What happens when the music stops?
On Minksy Moments
Moneyball is a fortnightly newsletter from Koble exploring the limitations of human decision-making and their implications for startup investing.
We’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of being successful.
🧠 Mental Model #12 – Minsky Moments – What happens when the music stops?
📖 Investor reading – How the titans of tech investing are staying warm over the VC winter – How venture capital can avoid the next Silicon Valley Bank fiasco – Lessons from finance’s experience with artificial intelligence
💬 Some tweets – I can’t think of a bigger honor than VCs thinking I’m wrong – The scale of private-market writedowns – A CEO only has three responsibilities
What happens when the music stops?
On the outside, VC is an asset class like any other. But on the inside, it feels all encompassing.
Buried in the day-to-day minutiae of deal sourcing, due diligence and portfolio monitoring, it’s easy to forget that startup investing is exposed to the machinations of the credit cycle.
But macro matters. We have seen from SVB that even a change in interest rates can have a large impact on long-duration asset valuations. Venture is not “special”; it’s subject to the natural laws of markets. What goes up, must go down – and vice versa (in the case of current rate hikes).
It’s fair to see that we’re all still processing the SVB debacle and its implications for investors and founders. One model that can help us work through that is “Minsky Moments”.
Hyman Minsky was an economist whose “Financial Instability Hypothesis” explained the boom and bust cycles that seem to characterise public markets.
Minsky Moments are points where the financial system moves from stability to instability. In the movie Margin Call, it’s the moment when employees at an unnamed investment bank discover that the firm is over-leveraged, so they embark on a fire sale. In real life, it’s the moment in June 2007 when two Bear Stearns funds exploded.
The 1998 Russian Crisis, the Dot-com Boom, the Global Financial Crisis all had their Minsky Moments, when reality prevailed and there was a sudden, catastrophic collapse of asset values marking the end of the growth cycle and the beginning of something very different.
Which is not to suggest that a collapse will happen any time soon. Rather, that the concept of clearly defined market inflections are as important for startup investors as participants in public markets.
As Abraham Thomas has pointed out in a brilliant essay on Minsky Moments, Venture Capital seems to be protected from Minsky-style effects. It’s (generally) not a leveraged asset class, it's illiquid and hence not exposed to early redemptions and margin calls, and volatility is low.
But underpriced risks remain. And the cause of these is speed. Thomas explains:
“If compressed timelines are the driver of Minsky inflows into venture, then anything that delays funding cycles could precipitate a painful reversal. First some startups delay fund-raising because they need to grow into their valuations; then the VCs who invested in those startups have to delay their own fund-raising with LPs because they don’t have the requisite markups; then the LPs reconsider their (hitherto ever-increasing) allocations to venture because the latest returns are uninspiring; and before you know it, there’s an exodus from the asset class. Minsky giveth, and Minsky taketh away.”
Thomas’ essay – required reading for investors looking to deepen their understanding of the crossover between public and private markets – captures the inescapable truth (originally coined by Benjamin Franklin) that “time is money”.
The venture industry has always been slow compared to public markets. Now it’s catching up. Startup valuations have been marked up at a dizzying pace; new investors have entered the market employing public/private crossover strategies that prize speed over rigor; and funds (until recently) have been deploying capital faster than they ever have.
Productisation, financial engineering, the pursuit of limitless scale… such technological forces and cultural trends will inevitably evolve traditional VC into something more leveraged, liquid, volatile, and ultimately, exposed to boom and bust cycles.
Higher returns, lower risk... what’s not to like? But money begets money, and you get a typical Minsky boom as fast money pours into the market. The question is, who’s going to be left standing when the music stops?
Certainly, large funds are exposed. But the trickle down effect to the long tail of boutique VCs could be significant. The SEC has ramped up scrutiny of portfolio valuations at Private Equity firms, and Lisa Abramowicz has noted, the scale of private-market writedowns is starting to become visible, with Tiger Global marking down the value of its investments in private companies by around 33% across its venture-capital funds in 2022.
Implications for investors
The SVB debacle is a stark reminder that to build a VC asset class that delivers sustainable returns, we need a diverse cast of funds, LPs, and service providers, to avoid concentrating and magnifying risk.
Ultimately, that means adopting the right kind of ideas to move venture forward – technologies that empower us to better manage risk. There is an argument (a strong one) that the structural evolution of startup investing – facilitated by data, technology, media, and time served – has evolved the asset class into something bigger, stronger, more capable of absorbing exogenous shocks.
“Risk-adjusted VC” is something we should all be striving for.
We will have to wait and see whether SVB, Credit Suisse, and the next (inevitable) crisis amount to a Minsky Moment for private markets. In the meantime, it makes sense to brush up on some economic history, and tread with care as the eternal boom and bust of capital markets plays out.
Work with Koble
At Koble, we’ve spent two years developing our groundbreaking algorithms, which discover early-stage startups that outperform the market and predict their probability of being successful.
We’re working with forward-thinking angels, VCs, family offices, and hedge funds to re-engineer startup investing with AI. If that resonates, get in touch.
🥶 How the titans of tech investing are staying warm over the VC winter – Market turmoil is forcing the biggest venture investors to shift their strategies. For Silicon Valley, it signals a return to a forgotten venture capitalism.
💥 How Venture Capital Can Avoid the Next Silicon Valley Bank Fiasco – VCs are de facto gatekeepers of innovation, but when this fails, we risk setting ourselves up for stagnation and decline.
🤖 Lessons from finance’s experience with artificial intelligence – For the stock market, automation has not been winner-takes-all. It’s more like a tug-of-war between humans and machines.
“Be fearful when others are greedy and greedy when others are fearful.”
― Warren Buffett
Regards from your [risk-adjusted] startup investing AI,
Koble is re-engineering startup investing with AI, applying quantitative strategies that have disrupted public markets to early-stage startup investing.