Has Wealth Creation Become More Exclusive?

As managing partner of Andreessen Horowitz, Venture Capitalist Scott Kupor argues that much of the gains from startups have shifted from later-stage, post-IPO to pre-IPO private markets. By the time we normal people get into the market, early investors have already captured a lot of the value.
From Scott Kupor's Secrets of Sand Hill Road (updated with data as of today).

"Consider the following example. Microsoft went public in 1986 at a $350 million market capitalization. Today, Microsoft has a market cap of approximately $1.2 trillion. That's a 3,430x increase in market cap as a public company. [An initial $1,000 investment in MSFT when it went public would now be worth $3.4 million.]
"In contrast, Facebook went public at a $100 billion market cap and now trades around $555 billion.[An initial $1,000 investment would now be worth $5,550.] ... For the public market investors to eventually earn the same multiple on their Facebook holdings as has been the case for their Microsoft holdings, Facebook would have to reach a market of more than $340 trillion. To put that in perspective, US GDP is about $20 trillion and global GDP is about $100 trillion. "

[Ron again, not Scott.]
In other words, folks who bought Facebook stock will never get the returns of folks who bought Microsoft stock.

Two possible explanations - not mutually exclusive.

My notion of the third economy is that finance was democratized (banks and stock markets made tools of us common folks in the same way that the first and second economies made tools of church and state). It seems sad that we've gone backwards on this and so much of the gain on capital has been pushed back into less accessible private markets that fund early stage startups where elite investors can get higher returns.

There may, of course, be another explanation for this. Capital no longer limits but knowledge workers do. Median pay at Facebook is $240k. That's median pay. It might be that the knowledge workers who are the limits to the information economy are now getting the returns that capital used to get.

My Argument For an Inheritance Tax And Against a Wealth Tax

It’s hardly surprising that in the wake of the first billionaire’s presidency we would have a backlash against billionaires and talk of a wealth tax. 

Trump transforming the White House into a home theater dedicated to Fox News is less indictment of billionaires, though, than an affirmation of the need for a much higher estate tax. 

Trump’s pride in having turned a half a billion from his father into $3 billion in half a century is like a rabbit breeder taking pride in having transformed a herd of two rabbits into a herd of three in a year. He's not good with capital. He's no Warren Buffet. There are three ways be an old rich guy.  The first is luck. The second is to start with little or nothing and earn and invest well. The other is to start rich and then end rich. Trump chose the third door, which as it turns out doesn't so much open onto a path as a lovely room.

One (of many) advantage(s) the US had over the USSR is that it left the allocation of most capital to individuals and institutional investors (like mutual fund managers or private and public corporations). The way that wealth works is this: the better you are at getting a return on capital, the more of it the market gives you. If Warren Buffet gets 13% return on a billion, he has two billion to invest in 6 years. The guy who gets a -2% "return" on his billion will have only $890 million in 6 years.

It is true that variation in the ability to invest leads to wealth inequality. It is also true that the market ruthlessly gives more capital to the folks best able to create more capital and takes capital from those who destroy it through bad investments. It's true that luck plays a role in returns but it is also true that - just as with ability to play basketball or write poems - different people have different levels of ability in investing. A smart community likes the idea of good investors having more capital than bad investors.

I don't think the kind of wealth tax that Elizabeth Warren is proposing is a bad thing, I'm just not real excited about it. I'd much rather see an inheritance tax of 50% (or more) for amounts over $10 million than a wealth tax. Why? I don't believe in aristocracies.

Michael Jordan was an amazing player. His sons also played basketball but did not make it to the NBA. It's rare that a child inherits the gifts of the parent. This is likely true of Warren Buffet's children as well; it is highly unlikely that they have their father's genius for investment. Just as there is no reason to give Michael Jordan's sons the ball to play in the NBA, there is no reason to give Warren Buffet's kids billions to invest. They can't do anything special with it.

Just from a perspective of "How do we create the most wealth," question, we should let great wealth builders keep their wealth and then tax that wealth when it passes from one generation to the next. Obviously the next generation might preserve a fortune if they get it, but it's not obvious that the next generation will get returns any higher than average. There is no argument for accumulating great wealth over generations. That is the definition of an aristocracy, and one of many reasons that aristocracies are associated with stagnant economies is because they are about protecting wealth, not creating it. Entrepreneurs have an impulse to disrupt the status quo; aristocrats have the impulse to protect it. 

Billionaires help to create - and are created by - dynamic economies. As they build companies and invest capital, they add to a communities wealth. Billionaires are a natural companion to dynamic and healthy economies. Aristocrats are not. And that is the reason I think inheritance tax is a good idea and a wealth tax is only a mediocre one.

Oh, now that we see the potential, we'll take that from you

I am a little ticked off. I had a stock taken forcefully from me and I a offended that such a thing is legal.

I am convinced that great stock opportunities come along at best a few times a year. On occasion, you encounter a company that Wall Street doesn't really know about and that has not yet generated any numbers to prove its potential.

Oh, and I really like fish tacos. It's a San Diego thing but you know, there was a time when pizza was just an Italian thing. If something tastes good, it'll take off.

Rubio's is a local restaurant chain that helped to popularize the fish taco this side of the border and on top of that, they offer relatively healthy Mexican food.

For all these reasons, I bought stock in the company. McDonald's market cap is about $78 billion. When I bought Rubio's stock, their market cap was about $50 million. If Rubio's had 1% of the value of McDonald's, the stock would rise 10X. It seemed to me a reasonable bet.

About two days ago, my Yahoo portfolio says, "No such symbol RUBO." I didn't have time to look into it until today. As it turns out, a company has taken Rubio's private. The good news is that they paid me about 75% more than I had paid. The bad news is that this is nowhere close to the 10X I thought possible. And, I was not even given the option to say no to their offer of $8.70 a share. This was, from my perspective, a forced sale.

So, on top of all the other problems with stock market investing, whenever a really good opportunity does come along, someone can force it from you? Really? That just seems wrong. And I'm a little ticked off. I might just go somewhere different for Mexican food this weekend.

Sell Your Gold Now

Gold is a lousy investment. Oh, I know it has gone up lots of late - outperforming real estate and stocks by a wide margin. But it is a lousy investment just in the sense that it does nothing for productivity or the economy. It is the natural resources equivalent of putting your money under your mattress. And my belief is that, in the long-run, for something to be a good investment in terms of returns, it has to be a good investment in terms of generating wealth. Gold at best stores wealth; it doesn't create it.

If you invest in real estate development or stocks, you actually put money into a general fund that can be used to create new jobs, new homes, and new products. By contrast, when you put your money into gold you divert money into a nothing more than speculation. (Unless you're betting on gold fillings make a big comeback.)

My guess? Gold will go the way that real estate did over the last few years: the "sure" investment that proves itself as susceptible to bubbles and busts as any.

Gold prices have recently dropped, but they're still high. I say sell now and put your money into something that actually creates something of value. Long-term, that is the only sensible play. For you or the economy that you ultimately depend on for prosperity.

Better than Gold

The price of gold has soared as every other market has behaved more erratically. Apparently the thinking is that gold is a safer investment in bad times, even good for a spectacularly post-crash, or even post-apocalyptic world.

I still don't understand the allure of gold. It has value in dentistry, say, and jewelry, but that would probably account for about .1% of the demand for it. Of all the magnets for capital, it seems to me one of the most useless.

If you really do think that markets are going to collapse and society is breaking down and want a hedge against this, don't buy gold. Buy canned goods, bottled water, and toilet paper.

Betting on Google (or Why Chrome OS Is a Lottery Ticket Worth Scratching Off)

The guys at Google came up with a secret sauce in the form of algorithms that efficiently and quickly search the Internet. They understand probabilities. And that might be as good a reason as any to bet on their continued success.

Google has a fascinating policy of letting programmers work one day a week – 20% of their time – on their own projects. This has already translated into popular products like gmail and google news. Some projects come from central management and some come from the cubicles. This is not much different from successful economies where some projects (e.g., NASA or the early Internet) come from centrally-planned government programs and some come from unexpected sources like the garage or the back of a cocktail napkin.

One of the insights to come from the world of probabilities and into the world of finance in the last century is the notion of the high probability of low probability events. The lottery is the simplest example. The odds of any ONE person winning are incredibly low. Buying a lottery ticket to win money is almost like buying an airplane ticket to commit suicide. The odds are terribly low for any one person to win and yet the odds that SOMEONE will win are incredibly high.

Venture capitalists differ greatly from bankers in this regard: they take an equity position in success and know that only a small percentage of their investments have to become the next Yahoo or … well, Google in order to offset the many investments that don’t pay off. They don’t embrace failure but they know it is inevitable.

Google has seemed to realize that a corporation has a huge advantage over a venture capitalist in this game. A corporation can provide a risk free environment in which individuals can start projects that might become market successes or merely technical successes or might never become successful. The corporation can provide the infrastructure (e.g., HR, marketing, etc.) that can absorb so much time from the entrepreneur. And if one of these projects like gmail or google news should become successful, they offset the many projects that don't come to fruition.

Further, even the failures are never clearly failures. If an employee learns a new skill or gains a new market insight from trying something new, that can be applied to the next venture. And with everyone taking on their own project, the entire organization has a vastly different mindset in regards to projects. Thinking about how to create and deliver products to market becomes pervasive. This sort of culture can be more valuable than any one project.

All that to say that the many critics who are already pointing out why Google Chrome OS – Google’s attempt to capture Operating System market from Microsoft – will fail could be right. The odds of this ONE product becoming a success are pretty low. (But it is still a good bet. Microsoft gets about $15 billion a year in revenue from Windows.) But each time they try another venture like this, the odds of generating profit to match what's generated by their search engine go up.

Oh, and one other thing. I remember when Microsoft’s Excel and Word were obvious failures. It took some time before they seemed like something other than cute substitutes for the seemingly invincible Lotus 1-2-3 and Multimate Word Processor. The fact that gmail does not have as much market share as Outlook does not mean it will not eventually have more. It is rarely the released product that conquers the market – it is usually the evolved product that owns a market.

It is true that lottery tickets are unlikely to pay off. It is also true that only people who buy them ever win the lottery.

The Last Sure Thing

My friend Beth is in the Netherlands, looking into rumors that originated from a rogue group of economists who believe that investment markets go through very, very long cycles. Their theory? The next big thing is going to again be Dutch tulips.

It would be irresponsible for me to advise you to move ALL your money into tulips, but I'm pretty excited. I have evaluated my 401(k) and if I move quickly, I still have money enough left to buy 2. Tulips that is.

I just hope this works.

What About Work?

Freud said that work and love is all there is. And yet work, like air, is nearly invisible to us.

I saw "Working" at the Old Globe last night. It reminded me of why I found Studs Terkel's book so fascinating decades ago. Hearing people talk about their jobs is sort of like listening to them talk about incomes or private sex lives. There is, oddly enough, a kind of intimacy when Terkel's characters confess to their ambivalence or resignation or dreams that makes us realize how little we really know about the daily work of people all around us.

All of business and economics stems from work and yet it seems as though business management and economic theory ignores work, or takes it for granted. This is a huge mistake and could easily undermine the bright and noble aspirations of Obama's bright and noble economic team.

Work gets defined by the economy and the economy by work. In an agricultural economy, work is subordinated to seasons and the demands of the animals and livestock. In an industrial economy, work is subordinated to the rhythms of machines and factories. In an information economy, work comes from applying algorithms or knowledge to tasks. In every economy, productivity is largely determined by big economic trends like industrialization and these trends, in turn, are defined by changes in work. Work matters and its demands are always larger than the individual.

Which brings us to today's economy and theories about how to move out of the recession AND again increase stagnating wages.

Obama's economic team believes that the Great Depression was ended by Keynesian policies. A sizable portion of their conservative opponents believe that the recovery was simply a natural consequence of the dynamics of capitalism and if anything, Keynesian policies just slowed things down. The players in this debate both seem to ignore work.

Peter Drucker thought differently. He attributes the massive increase in productivity in the 20th century (the average worker produced about 50X more per hour by 2000) to Frederick Taylor's application of knowledge to work. If he is right - and his is a credible claim - than the efforts of capital markets and Keynesian policy makers alike would have been for naught without this. We would still be working 3,000 hours a year (about 50% more than we do now), living a mere 47 years (rather than 77), and would have about 1/50th of the goods and services we now have. (And if you are past the age of 47 and say that this does not sound so bad, just consider the fact that in such a world your opinion would count for little: you'd be dead already.)

All that to ask, What is the theory of Obama's team about the source of progress for this next century? Now that the portion of our work force making and moving things has dropped to about 10%, Taylor's application of knowledge to work offers less promise. Now we have to transform knowledge work, and - just as we offered the children of manufacturing workers knowledge work as an alternative, a means of progress - we have to offer the children of knowledge workers the next stage of work.

It is not enough to pump more capital into the same markets. We've done that to create a series of bubbles. Capital - like labor - needs broader movements to harness onto in order to generate greater and greater returns. And it is not enough to stimulate an economy that isn't steadily improving the foundation - the work - upon which everything else builds.

Until we start talking seriously about work and how we expect it to change and improve in this next century, it seems as though any stimulus packages by governments and investments by Wall Street will simply translate into more drag and bubbles.

Economists, business managers and investors like to think of themselves as the keys to progress. They matter. But without changes in work, the machine breaks down. And work continues to be the most ignored of these vital elements. Maybe it is time to change that. Perhaps it is time to turn our attention from Treasury Secretary Geithner to Labor Secretary Solis. Money just change the score: work changes the game.

An Inane Idea for Education

The Obama administration is set on spending more on education, but they still haven't seemed to confront the basic truth about it: we need to increase the productivity of teachers in order for investments in education to get us more return. There are, as near as I can tell, only three ways to do this: 1. have each teacher teach more children; 2. have each child learn more (because of new methods or approaches); or 3. more directly apply what they learn to a productive life. It seems to me that there is a way to do all three. The first would slash the number of teachers needed and the last would create a surge in demand for the number of teachers needed. The number of teachers would be about the same but the net result would be better and, I think, more gratifying for teachers.

1. Teachers repeatedly teach certain concepts that could be better taught with a combination of video, computer games, and instant tests. Children at the computer doing certain kinds of drills would not only be taught just what they were missing but would provide continual feedback about where they are in learning. If schools got serious about this, they could raise the teacher to student ratio at least 20% - probably more like 100% to 200%. This increase in productivity would show up on the cost side.

2. Teachers would still be needed. They just would be able to focus on exceptions, rather than rote lessons. They could complement the computer aided instruction by coaching individual children on two things: lessons that the individual child seemed unable to get through the computer and by teaching lessons that did not lend themselves to computer aided instruction - such as music, dance, and inter- and intra-personal skills. These kinds of lessons are largely neglected now in schools, in no small part because teachers are so busy teaching the math, language, and logic lessons that could - at least in part - be taught by video and computer.

3. Finally, it seems to me that one of the biggest problems of our current education system is that it fails to help translate the life of the individual into the milieu of the times. We are born into a particular time in history and with a particular potential. Unhappiesness stems from either failing to understand how to apply our potential to the times or from failing to understand how to realize our potential. There is something terribly personal about potential. For a child to realize her potential requires a kind of attention that can't be provided by teachers busily teaching rote lessons.

Educators - school boards - should be busily engaged in the question of the times. It is unclear to me who - outside of educators - can do more to create the future. As they educate children into adults, they inculcate particular values and skills. The question that educators should continually ask is about the direction of history and where society should be steered. This is to address the question of the times in which they expect children will find themselves as adults.

Educators should further be asking themselves about the children they are failing. It is an apt description to say that these children are failing, in reference to children who have to be held back. They have been failed. And even those who are passed along are often failed in that they leave school having received more insight about themselves through horoscopes than through any insights shared by the school. Educators should be continually addressing the question of what potential are we failing to realize in this child, in these children?

This third point, this notion of education as something that steers us into the future and that identifies and realizes the potential of individual children - would create a huge demand for more teachers. This would at least offset the drop in demand that would follow from automating more of education. And it would greatly increase the productivity of teachers not by spinning the engine of education with more energy - more busy work - but by engaging the power of this more directly into the individual lives and times of the children who spend so much time in schools.

It is not enough to just put more money into education. We should demand a greater return on the money we already spend.

Who Needs Infrastructure?

Inflatable electric car can drive off cliffs

Lisa Zyga writes,

It's hard to say what the most intriguing thing about XP Vehicles' inflatable car is. Maybe it's that the car can travel for up to 2,500 miles on a single electric charge (the distance across the US is roughly 3,000 miles).

Or maybe it's the fact that you buy the car online, it gets shipped to you in two cardboard boxes, and the estimated assembly time is less than two hours. Perhaps it's that the car is made out of "airbags" - the same polymer materials used to cushion NASA's rovers when they landed on Mars. Then again, it could be the company's claim that you can drive the car off a cliff without serious injury, and that it will float in a flood or tsunami.

This is perhaps one more reason that the Big Three are flirting with death - a new wave of vehicles is emerging.

The thought of being able to drive off cliffs is exciting but it suggests to me an even more interesting option: doing away with roads altogether. Who needs bridges even, if you have a car that can float? Can you imagine how many trillions of dollars we'd save if we didn't have to rebuild or extend our ailing infrastructure?

The Diminishing Value of Capital - Entering an Age of Puny Portfolio Returns

Tom Stevenson of The Telegraph, summarizes Warren Buffet's take on reasonable returns:

Take the assumptions about future investment returns in corporate pension schemes. The average in America is 8pc, despite the fact that a quarter of pension funds are in bonds and cash (for which a 5pc return would be a reasonable expectation) and the rest in equities, which rose by just 5.3pc a year on average over the 20th century as a whole (a remarkable period of growth for the US economy).

Buffet suggests that expectations for returns are unreasonable based on history. Worse, I suspect that returns to capital will drop considerably over the next few decades for two reasons that are rarely mentioned.

1. There are trillions of dollars seeking returns. This money has driven up the price of stocks twice in the last decade, driven up the price of real estate for the last two decades, and is now driving up the price of gold and other commodities. This money is bidding up the price of various investment options because of a simple fact: the demand for investment returns is greater than the supply.

2. Related to this, many of the more exciting investment options are in ventures that don't require an enormous amount of capital. Or, more accurately, they require capital still not easily tracked or accounted for by accounting methods centuries old. Investments in Google have little to do with their banks of servers or buildings and almost everything to do with the ingenuity and knowledge of their employees. This is problematic for capital because it suggests that the best investment opportunities can be coy about their need for capital. Contrast this with the investments of a century ago; General Electric and General Motors represented investments that consumed huge amounts of capital.

As returns drop, it'll be easier for entrepreneurs to get money. Companies that expect to compete on the basis of returns to capital can expect to lag an already poor performing market. By contrast, companies able to foster a culture more like that of an incubator will prosper. For them, the cheap capital will be a boon, enabling them to seed even more ventures. These companies - and the investors who hold stocks in them - will be the big winners in this coming period of cheaper capital.

New Year's Eve Party Tips - How to Impress People

When the conversation lags at your New Year's Eve Party and a dead silence descends on the group you're with, just casually offer this little line:
"Even with the home mortgage debacle, I made $1.7 million in the stock market this year."

Of course, what you don't want to mention is that in order to arrive at that figure you added up only the totals for up days. Do not mention that adding up the tally from the negative days suggests a loss of $1.73 million, for a net loss of about $30k. It was an extremely volatile year. Any fool can lose money and if you're eager to impress strangers, there is no need to get into investment return details.

(Want to know how the stock market really works? Look here for a hilarious explanation.)

Foreigners Will Fund Your Retirement

Our attitude towards immigration and trade could cost us our retirement.

In a great column on American exceptionalism, Fareed Zakaria explains that Americans rank dead last among countries surveyed on their belief that trade between countries is a good thing. Americans acceptance of immigration has also precipitously dropped in recent years. This new anxiety comes at a bad time.

This month, the first baby boomer began to collect social security payments. She's merely the first of a very large parade. During the next twenty years, 46 million college-educated baby boomers will retire. There will not be enough American-born workers to replace them. By 2015, the United States and Europe will face shortages in workers. In 1950, the ratio of working age to elderly was 7 to 1; by 2030, it is projected to be 3 to 1.* No matter how we structure retirement, it ultimately rests on this: the people who are working have to make enough to pay for their own lives and the lives of those who aren't.

There are four things that will either make this coming demographic shift a non-issue or make it a huge issue.

One is productivity gains. If a person in 2030 is 3X as productive as a person in 1950, he can more easily take on the task of funding more retired people. To the extent that these productivity gains come from capital investments, returns to capital can help to fund retirements.

Two is the total ratio of non-working to working people. It is true that there will be more retired people for every working person in 2030, but at the same time there will be fewer school-age children for every working person. Non-working = in school + retired. As the retired number goes up, the in school number will go down. Factoring in school-aged children makes the ratio of working to non-working look less worrisome. Plus, real advances in medical and psychological treatments could make it possible for a higher percentage of the working age population to be productive.

Three is the number of immigrants. Just as we're projecting a drop in working age population, Africa, Asia, and South America is projecting an increase. Inviting immigrants to maintain our population of window washers and brain surgeons will help them and help us.

Fourth is trade and investment across borders. If my retirement fund pays me from returns to capital invested in a foreign company, I've helped to create jobs for foreigners and they've helped to fund my retirement.

The truth is, we need a combination of these four factors in order to smoothly sail past this jarring and unprecedented shift in demographics. No one factor listed above would be enough, on its own, to ensure retirement funding.

I've written before about how oddly inflated is the concern about immigration in this country. The truth is, we have only two choices: take a step back in prosperity or step further into this age of globalization. Insulating ourselves from the outside world is not an appealing option. The politicians who feed Americans' fear of immigrants or trade are doing worse than pandering to phobias - they're setting us up for failure.

The facts from the * paragraph are taken from James Canton's The Top Trends That Will Reshape The World in the Next 20 Years.

That Crazy Stock Market Invention

NASDAQ has doubled in the last five years. Here are some reasons that don't seem to be mentioned often.

1. Since George took office, the dollar has significantly fallen in value against most currencies. If a European investor were buying American stock five years ago, she'd have to first buy a U.S. dollar, paying about 1.05 euros per dollar. Today, she'd only have to pay about 70 (euro)cents for each U.S. dollar. A Canadian would have had to pay about $1.60 per U.S. dollar five years ago but only a dollar per dollar today. The net effect is that American stocks are discounted to foreign investors. Hugely. It's a 30 to 50% off sale.

1A. No country has done more to subordinate to the modern corporation than the U.S. Our corporations are hugely successful and we do a great deal to ensure their success. Investing in American companies is a great investment and still our best product. As our currency has fallen, foreigners are buying more of our best product, as most international economics textbooks would predict. This has helped stock prices to rise.

1B. Investing in American companies is a way to invest in the world economy. Companies like Intel and Microsoft get over half - considerably more than half - of their revenues from outside the U.S. To invest in the U.S. stock market is to invest in the global economy. The global economy is doing fantastically well.

2. There aren't that many investment options and there is an enormous amount of money to be invested. We're all capitalists now - it is not just Nathan Rothschild or JP Morgan with excess funds, looking to maximize returns. Today, almost everyone is saving something towards retirement in one form or another. Worldwide, there are over $20 trillion dollars in mutual funds, and that is just a subset of the investment total. Money might leave the stock market, but ultimately, there are not too many other places for it to go. A steady demand for investments has helped stock prices to rise.

2A. Companies are learning more about generating profit all the time. Company profits have steadily risen in the last decade or two and are likely to continue rising. Companies have not really been serious about profits, historically, and the potential gains in this area are still largely untapped. Stocks are still one of the most promising long-term investments available.

2B. The number of individual investors steadily increases as more people move beyond subsistence wages. This means that demand for good investments is steadily growing.

All this suggests that the stock market is still a place to put your money. (I write this Sunday night, suspecting that the latest news about job creation will, perversely, drive down prices on Monday. My concern is not with short term gyrations, though. I'm talking about investment options for the next five to twenty years.) The stock market will eventually be seen as one of the more incredible inventions of the modern world - an invention that not only generated wealth for millions and millions and millions of people, but has financed the creation of a slew of new technologies, products, and jobs. We have yet to exhaust its potential.