The Popular Markets Delusion

As the public equity markets have exploded in the past 18 months to accommodate the growth in technology software companies, it’s become a subject of considerable discussion here at Chicago Ventures. Everything from the recent nosedive in valuations across the adtech sector, Zulily’s precipitous drop, the crowdfunding IPOs, all the way to the continual nuances of everything SaaS.

Though we’d be foolish to ignore public market sentiment entirely, I think it’s equally foolish to base seed stage investments and theses off contemporary trends and momentum. Speaking 15 months ago to StrictlyVC Managing Editor Connie Loizos, Brian O’Malley (then partner at Battery Ventures) now at Accel Partners opined:

What’s interesting, and what has surprised me, is how much people are influenced in terms of which companies they think will break out based on which companies are having success today. 

There’s a lot of emphasis right now on these more enterprise-focused businesses, which has a lot to do with enterprise-focused businesses doing incredibly well on the public market. But the reality of my doing a Series B investment is that I’m not going to be selling for three to five years, and the market might be very different by then. Even still, people are willing to back much less mature companies in the space du jour rather than invest in something that has some scale in a space that’s out of favor.

If what Brian noted is true at the Series B level, how much more so is it true for a seed stage investor like Chicago Ventures.

This is one of the reasons I get frustrated when entrepreneurs try to sell me on the value of their market by referencing recent large acquisitions of similar companies. While those deals may well reflect the general size of the market, it’s unlikely to have a significant correlation to how their market looks in 7-10 years.

As an example, let’s take crowdfunding. Last month’s Lending Club and OnDeck IPOs have reignited chatter in the space. But what many early stage investors fail to recognize is that early thought leadership in the space emerged in 2008-2010, (and, in my opinion) culminated with Charles Muldow’s benchmark whitepaper A Trillion Dollar Market By The People, For the People. Even verticalized platforms such as FundRise have already begun claiming dominance.

This isn’t to say I would never invest in a crowdfunding platform. On the contrary, I am maintaining an acute eye towards an unconventional approach to the space that has failed to connect over the past seven years. The single best lesson I’ve learned from working with Gil Penchina over the past few months is: what has fundamentally changed in the world recently that enables this idea to succeed now when it has always previously failed? This is a nuanced variant of Chris Dixon’s famous “what’s your secret and how did you earn it?” Effectively: Why now? Why you?

This is one of the reasons I remain so fundamentally bullish on digital commerce. With a mere 6% of US retail sales happening online, does anyone reading this actually believe that figure will be less than 12% in a decade? Especially as millenials become the dominant household purchasers?

If I tracked the public markets, I would be shying away from e-commerce: Wayfair is trading at approximately 50% of its IPO price. Zulily is down 60% just in the past 6 months. The sector looks like it’s falling apart.

I remain bullish on digital commerce because I remain bullish on literally every macro factor that could exist. The market will double in the next decade. Friction is fast disappearing across digital checkouts – from single click to bitcoin to Apple Pay. While some traditional retailers may have figured out paid digital marketing, they deeply trail the market on content, community, curation, and concierge services. In 5-10 years, when millenials represent the plurality of GDP, which platforms win? What does the world look like then? If legacy incumbents can’t innovate and millenials spend more online than ever, it sure seems like a lot of whitespace.

Similarly, I remain beyond bullish on bitcoin. While momentum investors have laughably shied away because of the digital asset’s price drop, all the macro factors stack up: Interest amongst world class engineers has never been stronger. A powerful ecosystem is building around influencers. And global figures and corporations from Larry Summers to Docusign to entire countries are experimenting with the technology.

But like everything in life, predicting the future is a balance. Not all actors in the funding ecosystem are rational. With a $40M fund, we can only support world changing entrepreneurs so far. And because pre-IPO investors are affected by public markets, and late stage investor are affected by pre-IPO investors, and expansion stage investors are affected by late stage investors, etc etc, it all funnels down – all the way down to seed stage investors like Chicago Ventures. And sometimes we regrettably, frustratingly need to work within the delusion.

Consider it a work in progress for now; a balance of sorts between predicative imagination and investing into strong secular trends and tailwinds. That’s part of what makes this job so challenging – and so much fun.

About the author

Ezra Galston
Ezra Galston

Consumer focused hustling @Chicago Ventures, Young Entrepreneur @Foundation Capital, Class 18 @Kauffman Fellow, and Chicago Booth MBA. Former professional poker player, with 4 years experience doing marketing/biz dev in the online gaming industry. Launched a "poker hedge fund" in 2011, a record label in College, and produced a festival screened short film in 2006.

  • DavidSandrowitz

    Do you think there is any link, however tenuous it might be, to the availability of capital in the seed stage and the larger macro environment? I think that capital has moved into the seed stage looking for higher returns as well as due to a sentiment, misplaced or otherwise, that higher risk is palatable while novice investors’ nest eggs are in good shape. With Dow 18K, I think people are more willing to test the angel waters, but I think that means the money could dry up fast if the markets drop or volatility increases.

    • Tash

      David. Thank you for surviving. Thank you for your “I want to die post”. Thank you.

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  • egalston

    Yes, there’s a huge link – and likely for a lot of reasons. Don’t know if it has much to do with firms feeling like “nest eggs” are safe. Macro trends I see are that rate of return on bonds is at all time low so investors are looking for higher yield. In Chicago, we’ve seen that a lot of the HFT firms can’t put enough money to work, so they need to get exposure to their capital in other ways. Why so many firms are choosing to direct invest rather than fund of funds is a curious decision, maybe they want the added beta? Thanks for engaging!

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