street that I talked to up until this point, they forecasted like this period would be choppy and the second half of the year would be really robust and, like, you needed to be super long and things were gonna be incredible. And when I talked to them this week they're like, "Oh, God, we weren't positioned for this. We had no risk going into this. We're gonna be forced buyers." There's a bunch of companies that are whispering that they wanna go public now.

Jason Calacanis 10:50 Oh, really? Hmm.

Chamath Palihapitiya 10:51 And so the big banks have been calling around trying to book build quietly for some IPOs. And so if they try to kind of crack this capital markets open, I think there's, again, the marginal risk will be that we do whipsaw it, Sax says, and we go-

Jason Calacanis 11:08 When you say book build, you mean trying to see if you'll get some early takers to buy equity in an IPO, perhaps even in a company like Stripe that's been sitting on the sideline?

Chamath Palihapitiya 11:17 So not Stripe. They're in a complicated moment. But when they called the book build, they basically say, "Hey, listen. XYZ Company quiet filed. Look at the S-1. What do you think? Where's the price? Blah, blah, blah." And they're trying to get an indication of whether you'd wanna be in the IPO book. So I think that there's a lot of those testing the waters that are now starting again.

Jason Calacanis 11:37 Would there be an appetite in your mind for an IPO, uh, in the second quarter of, like, a Stripe type company putting... You know, I don't know what the other candidates are, the lead candidates, but Stripe is the one people talk about most.

Chamath Palihapitiya 11:48 The thing that we have to think about is, like, most of the market are not people, right? Most of the market are computers and algorithms and ETFs. It's an extremely formulaic buying model that you have components of an index, those represent certain percentages, you have to own those percentages to be relevant as that index. And so it's this reinforced buying loop as well as a reinforced selling loop, right? So when things start moving-... those folks have to just systematically move money in. All the humans know that, so the humans tend to front run all the computers and they basically are the ones that sell into these guys. And then that's what inflates these prices. And similarly, on the way down, humans try to front run it by being short into that stuff. So, we could see the capital markets open. Even if we don't, it's actually the worst scenario because now you have all this money going into a fewer number of names. That sort of explains Facebook has doubled in, in 30, 60 days.

Jason Calacanis 12:46 Yeah, it was about to get to that, yeah.

Chamath Palihapitiya 12:48 Te-Tesla, Tesla has doubled in 30, you know, 30, 60 days. A lot of the tech stocks, like high beta stocks that we are all, you know, helping to build, those companies have just absolutely ripped 60 to 100%. These are not healthy and normal moves, and so the question is, what happens if inflation somehow all of a sudden pokes itself back up? Right now it doesn't look like it is and Powell was clear and it's true, we're in a deflationary cycle.

Jason Calacanis 13:13 Well, he said deflation 11 times during his, uh-

Chamath Palihapitiya 13:16 Yeah, we're in a def- we're in a deflationary cycle.

Jason Calacanis 13:17 ... and he, he's very clear about his use of language.

David Sacks 13:19 That's why the market ripped. I mean, basically, that was all part of a narrative where inflation's on its way out, we've licked that problem, and that's what the market was pricing in. And I think now the question is, in light of today's jobs report, is that actually true or not?

Jason Calacanis 13:36 And I'm sorry-

David Sacks 13:37 I think-

Jason Calacanis 13:37 ... disinflation, not deflation, sorry.

David Sacks 13:38 Disinflation, yeah.

Jason Calacanis 13:39 Disinflation.

David Sacks 13:39 So I think, you know what-

Jason Calacanis 13:40 Just to make

Narrator 13:40 One way-

David Sacks 13:41 ... one way to look at this is, um, Jay Kal, you showed the chart of the Fed funds rate. Another chart is the yield curve. Can we just pull up the yield curve for a second? This is the yield on US Treasuries on, you know, our T-bills. And one way to look at this is as a prediction market of where the market thinks interest rates are going. Because the Fed sets the rate for the Fed funds rate, which is the overnight rate of lending to banks, but they do not set the rate of, you know, three-month, six-month bonds, 10-year bonds and so on. The market does, because the market trades those bonds and it imputes a yield that the market requires to want to hold those bonds. So, what's interesting is that if you view the yield curve as a, again, as a prediction market, it tells you at any given time what the collective wisdom is of the market. Now this thing is fluctuating, moving all the time, so that collective wisdom is changing. But where things are today, it's pretty interesting. It looks like what the market is saying is that within the next six months, the rate peaks at 4.75%. So Nick, if you just want to hold the, the mouse on the six-month dot, um, you'll see it's 4.76%. So, basically the market is predicting we get maybe one more quarter point roughly, not much. And then if you go to the two-year, it's at 4.09, so a little over 4%. So, what the market is actually predicting is that over the next two years, we're actually gonna get a 50 basis point decrease from the Fed. And then if you go to say the five-year or the 10-year, we're at three and a half percent. So the market's basically saying that long-term rates are gonna stabilize at three and a half percent. We're not going back to the abnormal zero interest rate policy, or ZIRP, that they had for 10 years. Three and a half percent will be the long-term stable, you know, cost of money. But you can see that the market, the prediction market thinks that the Fed has done enough to combat inflation, because the Fed funds rate now basically is where the bond market thinks it should be. And in fact, the bond market thinks it's coming down over the next two years.

Jason Calacanis 15:54 But coming down to what would be three and a half, in a world that we've lived in for largely of the, over the 14 years of this bull run, the majority of that was at close to zero, or zero.

David Sacks 16:05 Right, and that's why we're never going back to the bubble of 2021 where SaaS companies were trading at 100 times ARR. We're gonna go back to an environment more, like a more normal one where valuations are more like the 2017 valuation, something like that. It's, by the way-

Jason Calacanis 16:19 What is-

David Sacks 16:20 ... three and a half percent is not a bad, you know-

Jason Calacanis 16:22 It's still a great deal.

David Sacks 16:23 Yeah.

Jason Calacanis 16:23 Still a great deal if you got your mortgage at then.

Chamath Palihapitiya 16:25 If you listen to Buffett, Buffett's teacher, this guy Ben Graham. In Ben Graham's book, the way that he would look at a stock, and obviously look, things have changed, but the way that he would look at a stock is he would look at that risk-free rate. He would double it. And then the inverse of that is the maximum price to earnings ratio that he would pay for a stock, right? That's the trade-off is if you can get more than two times the risk-free rate, then it's worth owning a company. What that means is that i- if you take three and a half percent as a terminal rate, the right PE is around 14 for the S&P 500. Right now, the S&P 500 trades at 22 times PE, which would mean that we are 50% overvalued. Now that, again, that's a Benjamin Graham model, and I think the world has pretty cleanly moved away from it, but there's probably some rooting in that intellectual framework that's still valuable. And to your point, David, it just reinforces that, man, we need to start to learn a new regime here, because when rates are not zero, there is just a lot of excess that you can't support because the alternative trade-offs for investors are plentiful, you know? And plowing money into a money-losing startup becomes less attractive.

Jason Calacanis 17:36 And, and to just give people some background, that's The Intelligent Investor was that book, I believe, and he was talking about value investing, which is, hey, what's the earning per share? What's the ratio? What's the PE? And that's something that growth and momentum investing has been the opposite of, and, and this is a n-

Jason Calacanis 17:52 could be, I think you wrote a blog post about this, Chamath, sort of the regime change. If you look at the Googles, the Facebooks, the Apples, Amazons is, is a little bit of an exception here, those companies printed money. They had profits. They built up large cash reserves. If we look at the next cohort of companies, Airbnbs, Coinbases, Ubers, et cetera, they focus on the top-line growth.... uh, much like the Amazon, which was very obscure approach, correct, Chamath, uh, in, in the history of this?

Chamath Palihapitiya 18:22 Nick, do you just wanna throw up this chart? We did a little analysis over here and it was just basically looking back 60 years of company formation. We looked at all of the 100 most valuable public company startups, and we indexed that to the tenure interest rate.

Jason Calacanis 18:37 So what are we looking at here, Chamath, with this chart?

Chamath Palihapitiya 18:39 So basically, we went back from 1960 onwards, so basically, you know, 63 years. And what this shows you is the 100 most valuable public technology companies, then the size of the circle here is their market cap, and then it's overlaid on top of the tenure interest rate as well as gray bars for recessions. So, what is this graphic meant to illustrate? Well, it just was for us to study, is there a correlation between the value of companies and what the interest rates were or what the economy was doing at the time? And to your point, Jason, the trend is pretty starkly made on this chart, which is that if you were a company that was founded in a period of austerity, you had the ability, in general, to build a much larger company than that which was founded in a period of wealth and excess. Right? So when you look at when rates were sort of approaching zero or were zero, there was a lot of really successful companies, they're listed here in the, in the light gray on the right. But none of those things really represent the success that these other companies had. That's the first interesting takeaway. The second interesting takeaway, though, from this has nothing to do with rates per se, but it is that when rates intersect with the emergence of huge technology trends, so in the case of the 1970s it was the PC revolution, in the case of the late 1990s it was the internet revolution, those two things which required enormous progress in both physical infrastructure, so atoms, as well as software infrastructure, bits. When you put those two things together, those also created big companies. And so if you add that all up, the point is that whenever you see huge tectonic shifts in technology combined with periods of austerity, that's when the gargantuan dollars are made. So, in the 1970s, companies like Microsoft and Apple from the get-go had to be profitable. Right? And in the absence of one very important round of financing that Amazon was able to close, the next big lot of companies were founded again in rising rates where they just had to get profitable or find a way to be positive free cashflow or have positive working capital faster than anybody else. So, these are, like, really interesting trends that I think just say that as rates creep back up, and if we can intersect that with some improvements in technology over the next five to 10 years that we've all talked about, it could be a real boon for startups and startup investing.

Jason Calacanis 21:22 It would mean people are a little more resilient, a little more hardcore, to use a term. Freberg, what are your thoughts on this, uh, analysis by Social Capital?

David Friedberg 21:29 It's interesting. I mean, I think there's probably two ways you could interpret this. One is in an era of excess capital. All the capital gets competed away, and so you pay more salaries, you have, uh, it's harder to get high-quality talent, you make a lower margin, et cetera, et cetera. It's much more kind of, uh, competitive on the ground. And then another one is just obviously kind of, like, evolutionary fitness. When there's less capital, investors are more selective. I think what might make this era a little bit different than the past is just the amount of termed dry powder sitting on the sidelines right now, so the, the, the total VC capital raised last year I think was a record high. That means there's a lot more cash that needs to kind of be deployed in the next 12 to 36 months than has ever, um, been deployed in, in the history of venture. If that holds true. So, that may be kind of a, a counterbalancing effect here where it may take three years before that effect plays out, where there's more of a dearth of capital. It's certainly the case that, uh, institutional investors' endowments, pension funds, traditional family office LPs and venture funds are making far fewer commitments this year to new funds, a- as I think we all know, and that tightening will play out in the venture funds that'll get raised for this vintage, the next vintage, and so on. And so maybe that, that kind of evolutionary fitness concept starts to play out later. And also-

Jason Calacanis 23:00 And sizing. And sizing.

David Friedberg 23:00 And sizing. I, I think there's also this, like, you know, we talked about this on our text stream, but the venture business of the last 15 years, everyone since 2008, everyone's been trained and all the younger people that have come up and are now partners and running the firms on an environment of momentum investing rather than fundamental investing. And so there is also a question of how, uh, fit the investors are for a market space where valuations are flat or descending or the decision whether or not to invest is no longer driven by who else is investing and how much is the company growing and how much is their valuation going up. Uh, but it's much more about kind of the fundamental performance of the, the, the business.

Jason Calacanis 23:49 Does this match what you're seeing on the ground, Sax? Are, are people being more dogmatic pragmatic? Are, are the capital allocators really sharpening the knives and looking at these businesses a different way as it actually hit the streets?

David Sacks 24:04 Yes, there's a record amount of money, venture capitalists raised over the last, you know, couple of years. But it's gonna be deployed much more slowly and carefully over the next, say, three or four years than it was over the previous few years. So divide that amount of money by three or four because the pace...... of deployment's gonna go way down. And so yeah, I think people are gonna be more careful, they're gonna take longer to make decisions. I think it's gonna be much, much harder for new funds to get started. All of the, you know, hype around, you know, solo capitalists and, you know, all these, you know, seed funds and micro VCs and all this kind of stuff, I think a lot of that's gonna get washed away. I think, in hindsight, a lot of that was a product of the bubble. And yeah, I think you're gonna be in for a period of some retrenchment in VC, and I think that's good. I mean, I think to the point of Chamath's study, that, you know, that the counterintuitive finding in his study was that great companies are created during times when we're not in a bubble and, and capital is sloshing around everywhere, but when you're in a environment of moderate capital availability. And I think the point is that we all have to be under some stress, right? That's what evolution requires is, you know, if an ecosystem or an organism is not under stress, they have no pressure to evolve and become fitter and compete. And I think that's what makes our industry and our ecosystem very adaptive over time, is that it's constantly, you know, it, it does face survival pressures. But over the last several years, all the survival pressures were taken away, because anybody could raise money and-

Jason Calacanis 25:49 There was always another bridge available.

David Sacks 25:50 Right, exactly.

Jason Calacanis 25:50 There was always some extension and there was no reckoning.

Chamath Palihapitiya 25:53 Some convertible note to be done.

David Sacks 25:55 Right.

Jason Calacanis 25:55 There was no reckoning, you know, a lot of these companies-

David Sacks 25:57 Correct.

Jason Calacanis 25:57 ... just seemed to, you know, get another 12 months of runway, another 12 months of runway.

David Sacks 26:01 And then found- founders learned so many bad habits during that period of time-

Jason Calacanis 26:04 Yeah.

David Sacks 26:04 ... and so much entitlement and excess built up in the system during that time. And I think now, we're, we're seeing that a lot of that is working its way out. I mean, just look at the Facebook results the other day.

Jason Calacanis 26:18 So Facebook just-

David Sacks 26:19 Let's talk about Facebook as an example.

Jason Calacanis 26:21 Yeah.

David Sacks 26:21 Because here you have a company where the stock, over the past year, had been pounded. It was like down over 50%. And the market did-

Jason Calacanis 26:29 90 bucks a share, yeah.

David Sacks 26:30 Yeah, did, the market did not like its answers around the capital investments it was making, and then Brad Gerstenauer, our friend, wrote that letter encouraging them to get much more efficient and then they did that. And they basically started doing some riffs and basically just getting much more efficient in what they're doing, and specifically taking out layers and layers of middle management. I mean, that was really the big thing. So they kinda took a page out of Elon's book, in terms of what Elon had done at Twitter. I mean, not nearly to that extent, because I don't think they needed to, but they targeted this idea of, "We have too many layers in the company. Too many mid-level managers." And the stock ripped just, what was it, like, up 20, 25%, uh, yesterday? In a day?

Jason Calacanis 27:11 Yeah, in a day. And they're up to... I actually bought it, based, the day they had the layoffs, I put in a buy order and it was closed at $94 and now it's at $193. And FedEx, of all places, uh, is laying off 10% of its offers, officers and directors.

David Sacks 27:29 Yeah.

Jason Calacanis 27:29 So, the idea now is, hey, in the senior ranks, what is the inefficiency there? How do we get-

David Sacks 27:36 Well-

Jason Calacanis 27:37 ... more doers, more people who actually are building or operating the companies, to take the reins and get rid of this, as you're saying-

David Sacks 27:44 Yes.

Jason Calacanis 27:44 ... middle management? This waste that companies have.

David Sacks 27:48 Yeah, let me, let me tell you, let me tell you specifically the problem that builds up in these companies is that everybody wants to be a manager. And so you, you can't just come at this problem by saying, "We're gonna increase the number of reports that each manager has from five to 10." That doesn't work, because let me tell you what happens is that every individual contributor who's a star thinks that their career advancement requires them to manage a team. So what happens is you take that star IC and then you create a team around them. So that person then hires five people to manage. And those five people-

Jason Calacanis 28:19 Then they stop working. (laughs)

David Sacks 28:19 ... are not a star. Yeah, they stop working, they just start managing.

Jason Calacanis 28:22 Yes.

David Sacks 28:22 Well, maybe you get, like, 20% more production out of that six person unit than you would've just out of the star. But you're spending five times more money, so it makes no sense, and the problem is it cascades. So, you know, that IC becomes a manager, they hire five people, then those five people, one of them's a star and says, "Well, I wanna be a manager." And all the organizational pressure is to keep building more and more teams and more and more layers.

Jason Calacanis 28:48 Here's the quote from Mark Zuckerberg-

David Sacks 28:50 Mm-hmm.

Jason Calacanis 28:50 ... who illustrate your point from a recent all hands meeting. "I don't think you want a management structure that's just managers managing managers managing managers managing managers, managing the people who are doing the work."

David Sacks 29:01 Yes, it's the problem with infinite delegation.

Jason Calacanis 29:03 Yeah.

David Sacks 29:03 Every, like, star builds a team around them to delegate the work but then they hire a team to delegate the work to. And pretty soon, the most junior interns in the company are doing all the work and all the best people are just managing. So, it's, it's actually a huge problem and I think that, I'd say that a lot of CEOs don't quite understand the problem because they think that all they have to do is increase the number of reports that managers have. It's not. You also have to reduce the number of layers in the company. And, and, and just the ultimate example of this, just to put a point on it was at Twitter, what we saw, is that when Elon went in to basically do a riff at Twitter, the first question he asked in the engineering department is, "Who's checking code?" And they looked at the code repository and over-

Jason Calacanis 29:48 Yeah.

David Sacks 29:48 ... 50% of the engineering department had not checked in code in months. And you wanna know the reason for that? Is because the, the engineers were told that, "If you wanna be a manager in this company, you don't code. Managers don't code. Only ICs code. And no one wants to be an I- no one ambitious wants to be an IC, they all wanna get promoted." So it all gets completely-

Jason Calacanis 30:08 Explain what an IC is.

David Sacks 30:10 This individual contributor.

Jason Calacanis 30:11 Yeah.

David Sacks 30:12 So the whole thing turned upside down because of this idea that, again, ambitious people wanna be managers and managers don't do the real work.

Jason Calacanis 30:19 Yeah, it's like cowboys who don't know how to ride horses. It's like, it's a dangerous precedent to set.Wha- what are your takeaways, uh, Chamath, from what happened at Facebook when you look at it and the pressure that was put on, the ripping of the stock? Even though they're down two percent year over year, uh, in terms of advertising revenue.

Chamath Palihapitiya 30:38 There's a, uh, a guy on my team sent me this chart. He did a pretty detailed technical analysis of Facebook. Nick, can you please put that image up there? So basically-

Jason Calacanis 30:48 (laughs)

Chamath Palihapitiya 30:49 ... this sh- this shows the-

Jason Calacanis 30:49 This is really technical. (laughs)

Chamath Palihapitiya 30:51 This i- this is the first time Facebook mentioned the word metaverse in Q2 of '21. On the earnings call, they mentioned it 20 times. And-

Jason Calacanis 31:01 Yeah.

Chamath Palihapitiya 31:01 ... the gray line here is the stock price. So as they kept mentioning it, the stock price just, you know, reacted-

Jason Calacanis 31:06 Plummeted. (laughs)

Chamath Palihapitiya 31:07 ... as it did. But Q- Q4 of '22 was the first time that the word efficiency exceeded the word metaverse. And you saw, and you saw the stock price rip up. So what's happened at Facebook is really interesting, because it, I think it transitioned to what's generally called an ex-growth company, which means that people are now looking at a business that has essentially gotten to its peak size, and now what they're looking at is its ability to generate cash flow. The cash flow generation or cash flow yield of the business was like three and a half percent, but they're making enormous cuts both in CapEx as well as headcount over time. They're getting their expenses under control. And all of that should drive up their cash, free cash flow yield. And so I think why people got very excited is there are very few ex-growth stocks that you can own that can just compound and crunch ginormous amounts of money, and these guys are in an incredible position to do it. You know, more than 100-plus billion dollars of revenue. And if you get these costs under control and get efficient, get the employee base down to 30,000 or 40,000 over time, this is a thing that just spits out just ginormous amounts of cash. And so-

Jason Calacanis 32:23 So back to value investing-

Chamath Palihapitiya 32:24 ... it's really exciting.

Jason Calacanis 32:24 ... and Warren Buffett, that means the earnings per share go way up.

Chamath Palihapitiya 32:27 Yeah. You know, like, like, the Facebook P/E is quite modest actually. Now I actually put back in stock-based comp, and its P/E is about 11.

Jason Calacanis 32:36 So still reasonable.

Chamath Palihapitiya 32:37 If you go back to the, to the Ben Graham analysis, this is a company that perfectly meets that criteria of like, you can buy it at a P/E that's basically two times the risk-free rate. And so I think it's an incredible stock now that you can own. Because if they keep grinding out all of these kind of free cash flow gains, man, they'll, they'll just, they'll just have enormous amounts of money. They already announced a $40 billion buyback. You know, the thing to keep in mind is Apple had a moment like this. And when Apple went ex-growth, they did the brilliant thing, which is they said, "We're gonna borrow heavily, and we're gonna return cash." I may have posted this in the group chat to you guys. By 2025, Apple will have exceeded $1 trillion of cash distributions. I mean, that is just nuts.

Jason Calacanis 33:27 Does that include buybacks in cash distributions? Yes, so-

Chamath Palihapitiya 33:30 Buybacks and dividends. And so-

Jason Calacanis 33:31 Got it.

Chamath Palihapitiya 33:32 ... Facebook now, you can credibly see a path where Facebook could chunk out hundreds of billions of dollars of, of total shareholder value returned over the next four or five years. And so, you know, for value investors, it's somewhat of a, kind of a no-brainer. I mean, nothing's a no-brainer, but-

Jason Calacanis 33:49 Yeah.

Chamath Palihapitiya 33:49 ... really, really attractive value fundamentals right now.

Jason Calacanis 33:52 I mean, you did see Warren Buffett buying Apple. I think it's his largest position. You're gonna see him probably do the same with Facebook.

Jason Calacanis 33:58 There was an interesting mass extinction event tweet that went on that's related to all of this. Tom Loverio, a GP, a general partner, at IVP, which is a venture firm, tweeted the following thread. "There is a mass extinction event coming for early and mid-stage companies late '23 and '24. It'll make the 2008 financial crisis look quaint for startups below. I explain when, how, and why, and," uh, well started off with some detailed advice. Basically, four in five, four in five early stage startups, he claims, have less than 12 months of runway, uh, according to a Q4 survey of 450 founders by January Ventures. He sees late '23, '24, when this will all come home to roost. Mark Suster, from Upfront Ventures, friend of the pod, replied with the following, "Precisely our internal analysis, 5,000 seed, 2.5 million raised or above, A and B companies," so three different categories, "funded in the last four years, we estimate 50% will go out of business. Loss ratios in the last seven years have been artificially low d- due to excess capital," as we just discussed previously with the never-ending bridge.

Chamath Palihapitiya 35:05 We've talked about this before. If you look back over 40 years of venture capital, the average top quartile fund distributes 1.6 or 1.7x the capital they raise. Even though now we've gone through a period where people have shown these unbelievable markups, right?

Jason Calacanis 35:21 Mm-hmm.

Chamath Palihapitiya 35:21 TVPIs, the total value-

Jason Calacanis 35:23 Right.

Chamath Palihapitiya 35:24 ... of paid-in capital, distributions have not really budged that much. Distributions are still modest. They're below 2x. And so we have to go through what's called mean reversion, right? We have to-

Jason Calacanis 35:34 Sure.

Chamath Palihapitiya 35:34 ... go back to the historic statistical average, which means that a 50 to 60% mortality rate seems pretty reasonable. By the way, in the dot-com bubble, that's what we went through. You know, in 2001 to 2005, we had a 50% mortality rate.

Jason Calacanis 35:49 At the seed stage, I mean, you kind of expect 70% to go out. Series A, maybe a little bit less. Friedberg, what are you seeing on the streets? You're investing in startups.

David Friedberg 35:57 Yeah, look, I, I think that there's-

Jason Calacanis 35:58 Is there an opportunity, by the way, also in here? So what are you seeing, but is there an opportunity in this group of, this cohort of companies which seem to be, um, upside down and/or in-

David Friedberg 36:08 I'll ta- Yeah.

Jason Calacanis 36:09 ... a tsunami right now?

David Friedberg 36:09 This cohort of companies, I think, generally is overburdened with feature orientation and short-termism more than you would see in an era of, uh, reduced capital rather than excess capital. And what I mean by that is a lot of companies...... built a business or built a product that allowed them to show traction in the market faster and typically those products that are easier kind of paths to market end up being features, they don't end up being platforms. So it's very hard to become a big business, or to become a scaling business, or to differentiate in a competitive market. That's a generalized... that's a very general statement, but I think, you know, when you miss out on the platform play, you start betting as an investor on a lot of the derivative plays that look like the real big company, look like the platform. I mean, think about how many companies try to look like some iteration of Stripe, or try to look like some iteration of Uber, or try to look like some iteration of, you know, name your big kind of behemoth. And as a result, you get all these sort of feature-ish platform plays that have maybe a niche or some kind of, you know, narrow kind of market opportunity, they got funded. Those, those businesses obviously aren't gonna have the same valuation multiples of the winners in the market. And now, uh, and they burnt a lot of money to demonstrate growth because so much of investing over the last 15 years has been momentum investing, and so they, they try to grow then they try to get a higher valuation, investors plow more money in. Now the problem is that so many of these series B, C, D, and E companies have a true market value, they're not a valueless company, but the true market value of them is probably less than the total preference stock of the capital that's gone in. So they're worth less-

Jason Calacanis 37:52 Okay so wait, let me-

David Friedberg 37:53 Yeah, yeah.

Jason Calacanis 37:53 Let me, let me just make sure people understand that-

David Friedberg 37:55 I'll just, I'll just describe it, yeah. So when investors invest, they have preferred stock, so they have a right to get their money back. So they, let's say a 1X liquidation preference, they invest $100 million, the company is worth 300. So they own 25% of the company after they invest, but they have a right to that $100 million first before common shareholders get paid. The problem now is that a lot of those companies may be worth less than the 100. They're not worth 400 anymore, they're worth 100. And you can see this play out in the public markets with that, uh, that dataset I shared with you guys a few weeks ago. Over two thirds of companies now that have gone public since 2020 are worth less than the capital that they have raised, as in the venture market. So if they were still private, they would be worth less than their preference stock. And that's where these companies start to unravel, because now the investors have to totally recap the company, the founders don't wanna have all of their common wiped out, now they own nothing, and there ends up being a very ugly scenario that happens with the board at that point on how do we wind this thing down? How do we recap it? What's gonna happen? And that's usually where everyone starts to run for the hills, the founders, one or more of the founders leave and so on.

Chamath Palihapitiya 39:00 Freeberg, I have a, I have a question for you. So you mentioned this earlier which I think was a really important point but we didn't really touch it. Do you think there's gonna be a reckoning inside of venture firms about recalibrating general partners?

David Friedberg 39:14 100%. I mean, look-

Chamath Palihapitiya 39:15 And why? Sorry, just explain why, why.

David Friedberg 39:17 Yeah, so I think what's happened is over the last 15 years to become a successful venture investor you've gotten into the hot deals. The deals were... and, and hot deals, the valuations are typically climbing up. And, you know, when the valuations climb up, that's an indicator that the company is doing well and you should invest. That's been the model for operating in the last 15 years. But the truth is that maybe just because the valuations have gone up and more money has gone in doesn't necessarily mean that that's a great business, or as Chamath points out, that you ultimately get a positive net return on that investment down the road. And that window is now closed. So the, the, the investors that have been trained ge- this is such a generalization and I hate saying it because we have so many good smart friends that work in venture, but generally speaking there are a lot of folks who have come up who have been trained on this momentum investing model. And it's, it's like, it's like day trading, the stocks are going up, let's all put money into the stock going up instead of having a more fundamental approach to, is there real cash generation potential and scalability and platform ability of this company? And as a result, you're gonna have to see I think the junior partners that have come up and done well in this market ... There's gonna be a point-

Jason Calacanis 40:24 Can I build on your point? Well they're, they've, they've done well on paper, but they haven't done well on distribution, so maybe that, Chamath, becomes the-

David Friedberg 40:31 Well, so-

Jason Calacanis 40:31 ... way you decide who's a good venture capitalist. Which of these companies actually returned capital at a peak market?

Chamath Palihapitiya 40:36 Well, I think Freeberg, uh, is really onto something, and he mentioned this before so I got curious about this and I went into PitchBook, and my team and I looked at all of the people, the humans in our business, that have generated more than a billion dollars in distributions on a given deal. And there's 20 that have done that, in our industry. Like, there's people that have made hundreds of millions of dollars once or twice, but there's 20 people that have made more than a billion dollars more than once, okay? And if you look, not a single one came up through the ranks as a pure engineer or product manager.

David Friedberg 41:09 Right.

Chamath Palihapitiya 41:09 Everybody to a one is extremely commercial in their background and their-

Jason Calacanis 41:16 Hmm.

Chamath Palihapitiya 41:16 ... operating experience. Very few percentages of them were actually founders. A huge percentage of them were trained in banks and other places, so non-traditional, quote unquote, "roles" for what this current crop of GPs look like because we went through a phase where if you were a VP of product or a VP of design or a VP of engineering at a well-known startup, that was the most obvious onboarding into a venture firm. But if you just look back at the data, that cohort of people has actually never made money, again according to PitchBook.

Jason Calacanis 41:47 That's fascinating. Hmm.

Chamath Palihapitiya 41:48 And that's a really fascinating counterintuitive takeaway which is that... And, and by the way, what, what's so interesting about that is Pat Grady I think had a tweet and it just sums it up so cleanly because he just hired somebody from Coatue and the tweet was something to the effect of, "This guy is the most commercial guy we've ever seen." Something like that. And I thought that was so interesting because that is exactly what our heuristical analysis of this data was as well. Commercial people in venture are the ones that make the money.

Jason Calacanis 42:17 So you look at a Fred Wilson, Michael Moritz, Danny Rimer-

David Friedberg 42:21 Danny Rimer-

Jason Calacanis 42:22 ... Bill Gurley-

David Friedberg 42:23 ... Bill Gurley, they were investment analysts-

Jason Calacanis 42:24 I can share you the list, Dan.

David Friedberg 42:25 ... in public markets before they became venture investors. Or Mike Moritz who was a, who was an-

Jason Calacanis 42:29 A journalist, yeah. Which is, a journalist is just an analyst, it's another... if you're a good journalist, it's another word for analyst.

David Friedberg 42:34 Yeah.

Chamath Palihapitiya 42:35 It was really, really interesting looking at that list. So like, you know, there are people in there like Jim Goetz, Alfred Lin, Danny Rimer, Jan Hammer.... Fenton. So, if, if you look at all of these folks that are just tier one people, and we know all of them, the one common thread amongst all those folks is that unbelievably commercial. And so, Jason, in a m- in a moment like this where you have to really hold the entrepreneur's feet to the fire or be their partner to make extremely hard decisions, you have to have the ability to be respected by them in those moments where you can force a very difficult decision. And then separately, if you have to basically force liquidity so that you prioritize your limited partners, how do you do that while still managing the relationship with the entrepreneur? How do you know that you just need to cut your losses and get out? These are very difficult trade-offs that I think folks haven't been trained in doing, to David's point. So, it'll be really interesting few years to see how these organizations react.

Jason Calacanis 43:32 I think this goes, this goes to Sax's point about, hey, the ecosystem, if it's hard, if it's cantankerous, if, s- there's sand in the oyster, it could make the pearl. If you have a con- you know, a congenial relationship with, you know, your product manager VC and everybody's drinking champagne and caviar and, and, and high-fiving, maybe that's not as good as having a Bill Gurley, a Michael Moritz, and having, uh, a foil maybe who is putting pressure on the management team, "Hey, we need to hit these numbers." Freburg and then Sax.

David Friedberg 44:02 Yeah. Look, I think one, one counterargument here may be that there is this friggin' tidal wave of AI companies and there is this incredible amount of lubricant in the dry powder that's sitting on the side of the (laughs) of the market right now, that all these venture funds raised in the last two years, that is gonna lubricate all these A- AI companies into every vertical and every market. So, every company's wrapped up in an AI cloak, like a magic invisibility cloak. Every AI company's got an AI hat and a badge and a tattoo now, where every company's being rewritten as an AI company. And the money wants to find its way into AI and it wants to rewrite industry with every industry with AI. So, I think similar to what we saw with mobile and the social web, you know, going back 10 or 15 years, we're seeing kind of this AI wrapper and this AI technology enabler rewrite the possibility of every vertical. And the VCs have capital, more capital than they had 15 years ago or 10 years ago, or even seven years ago. So, there is this counter-narrative which may be that the game, the game goes on, the band continues to march on. The current crop dies out, but there's immediately a new crop waiting right behind it. Or what happens is the herd dies and everyone runs to the back of the herd-

Jason Calacanis 45:16 I think you're right.

David Friedberg 45:16 ... and gets recapitalized. 'Cause I can tell you, every startup I know that's not going well, everyone's talking about leaving to go do an AI company.

Chamath Palihapitiya 45:23 No, no, I think-

David Friedberg 45:23 And the venture firms are ready to write money. Yeah.

Chamath Palihapitiya 45:24 I think you're, I think you're right about that. I think the question is, the actual person making the check, will they be more or less likely? And at least what history would tell you is that we've hired an entire generation of people that, and this is clear, do not map to the people in our industry that have actually generated returns. So, you're right. They may take this money and misallocate it into these companies that are just, you know, rebranding themselves, but that just goes and further proves that there is a type of person that hasn't been recruited into these venture firms yet, that was the first generation that made all the money.

David Sacks 46:03 I think it's always been the case that there is some difference between the background of the VCs and the backgrounds of the founders. I mean, you guys mentioned Gurley and Moritz. Like we said, Moritz was a journalist who had written a book about Apple. He wasn't technical per se. And Gurley was a investment analyst on Wall Street before he then made the transition into VC. As th- you know, as we both know, they are like legendary VCs. You know, I think the, what you want to see in a VC, I think that background matters a little bit less than, you know, like, how curious are they, how good are they about learning a new area, how good are they at being like a heat-seeking missile. I mean, basically just like zeroing in on, like, what is the hot space, and specifically, what is the best company within that space? And somehow figuring that out. Being able to assess a founder, you know, that's like a very subjective thing. So, I think there's lots of qualifications that you wanna see in a VC. Now, at the same time, I do think that i- if AI is the next wave and the next sort of platform opportunity, as we all think it is, I do think that places more of an emphasis on technical skills. And I was, I was literally just having this conversation at Craft that, "Gee, maybe the next hire we should make at Craft should be someone who's really deep technically, so they can, you know, help go deeper on technical due diligence of AI companies."

Chamath Palihapitiya 47:34 They've never made money.

David Sacks 47:36 What's that?

Chamath Palihapitiya 47:37 They've never made money in the history of our business.

David Sacks 47:39 Who?

Chamath Palihapitiya 47:39 Those people. That archetype of hire has never done it on behalf of LPs or GPs.

David Friedberg 47:44 Well, in, in biotech and life sciences, they have. They're usually the best-

David Sacks 47:48 Who- what, what kind of hire?

David Friedberg 47:48 ... the best investors, usually VCs, they're-

Jason Calacanis 47:49 ... saying, he's saying a technical hire who worked in the trenches at a company is not as fit to get-

Chamath Palihapitiya 47:54 No, has not in the past, has not in the past.

Jason Calacanis 47:56 ... has not in the past gotten DPI, whereas somebody-

Chamath Palihapitiya 47:58 Right.

Jason Calacanis 47:58 ... who is more commercial-

Chamath Palihapitiya 47:59 ... able to analyze a business commercial-

Jason Calacanis 48:01 ... is gonna be able to get returns.

David Sacks 48:04 Right, right. So, so look, I think, you know, the ideal person would be someone who's fundamentally a great investor but also has some technical background and some technical chops. We also have a team approach at Craft. So, if you have someone who's very technical, they can just diligence the technical aspects of the deal. Somebody else can be responsible for, you know, making an assessment of the founders.

Chamath Palihapitiya 48:23 How we've solved this is we have a group of third-party individuals that we work with, that we keep on retainer, that we compensate. And whenever we need to do deep technical diligence, we partner with them to do that work with us. And what it allows us to do i- is get the best of their technical thinking without also putting them in a position of trying to adjudicate whether this company is good or not.What I'm trying to understand is, what is this technical edge and can I understand the boundaries of that? But I, I still keep the investment decision to myself and my partners, because otherwise, the difficulty is, in my experience, deeply, deeply technical people are extremely good at diligence, but generally-

David Sacks 49:04 Right.

Chamath Palihapitiya 49:04 ... are poorer at making investment decisions because there's a part of their brain that flips on which is like, "I could do it better, or I could do it this way, or I could do it that way." And I think, like, that anchoring bias can be very dangerous. And you, you almost want to be a little dumbed down from that depth of knowledge because you either find everything that is, like, not worth doing, and then you can miss a market, or you miss the thing that is good enough because you're like, "Oh, well, I would have done X, Y, and Z in a different way." So we kind of, like, use them, but we keep them at arm's length so that they never feel the pressure of having to actually decide on our behalf how the money should be spent.

David Sacks 49:42 Yeah. I mean, that's interesting.

Jason Calacanis 49:43 Yeah. The number one thing we're doing at this early stage is training (laughs) our founders, I know this sounds crazy, on accounting best practices and pricing best practices. And we literally have founders who have never made a plan, I'm talking about at the seed stage, who don't know accounting. And so we are running four seed stage startups, and I'm kicking myself that we didn't do it two years ago or three years ago, but better late than never, on how to just maintain their books and understand operations and the, the operational lack of discipline in the market, I'm seeing series A and series B companies that literally don't understand their own accounting. And so when we start talking to their accountants, there is a huge gap between what the accountants think of this business and what the founders think of these businesses. A- and founders think they have more revenue than they have or less revenue. They, they really don't even know how to calculate their runway in an honest way. And so there is, back to your point, Chamath, about on the, on the venture side of the business, a lot of product focus, a lot of operational focus. There's not enough focus on just the bottom line.

Chamath Palihapitiya 50:46 The reason that happened, it's, is what Friedberg said before, which is, like, somebody would build something, there was a little bit of momentum and you'd have to go and present these bonafides to these entrepreneurs to get him to the deal. And so vent- what venture firms thought was the right bonafide to present is, "Oh, I built XYZ product at this other company."

Jason Calacanis 51:04 Right.

Chamath Palihapitiya 51:04 And they thought that that edge could get you into a deal. Maybe, but it could turn out that that was the wrong company to be in in the first place. (laughs) And so you just missed an entire generation of value creation because it happened sort of off piste.

Jason Calacanis 51:18 Off the trail.

Chamath Palihapitiya 51:19 Yeah.

Jason Calacanis 51:19 Like, yeah. You really do need to understand fundamentally, 'cause we're talking about public markets here, the Facebook analogy, what is the ultimate earnings?

Chamath Palihapitiya 51:29 The terminal buyer.

Jason Calacanis 51:29 What is the ultimate cash-

Chamath Palihapitiya 51:30 What are they?

Jason Calacanis 51:30 ... that is going to get thrown off this business? And, and that's what the whole industry needs to, I think, pivot to and just, that needs to be the operating principle.

Chamath Palihapitiya 51:39 Do you guys know how much money Facebook, Amazon, Google, and Microsoft raised combined total before they went public?

Jason Calacanis 51:46 It's very small. I mean, Google is minuscule.

Chamath Palihapitiya 51:49 Less than a quarter billion dollars.

Jason Calacanis 51:50 Unbelievable. Yeah.

Chamath Palihapitiya 51:51 All four companies-

Jason Calacanis 51:51 The inefficiency is extraordinary. And then on top of this inefficiency, I don't know if you're seeing this.

Chamath Palihapitiya 51:55 They were all profitable when they went public.

Jason Calacanis 51:58 On top of all this inefficiency is a dependence on venture debt. I don't know if you're seeing this, Sax, but, uh, the amount of focus on adding debt to unprofitable companies over the last five years has been just extraordinary. I- I don't understand what...

David Sacks 52:13 I've never understood the venture debt model or really how it works. I feel like it's a category that doesn't make any sense.

Jason Calacanis 52:20 Say more.

David Sacks 52:20 I mean, the, the... Well, I mean...

Jason Calacanis 52:22 Explain it to people what's happening.

David Sacks 52:24 I don't really understand how it makes sense for lenders or for founders, to be honest. I think the whole industry doesn't make any sense. For founders, I don't like it because the money has to be paid back, right? It's debt. So founders take in this venture debt thinking like it's an equity round, but without dilution or with some warrants and they don't realize, "Well, wait a second. Uh, we gotta pay this back in a year or a year and a half out of the next round they do." But that creates an overhang on the next round because the new VCs coming in, they want their money to go into the company, not paying off a bank. So it actually makes the next round less attractive. The other thing about it is that the lender is not getting an equity reward, so they don't wanna take equity risk. They may be getting a nice, you know, coupon, they might be getting 9% or something like that, which sounds high for debt, but they're not taking true equity risk in the company. So the last thing they want to do is be your last six months of runway, right? They wanna be your first six months of runway and then, and then get paid off on the backend. And I think a lot of founders think, "Oh, well, I'll take this money and it'll extend my runway from 18 months to two years." But what will happen in that last six months is all of a sudden the bank will come to you and say, "No, no, no, no. Like, you have this or that material adverse condition." It's called a MAC out. And there's all these, like, terms that founders don't understand because it's highly legalistic-

Jason Calacanis 53:51 Covenants. Yeah.

David Sacks 53:52 ... covenants. And so-

Jason Calacanis 53:53 Ratios.

David Sacks 53:53 ... all of a sudden the founders find themselves with a lot less flexibility in that last six months to a year. Either a covenant gets triggered that makes them pay back the money immediately or their business flexibility goes way down because they're consulting with their bank about everything.

Jason Calacanis 54:09 All of this is coming home to roost right now.

David Sacks 54:12 I think it's a terrible deal for founders, and I think that even for the lenders, I mean, I guess I assume that these banks know their business better than I do, but, but I, I think that the reason I don't trust it as a category from, you know, from a lender point of view or from, like, an investor point of view is that all the data about defaults over the last five to 10 years happened in this free flowing zero interest rate environment. And so the startup mortality rates were artificially low 'cause it's so easy to raise. So yeah, venture debt makes sense in an environment-... in which founders are generally able to raise the next round and then pay back the venture debt. But let's say that, that, that tweet storm you, you mentioned, Jason, can you bring that back on the screen? I actually think this tweet storm is basically correct, is, you know, I've referred to it on this show before, that I think one of the things that built up during this bubble is latent startup mortality. So many startups that should have died from not being able to raise the next round, lived because they were able to raise money.

Jason Calacanis 55:17 Walking dead.

David Sacks 55:17 And what this tweet storm is predicting is that in the second half of 2023 and then '24, you're gonna have a huge crunch where all these companies have to go out and raise. They've been waiting, so they're all gonna get to the point where their cash is so low they have to go out and raise. And now all of a sudden, they're going to be confronted with the new market conditions.

Jason Calacanis 55:36 I wonder how many of them have venture debt as an overhang and that-

David Sacks 55:39 As those, those ones, yeah.

Jason Calacanis 55:41 ... and they're gonna find they have less runway than they thought, because again, those banks, you know, they are gonna try and collect the debt before the startup runs out of money. Not, you know, when it runs out of money. Catch two falling knives, basically. (laughs)

David Sacks 55:55 Yeah. Exactly. So, so look-

Jason Calacanis 55:57 Good luck with that.

David Sacks 55:57 ... I just wonder, I, what, what I, what I don't trust is whether the, the return models on venture debt that were created over the last five to 10 years will be a good predictor of what the returns will be in the next five, 10 years when a lot of the mortality that should have happened in the past now happens in the future.

Jason Calacanis 56:15 Well, I mean, and Sax, correct me if I'm wrong here, but I'm also starting to see really gnarly term sheets, people foreclosing on businesses, people offering, like literally had a term sheet come in like, "We're gonna, uh, forgive the last note and take this business over for a dollar," and everybody gets wiped out. The amount of bad feelings that you have to go through, even if the- there is a core business, to Freidberg's point earlier, hey, they raised 100 million but there's a $50 million business in here that people would love to invest in, who wants to go through the hand-wringing, the negotiation, the toxicity of a recap? It's an extremely hard process to go through. Are you going through any recaps right now, Sax? And what is the-

David Sacks 56:55 Not yet, no. I mean-

Jason Calacanis 56:55 ... what is the approach of the firm in terms of-

David Sacks 56:57 Well-

Jason Calacanis 56:57 ... dealing with these kind of situations? Do you even wanna start that discussion up? Or is it too painful?

David Sacks 57:03 Well, uh, we're not at the-

Jason Calacanis 57:04 For a new company, not one you're already in.

David Sacks 57:06 We're not, we're not at the... I don't think, for most of our companies, we're at the recap or restructuring stage. I mean, I'm talking about the ones that aren't going well. People still have a fair amount of cash in the bank. And we've been beating the drums for literally a year-

Jason Calacanis 57:17 But what about new opportunities? A new opportunity comes to you, it's one of these overhang companies that wants to restructure. Would you even engage that or is it just too hard?

Chamath Palihapitiya 57:23 I looked at seven at the end of last year and I tried to reprice three of them. And every single one was able to get a convert done away from us.

David Sacks 57:33 Yeah. So, I mean, w- yeah. I mean, th- that-

Chamath Palihapitiya 57:35 We tried to find a market clearing price for this equity, but nobody wants it, to David's point, because there's too much money on the sideline and people are willing to give them a lifeline that doesn't force them to come to hard terms with what the reality of the moment is.

David Sacks 57:50 Yeah, I, I agree with that. We're not quite there yet. And, and I think the, the reason why that, that tweet you posted got some traction is it's saying, listen, the crunch is gonna happen second half of 2023 and 2024. That's where you're gonna see the down rounds, that's where you're gonna see the restructuring, the recaps, and all the rest of it. And, um, look, I'm sure like every VC firm's gonna be a player in that. But yeah, it's gonna be a lot of miserable work-

Jason Calacanis 58:16 This is when you're gonna see-

David Sacks 58:17 ... for, for founders and, and VCs.

Jason Calacanis 58:17 ... this is when you're gonna see people's true colors. When, when, when you have to recap a company and-

Chamath Palihapitiya 58:22 Yeah. Oh my god.

Jason Calacanis 58:23 ... that's when you can really start to see-

Chamath Palihapitiya 58:24 Do you guys remember how crappy-

Jason Calacanis 58:25 ... really

David Friedberg 58:26 Yeah.

Chamath Palihapitiya 58:26 ... it was in 2003 to be here? Remember 2003?

Jason Calacanis 58:29 Painful.

Chamath Palihapitiya 58:31 Oh my god.

David Friedberg 58:32 Oh, I got some-

Jason Calacanis 58:33 Yeah.

David Friedberg 58:33 ... yeah. There was-

Jason Calacanis 58:33 I mean, lucky to raise 500K on a $3 million company.

Chamath Palihapitiya 58:36 Oh my god. Like 2004? Like what a brutal year.

David Sacks 58:40 Yeah. There's gonna be a lot of that. I think the next 18 months or e- let's say the next two years are just gonna be pretty rough for a lot of companies. And it's just that they didn't cut enough. I mean, we've been beating on the drums for a year for companies to lengthen their runway. And some did to some extent, but many didn't do enough and they're gonna get caught in this crunch. Can we just go to that chart that Brad put out? I think that what a lot of founders don't quite understand still is that things are just never going back to 2021. I think a lot of founders listening to the top of the show where we're talking about inflation is under control, they see the market rally, Facebook's up 25%, they may be thinking, "Okay, we just have to weather the storm for six months or a year and then everything's back to normal." And I think what's important to understand is that the market did bottom out about a month ago and is up pretty nicely. If you see here, this is the SASS Index, it's the median enterprise value divided by next 12 months revenue, and it was really beaten down about at the end of the year, at the end of last year coming into this year. You were, yeah, it was like, it was like four to five acts multiples of, of next 12 months revenue for SASS companies. That's all the way up to 6.1 now, so you're talking about 20 to 50% rally for a lot of companies, which is huge. We're still below the long-term median, which is just under eight, okay? But what people need to understand is that even if we revert all the way to the mean of eight, which I think at some point we will, that's still well below the bubble of '21 where they got to 16. So, even if things continue to inflate, valuations will still never quite be where they were in 2021. And-

Jason Calacanis 1:00:27 If you think it's getting back to 12 or 16-

David Sacks 1:00:29 It's not h- it's not happening. It's never happening.

Jason Calacanis 1:00:31 ... it's not happening. It's not happening. For high growth companies, for high growth companies in 2021, you were, in the public markets, you were seeing multiples of 30 to 35 times. Now those companies are maybe at eight to 10.

Chamath Palihapitiya 1:00:44 Yeah.

David Sacks 1:00:44 Or 12.

Chamath Palihapitiya 1:00:45 I think the reliable way that we can look at this for the future is that we're never going to see these kinds of multiples again, unless rates are zero and all kinds of tourist capital...... need to find a home to escape 0% returns in every other asset class. But if even the safest asset class now will give you three and a half, 4%, this is probably the new normal for quite a long time and we're gonna be back in that early 2000s kind of mindset, which takes a lot of hard work to build value around.

David Sacks 1:01:22 We talked about this sort of whip saw economy and, and there's a lot of mixed inflation data. I think founders need to understand that there's a bifurcation. What's happening in the tech ecosystem is not necessarily what's happening in the overall economy. The tech ecosystem is clearly going through a reset and a recession. Job cuts are now the rule, valuations are much lower. Whereas in the overall economy, we saw a jobs report today of over 500,000 new jobs. So, the fact of the matter is that even if the overall economy avoids a recession, that doesn't mean that things are just gonna bounce back-

Chamath Palihapitiya 1:01:59 Tech's in a world-

Jason Calacanis 1:01:59 ... depression slash recession.

Chamath Palihapitiya 1:02:01 Yeah, we all said.

Jason Calacanis 1:02:01 Best case is recession for tech.

David Sacks 1:02:02 Well, tech, tech is a boom bust cycle, and we had a phenomenal-

Chamath Palihapitiya 1:02:05 Yeah.

David Sacks 1:02:05 ... 10 years of boom. Now we're in a bust.

Chamath Palihapitiya 1:02:08 Totally.

David Sacks 1:02:08 And so I would just like tell founders, you know, "Look, it's good if we have a soft landing in the economy. I wouldn't assume that that's gonna happen. I still think there's a really good chance of recession later this year. But it almost doesn't matter for you. What matters is your business and the capital availability for startups, which is fundamentally different and will remain different than it was in 2021."

Jason Calacanis 1:02:33 Freeburg, you were talking in the chat about Adani Enterprises and uh, Hindenburg doing this short research and publishing it. Stock has just absolutely gotten clobbered. They were trading at, uh, gosh, 4100 was the 52-week high. And this thing has just cratered in the last five days.

David Friedberg 1:02:55 I mean, I think-

Jason Calacanis 1:02:55 You wanna explain what's going on here?

David Friedberg 1:02:57 Well, I mean, the story that, the conversation I thought it would be interesting for us to have is the role that these short seller research analysts play in driving efficient markets by identifying perhaps things that the market broadly is missing. Particularly given that a few weeks ago, we were all kind of talking about the FTX debacle and how no one was doing their diligence and no one was digging in and no one was kind of revealing publicly what was going on inside of that business that ultimately caused significant losses. You know, the claims made by Hindenburg is that this company Adani, which is founded and run by a guy named Gautam Adani, he started the company like I think 30, 35 years ago, and he's built this thing into this, you know, sprawling empire as people would say where he owns ports, he owns mining companies, he owns energy transmission businesses. He's got a whole green energy business. And he's taken a bunch of these companies and he's floated them publicly so they're all kind of publicly traded. There's some degree of interrelatedness between all these businesses. It reminds me a lot of, I don't know if, if any of you guys remember Eike Batista out of Brazil. You guys remember this guy? Where, you know, he kind of built this sprawling empire, very kind of broadly diversified industrial conglomerate with, you know, lots of different kind of segments and used a lot of leverage, a lot of debt to grow the business and a lot of interrelated intraparty transactions, and ultimately the whole thing kind of came crashing down. And at this Adani business, it's super technical and super complicated, all the kind of accounting shenanigans that Hindenburg is claiming has been going on and capital markets shenanigans that they're claiming have been going on with this business. But their kind of report, which I think is like 400 pages long, has caused-

Chamath Palihapitiya 1:04:48 The response was 400 pages, crazy.

David Friedberg 1:04:49 The response was long too, yeah. And then the markets shrugged off the response that he put out, didn't really care and they kept, kept selling the stocks off. So there's like seven or eight publicly traded companies, all of which are just getting decimated. Look, I don't have any strong opinion on this business. I, you know, I kind of skimmed through the thing, but you know, it really made me question like how such a big, call it accounting or capital markets fraud, if it really is that, can go on, and how much of a role these sorts of players play in the market. And whether you guys think that this is a good thing in the market to have these short seller reporters out there, you know, doing this analysis, publishing it. Jason, by the way, you called out Nick- Nikola, Nikola, the, the electric car company. As you know, Hindenburg put out that Nikola report-

Jason Calacanis 1:05:33 Yeah.

David Friedberg 1:05:33 ... stock tanked, right? They claimed it was all fraud, et cetera, and then the thing got destroyed.

Jason Calacanis 1:05:37 And it was, Trevor Milton got convicted, yeah.

David Friedberg 1:05:39 Right. And so I mean, I guess do you guys think that these guys have a, have a positive role net net in the market in kind of identifying and calling out this stuff? 'Cause we all have friends that are on the wrong side of short sellers and they complain about it and it can be really difficult to grow and build a business when people-

Chamath Palihapitiya 1:05:54 Elon had these guys literally claiming he was running a fraud for years and years, and it was an intense amount of scrutiny because when the tra- when the stock was less trafficked in, when we were in it in 2015 and '16 and '17, that was the constant refrain, and Elon was constantly batting back folks like this who would make claims. And the way that these guys are allowed to operate is because they use the First Amendment and say, "We have the right to say this stuff." I think that shorting falls into two buckets. One is you use it as a hedging instrument, so when we talk about spread trades like long Google, short Facebook, or long Facebook, short Google, you should be allowed to short. I think that, that's a very reasonable thing to do. I think the, the question is if you were on the inside of a company and you say, "XYZ is happening," for example, Trevor Milton, and it causes the stock to go up and it turns out to be fraudulent, he's held accountable. The question is, should there be the same responsibility for people on the outside who if they have enough distribution can say the exact opposite of XYZ is happening? In this case, XYZ is not happening, which then causes the stock to go down because what the business model of these short sellers is, write a document-... it looks very polished and very credible. Put on some positions, then put the document out. If the stock goes down, you close it out. In my opinion, I think that short sellers are a really important part of a well-functioning market or the ability to short. But what I would like to do is take an extra step, which is y- you should hold these folks accountable the same way you'd hold an insider accountable, which is almost to the effect of like, when you put out this screed, if you make money from it, it should sit in escrow and the SEC should actually adjudicate whether it's true or not. So in the case of Hindenburg and Nikola, they shorted the stock, they put out a report, it turned out they were right. All that money is completely well earned. Now, what if this Adani thing turns out to be not true or true? Nobody knows right now, except 50% of the market cap has already been wiped out. So that's where things, I think, are, are in a bit of a gray area. The last thing I'll say is that if you look at in the developing world, there's a very gray line between some of the leading entrepreneurs in these governments because these entrepreneurs are doing the work of some of these governments, whether it's Eike Batista in Brazil in one moment, right around natural resources, or Adani and Ambani in India, or a lot of the people that, that made a lot of money in China or the people that are making money in, in developing markets, Turkey, Russia, et cetera. The government uses very talented entrepreneurs to go and concentrate capital to develop infrastructure progress. We did that in America in the 1800s as well. So that's where I think, you know, you have to also balance it 'cause his response was basically like, "This is an attack on India." And in a way you can see where he's coming from, right? Because he's building ports and roads and bridges and he's like, "Without this stuff, how is India supposed to even exist in the 21st century?" That's a reasonable claim. So I agree with you, Friedberg, I don't know whether the report is right or not, but this extra step of actually having the SEC actually tell us what the answer is, I think would be a very important improvement to how this kind of stuff works.

Jason Calacanis 1:09:06 The other improvement that the SEC has been proposing in Rule 13f-2 is that... (laughs) people would need to disclose their short positions.

Chamath Palihapitiya 1:09:20 Right.

Jason Calacanis 1:09:20 This proposed rule would require institutional investment managers, I'm reading from the SEC website-

Chamath Palihapitiya 1:09:24 Right.

Jason Calacanis 1:09:25 ... managers exercising investment discretion over short positions meeting specific, specified thresholds to report on the proposed form SHO, information related to end of month short positions in certain | (crosstalk)

Chamath Palihapitiya 1:09:35 That is a no, that is a no-brainer.

Jason Calacanis 1:09:37 ... daily activity affecting the sh- short positions.

Chamath Palihapitiya 1:09:37 That should absolutely pass. That, I mean, that's a no-brainer. Yeah.

Jason Calacanis 1:09:39 And the commission would aggregate the resulting data by security, therebo- maintaining, thereby maintaining confidentiality of the reporting managers-

Chamath Palihapitiya 1:09:46 Yeah.

Jason Calacanis 1:09:47 ... and publicly disseminating the data to all investors. This new data would supplement the short sale data-

Chamath Palihapitiya 1:09:51 I think this relates to overlending of stock-

Jason Calacanis 1:09:54 ... that will be public about more from 10 run stock exchanges.

Chamath Palihapitiya 1:09:54 Right? I mean, this is less about like who's doing what and it's much more about are we kind of creating critical fail points in the system by seeing over-leverage and overlending in certain, uh, trading assets.

Jason Calacanis 1:10:03 Well, there should also be some rules about the spreading of fear, uncertainty, and doubt. That FUD that happened with $TSLAQ. I mean, paradoxically, you know, thousands of-

Chamath Palihapitiya 1:10:14 No, but people that, but that's an example-

Jason Calacanis 1:10:16 ... anonymous accounts, you know-

Chamath Palihapitiya 1:10:17 That's, that's an example of people essentially lying in public-

Jason Calacanis 1:10:21 Yes.

Chamath Palihapitiya 1:10:21 ... to try to get the stock to move and Tesla's not a fraud. That's a real company. But there is a real-

Jason Calacanis 1:10:26 I mean, they were winning Car of The Year while this was going on. The breaking, delivery records.

Chamath Palihapitiya 1:10:30 But there is a real human cost to that company, right?

Jason Calacanis 1:10:31 Yeah.

Chamath Palihapitiya 1:10:31 To employees that got spooked, to partners that may have gotten spooked.

Jason Calacanis 1:10:34 Yeah.

Chamath Palihapitiya 1:10:34 The pressure, you know, we saw this, the pressure on Elon in those periods of time. And he was, he was like on the knife's edge where there was the potential where the company may not have been able to finance its cashflow needs because of those $TSLAQ guys. And so it's not to say that the $TSLAQ guys can't say it, but they should be forced at some level to prove it if you can create crazy stuff. I posted a link, by the way, for anybody that's interested in reading this. There's a person, uh, called Carson Block who's being investigated.

Jason Calacanis 1:11:02 Yes.

Chamath Palihapitiya 1:11:02 Because he may have pushed the boundaries of how short sellers do this. It's a really fascinating read in The Atlantic for anybody who wants to read it. But thi- this is sort of where the short selling thing can a little bit go awry. And it's, the title of this is The Man Who Moves Markets and it's, it's quite a, quite a really interesting read if you're interested in, in how all of this stuff works.

Jason Calacanis 1:11:22 All right, everybody. That's The All-In Podcast 4, February 3rd and 4th. For Sacks, Friedberg, and Chamath, I'm J-CAL, the world's greatest moderator. We'll see you next week.

Chamath Palihapitiya 1:11:31 Love you boys. Bye-bye.

Narrator 1:11:34 Let your winners ride. Rain Man, David Sacks. I'm going all in. And it said we open sourced it to the fans and they've just gone crazy with it. Love you,

1:11:46 Ice Queen of Quinoa.

1:11:47 I'm going all in. Let your winners ride. Let, let your winners ride. Let your winners ride.

Jason Calacanis 1:11:54 Besties are back.

Narrator 1:11:55 (laughs) That is my, uh, dog taking a mow in your driveway, Sacks. (laughs)

1:12:02 Oh, man. My haberdasher will meet me at Windsor.

Jason Calacanis 1:12:05 We should all just get a room and just have one big huge orgy 'cause they're all just useless.

Narrator 1:12:09 (laughs)

Jason Calacanis 1:12:09 It's like this, like, sexual tension that they just need to release somehow.

Narrator 1:12:13 Wet your bed.

1:12:14 Be wet. Your bed.

1:12:16 Your bed.

1:12:16 Bed wet. (laughs)

Jason Calacanis 1:12:18 We need to get merch.

Narrator 1:12:19 Besties are back. I'm going all in. I'm going all in.