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Comment by JCM9 | Hacker News Reader

2023 is going to be a brutal “forest fire” market cleansing for non-profitable startups. As these companies run short on cash the best of the best will convince VCs to top up cash reserves, but this will be a tiny minority. Most of these companies will need to take a down-round hit to move forward.

For others some will scramble to get acquired in an M&A / acqu-hire frenzy to try and save being wiped out completely. Investors here are usually just looking to make back some of their investment to avoid a total loss. Many other startups will simply implode and turn into total losses for investors.

The M&A scenario is where you hear about a startup getting acquired for a billion $ and employees are popping corks only to find out that they get nothing (despite all those options/shares) and are now an employee of some other shop that has them on a short list to be axed to realize “synergies” created by the deal.

Companies are scrambling to extend runways via these layoffs, but for those in that position this is at best a temporary patch on a gaping hole. The above options become inevitable unless something drastically changes with the company’s product, market adoption and financial fundamentals.

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Just like a forest fire, if you let it happen when it should, it’s not so bad. But if you keep suppressing it (with firefighters…or low interest rates) then when it finally happens, it can be a disaster.

Low interest rates didn't force VCs to invest this money. And it didn't force LPs to give the money to VCs. And obviously, startup founders weren't forced to take it. The various central banks played a role here, but definitely not a starring one.

> Low interest rates didn't force VCs to invest this money. And it didn't force LPs to give the money to VCs.

One can debate whether "force" is the right word, but 100%, absolutely the goal of low interest rates was to force savers into riskier assets, when banks and bonds were returning close to 0. So many companies never would have funded in a normalized rate environment.

Can you show me something from a few central banks saying that they were trying to force savers into riskier assets?

I agree that can be a consequence (although it isn't necessarily so; many people just leave their savings be), but I don't believe it ever was a goal.

And regardless, I think it's a big leap from "some savers wanted higher returns" to "let's throw a lot of money into things without due diligence or a coherent success story". Which unarguably happened lately. E.g., all the "smart" money invested in FTX, which we now know to be an absolute clown show. Other, better choices were possible. Including the supposed experts saying, "Sorry, we can't deploy this capital for you, as we don't think there are good opportunities in the current market conditions."

Central banks are forcing the rich to create capital flows because our politicians can't do it (e.g. taxes).

They do this by suppressing interest because parked money loses value to inflation in such an environment.

In reality, the better solution is probably to raise taxes, but none of our politicians have the will.

Rich people aren't forced to do anything here. They're rich. They have have plenty of choice. They may be choosing riskier investments in pursuit of the returns they want. But then they are also choosing higher risk of the sort of losses that would also lose money over time.

They are forced to because in a low interest environment, they are literally losing value to inflation.

They are not forced. The FBI did not show up with guns and say, "Invest in this dumb-ass startup or we shoot you."

During a recession, they decided that rather than lose some value to inflation, they wanted to risk losing all of their investment in hopes of a higher long-term return.

This is called a choice. They made it. Nobody owes them a guaranteed safe rate of return just because they're rich.

So many of these kinds of arguments end up just being semantics. Strictly speaking, they were not forced.

Realistically, an environment was purposefully created that would make the average actor move a certain way. Sure, the individual may have had the option to just eat the losses.

This is not just semantics in that people often use particular language to direct attention away from actual agency.

Returning to my original point, forest fires are about a natural phenomenon. Fire doesn't want anything and doesn't make choices.

But startup founders and venture capitalists and limited partners are all morally competent actors who get to make choices. No matter how much money is available, nobody is forced to put together a startup. Nobody is forced to invest in it regardless of its chances of success.

Language that makes their bad choices the fault of government or whomever is something that is very convenient for preserving their egos and keeping the game going. But it is not factually correct, and I am not obliged to swallow my objections to it just because some find it an uncomfortable truth.

You seem to be overly focused on a single definition of "force". Nobody (except maybe you?) is confused that the FBI might be holding a gun to VC's heads. Webster has a lot of definitions of "force", and most of them don't have anything to do with coercion in the face of violence. For example

    3 : to make or cause especially through natural or logical necessity 
        "forced to admit my error"

    8 : to induce (a particular bid or play by another player) in a card game by some conventional act, play, bid, or response

Yes, but no. No reasonable definition of "force" applies here.

They are incentivized to do it, though.

I never said otherwise.

Central banks don't say a lot about what they are / are not trying to do. Ask the reverse question: What do Central Banks say they are trying to do when lowering interest rates? They only really make vague statements like 'easing conditions' or 'providing liquidity'.

In the US, we can only go by their stated goals, dual mandate from congress: keep inflation and unemployment low. https://www.stlouisfed.org/in-plain-english/the-fed-and-the-...

So what are the mechanisms that they can keep unemployment low (create jobs)? They lower interest rates, which causes people to sell assets that don't create jobs (treasury bills) and buy ones that do (corporate bonds, VC funds, etc) in attempt to get a return on capital (however, with more risk).

It's not some secret that lowering / raising interest rates affects all investors risk curve.

I of course agree that they are affecting incentives. I am specifically disagreeing with the claim that the "goal of low interest rates was to force savers into riskier assets". Force is the wrong word here, and I don't think individual savers are at all the people the Fed is trying to affect here.

And although they are affecting incentives, people are not robotically obliged to follow them. VCs cannot be simultaneously such brilliant investors that they deserve to be wildly rich and also so without agency that a drop in the federal funds rate forces them to waste money on bad startups.

> some savers wanted higher returns

Or, to put it differently, some savers didn't want to pay the bank for holding their money and suffer 10% inflation. Of course that'll push them into funds and shares. Is it a goal? Possibly not, but it's a known and unavoidable side-effect, like having to poop at some point after you eat things.

As for the terms of investment being better for companies: that's just supply and demand. Everyone wants to invest their money, so the deals get worse.

Yes, as I have been clear, I'm not saying it's not a predictable outcome. I'm just saying it's not a central bank goal. Their goal is just to prevent recessions and keep inflation under control.

> that's just supply and demand. Everyone wants to invest their money, so the deals get worse.

If people would rather lose money in a bad investment than due to overall inflation, that is a choice they can make. But that doesn't force the creation of bad investments. Some people create the bad companies, and others, ones who nominally should know better, put other people's money into them.

Forcing is probably too strong since nobody is holding a gun to anyone's head, but risk is part of the cost of the investment. When the supply side is limited, the cost increases - that could be paying more for less equity or taking riskier deals.

Since there isn't an unlimited amount of low-risk deals that you can bid on and pay more to be a part of, accepting higher risk is the only other option that still has a chance at being better than keeping the money in a bank and losing 10+% per year.

Exactly. Some people want to maintain their return on capital during a recession even at higher risk of losing their money. That's a choice they make based on desires they have.

Other people make different choices. Which can be quite good ones! US inflation in 2022 was 6.5%, but the NASDAQ lost something like 30%.

Might VCs choose a spray-and-pray approach when money is abundant? Sure. Might LPs choose to give money to those VCs? Yes. But my point here is this is not mean old Jerome Powell ordering around robots or slaves or whatever. VCs can just not invest if there isn't something good. They can return the money or not take it.

Heck, even startups are not compelled to take the money. The last time I did one we eventually decided we had dug a dry hole, so we gave back the remainder of they money to investors. We were not compelled to spend it past the point we thought it was actually a good investment.

> Exactly. Some people want to maintain their return on capital during a recession even at higher risk of losing their money.

But we weren't in a recession when they made those investments, we had negative rates, 6-10% inflation and low unemployment in many countries (and certainly in the US). It's hard to argue that we're in a recession even now, since inflation is still high and unemployment is still low, these layoffs are publicized, but they're not moving the needle much.

> They can return the money or not take it.

What do investors do with the money instead? Yes, they can pass it on to the bank and have a 100% chance of the value going down 6-10% a year. How is that a choice, do pension funds just say "sorry, folks, we didn't see any good opportunities while the fed injected money, so your pensions will be 50% lower than expected"?

You conspicuously ignore the VCs here. They were not obliged to do jack. Neither were the founders who took more money than they could successfully apply. It's funny how many people here are stubbornly unable to find the people with moral agency in the startup funding chain.

But yes, part of fiduciary duty is acting for the benefit of the person whose money you are holding. That obliges them to get the best return possible, no more and no less. If a lack of good opportunities means that the best actual return is a lower one than people hoped, that's the job. Because it's not like the people whose pension money went into FTX are going to do particularly well on the deal either.

I feel like it is pretty uncontroversial that the purpose of the Fed fiddling with interest rates is to encourage or discourage investment. What else would they be up to?

I am specifically objecting here to the notion that the "goal of low interest rates was to force savers into riskier assets".

What a given central bank is up to depends on the central bank. But the Fed is pretty clear about its goals. E.g.: https://www.stlouisfed.org/in-plain-english/the-fed-and-the-...

I agree it's true that they change interest rates as a way of influencing investment rates as they pursue their goals. But I believe they have very interest in influencing the average individual saver in any particular direction, let alone having that as a goal. And I absolutely disagree that "force" and "encourage or discourage" mean the same thing.

My broad point here is that the Fed, using pretty blunt instruments, tries to keep us from both recession and inflation, but that does not "force" rich people to do anything. Those investing in startups have enough money that they have incredible agency in what they do with that money.

I can believe that VCs feel compelled to invest so they can keep up their reputations and their fat checks. But if so, they are compelled by prestige and greed, not by Jerome Powell.

They write here that they intend to maximize employment and yet I can easily pick up a newspaper and read them fretting that employment is too high. e.g., https://apple.news/AtzUI_uozTyOjXZhyAcUpPw

Now sure, we can say that’s just the “dual mandate” at work, since they tie this concern to inflation. But still, I wouldn’t take a public statement like this as gospel.

I suppose it is true that no one person is forced to do anything, but if you create strong incentives to do one thing and disincentives to do another then I don’t think the difference is that meaningful in the aggregate.

Yes, that is exactly the dual mandate at work. Too tight a labor market causes labor price inflation, which quickly causes general price inflation, eroding the value of the higher wages and causing all sorts of other problems. None of that is proof that their goal is to "force savers into riskier assets".

And I'd say the difference is absolutely meaningful, because people have moral agency. People have "incentives" to do all sorts of harmful things. But we can still expect them to make good choices, and to own it when they make bad ones.

As an example, take FTX and Sam Bankman-Fried. He clearly had plenty of incentives to do what he did. That doesn't make what he did any less wrong. Indeed, morals that only applied when one had no incentive to act against them would be meaningless. It's exactly when the incentives favor harmful actions that morals most matter.

I can’t really agree that investing in a financially unsound business is “immoral.” I’d also point out that in that story the Fed is fretting about high employment in spite of prices beginning to stabilize, so I think maybe “Political Aspects of Full Employment” would be a more useful tract to read to understand the dynamics at work than “what the Fed does in simple English.”

You're welcome to argue that investing one's own money badly is not immoral, just dumb. But there are other people involved here, and it's surprising to me they have escaped your notice.

Here you go: https://en.wikipedia.org/wiki/IS%E2%80%93LM_model

From the article: I(r) represents business investment decreasing as a function of the real interest rate

Businesses invest less as the rate increases. That's equivalent to businesses save less as the rate decreases.

That's a theoretical model of a consequence. I never denied the consequence, I denied that this particular consequence is the goal for central banks. Which is why I asked for something different than what you provided.

Central banks are famously cryptic. If you’re looking for a smoking gun, this 2020 statement by Powell might satisfy you.

“If you look at P/Es they’re historically high, but in a world where the risk-free rate is going to be low for a sustained period, the equity premium, which is really the reward you get for taking equity risk, would be what you’d look at,” Powell said.

As you may know, this statement was made after Powell famously reversed course on his 2018 unwind of Yellen’s put after asset prices started to fall.

https://www.hindustantimes.com/world-news/powell-busts-out-f...

Central banks are famously cryptic about some things, especially about things that may be taken as indication of future action. But they are pretty transparent about goals. E.g.: https://www.stlouisfed.org/in-plain-english/the-fed-and-the-...

What you have is at best an acknowledgement of a typical consequence of one kind of Fed intervention, but I don't think that's at all evidence of a goal.

I suppose I can only appeal to the broadly held view that investment and debt are considered to have effects on employment rates and economic growth.

Sure. I agree that there are broad effects and never said otherwise. My objection in this subthread is to the much more specific claim "the goal of low interest rates was to force savers into riskier assets".

At no point has your question been misunderstood.

The whole concept of reducing interest rates was to encourage borrowing and discourage saving, to get money moving. Naturally this was into more risky investments as pretty much everything is more risky than savings accounts, bonds, and not borrowing money at all.

That’s quite literally the goal of low interest rates is to encourage spending and investing.

The general goal of rate cuts is, yes, to increase overall economic activity. But that doesn't mean that any specific person is obliged to put money in a particular thing if it's bad.

E.g., when interest rates drop, so do auto loan rates. But even if you can now suddenly afford a Hummer, you still get to decide whether or not that is a good choice for you. And if it turns out it wasn't, you don't get to blame the Federal Reserve for your choice.

A Hummer is not an investment.

The problem in a low interest environment is that parked cash loses value to inflation so it is forced to flow.

Then it's a good thing I never said a Hummer was an investment.

Cash isn't forced to do anything. It's not an actor here. People are. Those people make choices with their money. They choose more risk during a recession rather than a predictable loss.

> But even if you can now suddenly afford a Hummer, you still get to decide whether or not that is a good choice for you

Our question here is whether wealthy investors should invest their capital into VCs or interest-linked instruments. The whole point is that your analogy of the buying the Hummer is useless because a Hummer isn't an investment but an expense so there's no point in using your analogy.

No, that's not the point of my analogy. Some people thing buying a Hummer is a very good use of their money. Some don't. Some do and later change their minds.

My point is that easy money does not cause choices. People choose. Jerome Powell did not make anybody buy a Hummer, even if that was a predictable outcome of a drop in interest rates. Investment in bad startups may be a predictable outcome of easy money, but specific people still specifically chose those specific bad startups when they could have made better choices.

I think you should spend a bit of time looking into how VCs operate. Their LPs are looking for returns and inject them with more and more cash during ZIRP. A VC fund isn’t a bank, they have to invest. So they make progressively poorer and poorer decisions under the constant weight of easy money.

That's some impressive condescension from somebody who does not know how VCs work. They are not obligated to take the initial investment, they are not obliged to make a capital call, and they are not obligated to just spend the money they do take. They choose to make poorer and poorer decisions because it's in their short-term financial interest to do so.

The Forest Service lands in the middle. The contemporary approach to land management in relation to fire involves regularly setting controlled fires under optimal weather conditions.

It’s good for forest ecology, which depends on fire, and it’s good for people, since we generally don’t like crazy forest fires.

https://www.fs.usda.gov/managing-land/prescribed-fire

Depends on for whom we mean. I don’t mind having had the opportunity to book a lot of wages in the meantime.

Low interest rates lower the activation energy to discovering good ideas too.

In reality, low interest rates allow businesses building a growth story on sellong dollars for pennies to survive much longer rhan they should. All while ruining businesses that would otherwise be totally viable and sustainable but don't have access to VC money. IMHO, the start-up cleaning that seems to be on the horizon can only be a good thing.

> or low interest rates

Are VCs borrowing heavily?

For some reason I imagined that wasn’t the case generally.

That's not it.

When interest rates are low and you have piles of money, you seek higher risk investments with higher returns because low risk investments have virtually no returns on interest (if you factor in inflation, you've lost money over time in a low interest environment).

Think about this way: you wouldn't put $10,000 into a cash deposit for risk free 0.1% annualized return, but you might for 5%. So the shift in interest has changed the favorability of different investment vehicles.

If you are a VC, you might fund 100 companies and only 2-3 will be super profitable and generate the majority of your returns. Those returns in aggregate need to be greater than what could be achieved by parking the money in lower risk instruments. Easy in 2020 when interest was nearly 0. Now? Those lower risk instruments are much higher performing than they were 3 years ago. So if a VC portfolio had returns of 5% previously and now I can just park my $1m in a CD and get 4% RISK FREE, that VC suddenly has to perform at a higher level to compete. Otherwise if I'm a wealthy investor, why not just park my money in bonds or other investments that benefit from higher interest?

VC's probably aren't, at least not in the way you or i might, rather they're the recipient of other's investment cash. If interest rates are low, there are fewer opportunities for getting any kind of a return, so more investors will look at riskier options. Institutional investors, mutuals, retirement finds etc all have targeted return rates, even if it's "just" x% above inflation. So while their risk models might still only let them invest a small fraction of their capital in high risk instruments, that's still a small fraction of a very, very big pie. Google tell me the US VC market is 68.9bn, measured by revenue or 233bn globally.

While it's the extreme comparison, Blackrock have 8.5 trillion worth of assets under management.

So it would seem to me that relatively small changes in risk appetite have the potential for huge changes to vc funding.. because it was always a tiny part of the wider market

No, but some people have put their money into startups because banks were paying 0.5% interest.

Now, investors are getting a much better offer from the banks. Maybe they'll decide selling $10 taxi rides for $7 isn't something they want to continue funding.

Most banks would pay a negative interest. If you have any sort of fortune, you need to invest to make any interest, otherwise you'd see that fortune become smaller and smaller.

Arguably some have found it beneficial to invest in bonds with negative yields, because then they'd at least know that their money was safe and exactly how much it would cost over a given period.

> The M&A scenario is where you hear about a startup getting acquired for a billion $ and employees are popping corks only to find out that they get nothing (despite all those options/shares) and are now an employee of some other shop that has them on a short list to be axed to realize “synergies” created by the deal.

Can you explain this point a bit more?

If a company was acquired for billions, and they have a contract entitling them to shares of the company, why wouldn’t they have a nice exit?

Startup equity is a minefield for employees.

If a startup issues options to you while the valuation is high (2021-2022, for example) and then the valuation falls, your options could have a negative value.

Follow-on investment rounds could come with liquidation preferences, meaning the most recent investors get paid first. This is commonly 1X, meaning most recent investors get 100% of their money back at minimum (if the money is there) before the remaining money can be paid into the rest of the preference stack. I've seen situations where liquidation preference can be 2X or more. It's also common for liquidation preferences to stack, so you as the employee are at the bottom of a stack of guaranteed payoffs for investors. You only get a share of what's left.

Remember the Eero WiFi routers that everyone loved? Amazon bought Eero for $100 million, but most of the employees ended up with worthless shares. Amazon sweetened the deal by giving the founders multi-million dollar acquisition bonuses, but employees got nothing. There are several stories about it if you want to read more: https://mashable.com/article/amazon-eero-wifi-router-sale

> If a company was acquired for billions, and they have a contract entitling them to shares of the company, why wouldn’t they have a nice exit?

Read the Eero article for a real-world example. Employees had shares, but they were issued at prices as high as $3.54 per share. By the time of acquisition and after all the other issues were sorted out, the shares were only worth $0.03. Exercising those options would have negative value. Employees who exercised early could have actually lost a lot of money on their shares.

Preferred shares get paid first.

Most investors get preferred shares that give them a “liquidation preference” which means they can get the money they put into the company back out (or some multiple of that money) off the top of the purchase price.

If the purchase price of the company isn’t greater than the money VCs put into the company, the common shares are typically worthless.

Sometimes preferred shareholders have to choose “exercise this preference” and then the shares go poof (“non-participating preferred”) and sometimes preferred shareholders can get this preference AND then also become common shareholders alongside everyone else and get to share what’s left after the preference is paid (“participating preferred”)

The investors usually have liquidation preferences and/or participating preferred stock, or similar.

Common stockholders (including founders) are only entitled to a share of what's left over after investors are paid, as their equity rights are more junior -though often founders/execs will get large bonuses to make the deal happen even if their stock is worthless.

Preferred shares with liquidation preferences can entitle an investor to recoup a multiple (or at least not lose money) before any common shares shareholders can get paid anything. VC stands for Vulture Capital in some circles.

It's a pyramid scheme not an unprofitable startup. You could always pivot, find a relative with more money, make your guys work as cheap consultants for bigger corps. But who will hire or lend or invest in a crypto thing NOW, afrer FTX Bahamas extradition and the Celsius examiner's report.

Now all is clear: there is no business model, there is simply a black box where there is less money coming out than there was coming in. It doesnt transform nature (what people call "adding value" or "providing utility") so it can't make money.

Downround or liquidation preference.

>take a down-round hit

That sounds like it could be below-the-belt.

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