🌌 Reshaped #18
Debt for startups, facial recognition backlash, bonds for philanthropy, antitrust on fire, Chinese talent pools and much more
Welcome to a new issue of Reshaped, a newsletter for those who do not want to miss a thing about the huge transformations of our time.
This week opened with the decision by IBM to stop producing facial recognition technologies. It was easy to expect similar positions from other tech companies — especially from Microsoft, which is branding itself as the “good” tech company. Among the other news, do not miss the updates on antitrust suits in Europe and the US, against Amazon and Google respectively. The next weeks will tell us if this is the start of something big for the tech industry or just another announcement.
I also shared the first roadmap of a new series of articles about debt financing for startups. The topic is not new, but I think there is much to say about it. I hope to get your feedback about it!
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News
📹 In a letter to Congress, IBM CEO Arvind Krishna announced that the company will no longer research, develop, and sell any facial recognition technology (The Verge). This is a strong commitment, which reflects the fears that such a technology could be used for mass surveillance and violate human rights. However, IBM was far from relevant in this market, which means this decision will not have a huge impact on the company (MIT Technology Review). The announcement pushed other tech companies to take similar positions. Amazon will stop providing the police with its facial recognition software, Rekognition (The Wall Street Journal). Launched in 2016, the cloud application is now diffused in many police departments in the US, even if nobody knows exactly how many. Similarly, Microsoft announced that it will stop selling its facial recognition solutions to police departments until an appropriate national law is approved (TechCrunch). These calls for regulation will reshape the competitive scenario for new entrants. On one hand, startups will have more chances to win market shares; on the other, they will have to face strong backlash from investors and policymakers. This means that secondary markets could become the only viable exit possibility, with Big Tech companies ready to consolidate the market through acquisitions later on.
🍕 Uber lost the race to acquire Grubhub, which reached a $7.3 billion deal with the London-based delivery company JustEat (CNN). This is a severe blow for Uber, which aimed for market dominance in the US. However, the deal seems to be definitely reasonable. First, JustEat and Grubhub operate in two distinct markets, which reduces concerns over market consolidation and monopoly power — even if antitrust scrutiny seems to have had no influence in the negotiations. Second, the two companies have the same business model: they provide a platform for managing orders to restaurants, which then care about the delivery. Uber Eats, on the contrary, directly supervises the delivery phase as well. Its direct competitor Doordash is close to a new funding round that would bring the valuation of the company up to $15 billion (The Wall Street Journal). This will further strengthen the company, which is currently the market leader in the US. Meanwhile, California regulators declared that Uber and Lyft drivers are full-fledged employees (Business Insider). With Big Tech investing in gig-intensive industries, there could be a shift towards more structured labor management.
👋 SoftBank cuts 15% of the Vision Fund workforce, laying off roughly 80 workers worldwide (Financial Times). This comes after the disclosure of the terrible performance of the fund, which I analyzed in a recent issue of Reshaped. In the meantime, Facebook is said to be ready to launch its own venture capital fund to scout and take control of the next social media unicorns (Axios).
💵 The Ford Foundation announced the issuance of bonds worth $1 billion to support non-profits in the US (Bloomberg). Non-profits are struggling during the pandemic and their role is more urgent than ever. By issuing debt, some of the major US foundations will have the possibility to provide grants without eroding their endowments (The New York Times). Until now, foundations have used debt instruments to finance internal projects or structural investments. This is the first time debt is used to finance redistribution programs, which might be a revolutionary innovation for non-profits. For sure, this is a way to redistribute the benefits stemming from the financial stability of the major foundations to a larger audience of organizations, while maintaining endowments intact.
📡 The British government will enforce new rules to avoid Chinese takeovers of national companies (The Times). The UK joins the list of European countries taking measures to prevent an increase in Chinese influence in the economy. However, Boris Johnson might go further, regulating also the collaboration between British universities and Chinese companies. In the meanwhile, Huawei is launching a big advertising campaign in the UK to celebrate 20 years of business in the country (BBC). It happens while the company is under scrutiny by British authorities regarding its 5G technologies, which could make it impossible for Huawei to market them in the UK.
🛑 Antitrust regulators in the US could decide within the next month whether to file a suit against Google or not (Politico). The company has a clear dominance of the online advertising market, which would be impossible to hide to any regulator in any state. The battle, for Google, will focus on avoiding the breakup of the company, which, in any case, would take years to be decided and implemented. At the same time, Amazon is facing similar troubles in Europe, where it is accused of unfair competition with its third-party sellers (The Wall Street Journal).
📊 The data-mining company Palantir will soon debut in the stock market (Reuters). The IPO will also reveal the new valuation of the company, co-founded by Peter Thiel in 2004. The last valuation of $20 billion dates back to 2015, when the company raised money for the last time.
💰 Debt for startups
Recently, many analysts and practitioners have commented on the emergence of a new form of venture debt. Basically, evidence shows that, for software startups with a large enough customer base, revenues are predictable with a high degree of precision. The business model of these startups is very standardized and the challenge for founders is to obtain early customers and demonstrate traction. The rest follows a playbook that leaves little space for creativity.
In this scenario, a founder might prefer to finance its venture through debt rather than equity. And, in the wave of the so-called “securitization of Silicon Valley”, new players might emerge to offer debt instruments to those startups that can demonstrate growing (or even stable) cash flows. If a founder can avoid diluting its equity with a new round, the dominant role of VCs in the innovation economy is at risk.
There are two fundamental conditions that enable debt instruments for startups. One is the predictability of revenue streams and cash flows. The other is a relevant customer base, which can sustain those revenues in the medium term. Of course, these conditions are strictly correlated and usually lead to the golden goal of post-WeWork startups: profitability. It would not be a mistake to summarize it all saying that profitability — achieved or close to be achieved — is key to unlock debt instruments.
Business models based on recurring revenues are now widely diffused worldwide. It often happens that founders have to justify their choice to run a software company without the typical SaaS business structure. Those startups satisfy the conditions mentioned above, provided that they manage to reach product-market fit. The latter becomes an unequivocal metric for the validation of the business model, which leaves little space for creative variations to the standard.
This provides the first evidence that equity and debt financing for startups can coexist. If equity instruments are required to enter the market and reach product-market fit, debt steps in to provide cash when the company is trustable enough regarding its revenue generation capabilities. In the beginning, we will simply see a greater share of startups avoiding equity dilution through new financing rounds. As suggested by Alex Danco, this could happen especially far from Silicon Valley, where new hubs could brand themselves as more debt friendly.
Later on, equity and debt financing will necessarily assess to a new equilibrium. In the next weeks, I will concentrate on the main balancing factors that will determine this new equilibrium.
First, I will analyze the most straightforward scenario, in which VCs will have to engage more in the early stage of venture financing while leaving the floor to debt instruments for later stages. This would mean more risk for VCs and less power to lead big rounds for scaleups. Consequently, VCs might start offering debt instruments, partnering with other organizations specialized in the field, to retain control on hyped scaleups with huge potential rewards for equity investors. Alternatively, VCs might concentrate their investments in new business models or particular industries that would be hard to fit the debt instrument.
Second, if business models that provide recurring revenues are perceived as a secure investment, organizations providing debt for new ventures might engage in seed investments aimed at increasing the flow of startups that make it to later stages, which are the ideal targets of debt instruments. I will dedicate particular attention to how those organizations might enter the seed stage — relying on existing venture debt best practices.
Third, increased competition in the early stage resulting from the previous point would reshape the entire venture financing model. This is now monopolized by VCs and related intermediaries like accelerators and (to a much lower extent) corporate funds. A founder recurring to venture debt is considered an outlier in the brilliant world of entrepreneurship. This shift might change not only the financing structure, but also the perception of those intermediaries among practitioners and the media.
Fourth, which role will Big Tech play in this new environment? Big Tech is relevant for two main reasons. Those companies are plenty of cash and very acquisition-prone. This secondary market provides exit routes that are fundamental for startups that do not want or can become public. Acquisitions play a vital role to maintain an edge over competitors and prevent newcomers from eroding their market power. A second reason is the strict tie that links Big Tech and the VC industry. Easier exits provide strong incentives for equity financing, which means that the trend of acquisition will have an even greater impact on the financing strategies of VCs.
This brief summary has two main goals: get feedback and generate engagement. If you are interested in the topic and want to contribute, this project is open for you. And, of course, if you think there is a fatal flaw in the starting assumptions, do not hesitate to answer this email.
Alternative perspectives
🔬 On Chemistry World, Philip Ball criticizes the meritocratic approach to science, which contributes to crystallize social dynamics. According to the author, rewarding those who deserve the most should go hand in hand with greater attention to how the scientific system is inclusive and open to all the components of society.
For the implication is that methods of advancement, recruitment and reward in science are just fine as they are, and we shouldn’t mess with them on account of some politically correct, ‘ideological’ agenda. But to believe that, you will need to believe that the current disproportionate representation of ethnic minorities, especially black people, and women is simply part of the natural order: it just so happens that white men are better suited to Stem subjects. […] Part of the problem is that science has for so long told itself that it is exceptional, internationalist and universal, apolitical and driven only by merit, that to challenge this idea can be interpreted as challenging the integrity of science itself. But diversity is not just about fairness, even though that makes a compelling case on its own. It is about acknowledging the lessons of science itself.
💻 In a new post on his blog, Jesse Li explains the true nature of software, which is a tool that represents and empowers the social dynamics already in place. The software industry, which is too strictly related to capital forces, has failed to save the world as promised. To do that, political goals for our society should be better defined.
These examples give us a decent idea of what software is good for. On its own, it never enables anything truly new, but rather changes the constant factors of speed and marginal cost, and raises the barrier for participation arbitrarily high. Once the software train begins to leave the station, we have no choice but to jump and hang on, lest we get run over or left behind—and we are not sure which is worse. […] Startups love to save the world, but look at the state of the world now—is this what it’s like to be saved? Is the world even a little bit better because of startups like Instagram, Uber, and Peloton? Startups are spaces of remarkable innovation, and they are experts at channeling the multivoicedness of code—just look at the network of voices that GitLab channels (visualized below). But under capitalism, these voices are distorted and constrained, and they cry “growth, growth!” as venture capitalists and founders demand user acquisition, market share, and revenue—in a word, they demand access to capitalist accumulation.
Other readings
🏭 On The Information, Wayne Ma examines how Apple understood that a fully automated manufacturing process would not be optimal for the production of its iPads. The article, which builds on a strong body of knowledge about Foxconn’s automation strategies, went viral during the week.
🐉 On The New York Times, Paul Mozur and Cade Metz analyze a new report explaining the contribution of Chinese researchers working in the US to the competitive advantage of the country in artificial intelligence. However, the new international relations scenario threatens the mobility of Chinese undergraduates, who could find it hard to continue their education abroad.
📿 On The New Yorker, Casey Cep analyzes how it is possible to reconcile religious faith and progressive political ideas.
📕 On The Guardian, Arwa Mahdawi explains how the publishing and journalism industries are permeated by racial inequalities in the payments of authors. Transparency in the payment policies might help to reduce these disparities.
💼 On Fast Company, some VC partners and business leaders explain how COVID-19 has reshaped the venture capital industry. A common line behind most of them is the focus on the resilience and the endurance of new ventures.
🎓 On City Journal, Tara Isabella Burton provides a long and documented portrait of Peter Thiel, the controversial Silicon Valley investor, with a particular focus on his view of the education system. Even if I tend to disagree on everything with Peter Thiel — or maybe exactly because of that — this is by far my best piece of the week.
Thanks for reading.
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Have a good weekend!
Federico