Posts from economics

First and foremost, this is not tax advice. I am not a tax advisor and you should never take anything you read here as tax advice. If you read something here that makes you think you should take some tax-related action, please always consult your tax advisor.

With that disclosure out of the way, I would like to talk about 83b elections.

An 83b election is a choice a taxpayer can make to pay the taxes in full at the time of the grant of an asset that vests over time and would otherwise be taxed as the asset vests.

So why would you want to do that?

Well, if the value of the asset at the time of grant is quite low and the taxes would not be significant to you, you might want to make an 83b election. Otherwise, you will be taxed as the asset vests and if the asset increases in value, those taxes could be significantly larger.

Let’s look at an example. Let’s say you join a company that is very early stage and you are one of the first employees. Let’s say you are granted 100,000 shares of restricted stock that vest over four years and the current value of each of those shares is $0.10. That means the entire grant is worth $10,000 (100,000*0.1). If you file an 83b election, you are volunteering to pay the taxes on that $10,000 even though the shares vest over the next four years. The taxes on that $10,000 will depend on where you live, but will generally be in the range of $2500 to $5000.

Now let’s say you decide not to file an 83b (or worse, you never heard of an 83b election and nobody suggested you file one). Let’s say one year later, your first vesting period happens, and 25,000 shares vest. And let’s say that the stock has increased significantly in value to $1/share over the first year. That means that the 25,000 shares that have vested will generate $25,000 in taxable income to you and the taxes you will owe on them will be in the range of $6,000 to $12,000. And you still have 75% of your grant unvested and the stock might keep going up, creating more taxes for you over the next three years.

You have 30 days post grant to file an 83b election so you must move quickly if you want to do this.

The downside of the 83b election is you will have paid the taxes on the stock even though you may leave the company and not vest into any or all of it. That is the risk you are taking when you file an 83b election and you must consider that risk when you make the election. In life, there are generally no free lunches.

If you are being granted restricted stock, founders stock, or some other asset that vests over time, you should ask your employer and your tax advisor if you should file an 83b election. There is a good chance you will want to.

The reason I decided to write about 83b elections today is that USV signed onto a comment letter to the IRS last week asking them to make e-filing and e-signing of 83b elections permanent. You can read the comment letter here.

83b elections are an important tax strategy for founders and early employees in startups and they should be used more frequently than they are. And it should be dead simple to file one. Taxes are hard enough for the average startup employee to understand and comply with. We should not make it harder.

I want to focus this post on the macro environment for tech, startups, web3, and climate because that is where my head is at right now.

I believe that sometime in the first half of 2023, the central banks around the world will start backing off the tightening that they have been engaged in as inflation continues to ease and the economy continues to cool. Interest rates will level off in the first half of 2023 and I think there is a good chance of a “soft landing” or a very mild recession in 2023.

With that macro view in mind, what would that mean for tech, startups, and web3?

The largest tech companies will emerge from this downturn leaner and more profitable and growing more slowly. They will be mature businesses that behave like the blue chips that they are. I think these companies, like Apple, Amazon, and possibly Google, will see their stocks come back into favor ahead of everything else in tech. I am hedging on Google because I believe the massive advances in AI/ML that we are seeing right now may be a threat to their core search franchise.

Startups are going to have a tough year in 2023. While many have gotten their burn rates way down, most startups still are losing money and will eventually need to raise capital in 2023. Because most startups avoided raising in 2022, there will be a glut of startup companies in the market for capital this year and while there is plenty of venture capital sitting on the sidelines waiting to be deployed, VCs will be much more selective, instead of funding everything that moves as we’ve done over the last few years.

Good businesses with product market fit, positive unit economics, and strong leadership teams will raise capital although it will be at the new normal in terms of valuation. I believe that “new normal” is more or less where we were in 2015 where seed rounds were done around $10mm, A rounds were done around $15mm to $25mm, B rounds were done around $25mm to $50mm, and growth rounds had a cap at 10x revenues. This new normal will lead to many flat rounds, down rounds, inside rounds, and rounds with a lot of structure on them. None of that is good, but the worst of those options is rounds with a lot of structure. I believe founders and CEOS and Boards should take the pain of a new valuation (flat, down, whatever) over structure.

But there is a huge number of startups out there that have not really found product market fit, have not created positive unit economics, and have unresolved issues in their founding teams and leadership teams. These startups will struggle to raise capital at any price and most of them will fail. This has already started to happen but because so much capital was raised in 2021 and the early part of 2022, it has taken longer for these companies to fail. I think we will see a lot of startups in this category go under or taken out in fire sales in the first half of 2023.

While all of that sounds gloomy and downright horrible, I do think the startup sector will end the year in a much better place. The good companies will have gotten funded, the bad ones will have shut down, and VCs will be back to competing with each other to win deals, which is where founders always want VCs to be.

I think web3 will behave similarly in some respects but different in others.

I think the large caps in web3 (BTC and ETH mainly) will start to attract more interest from investors and should do well in 2023. I am more bullish on ETH personally because it has the best underlying economic model of any web3 asset.

Like the startup sector more broadly, web3 will go through a triage of sorts in 2023. Projects and protocols that have found product market fit, have real token economics, and ship new features quickly will attract new interest and rise in value. But many web3 projects have not found product market fit, have weak or no token economics, and do not execute well and I think we will see many of them continue to flounder and fail in 2023.

There is a much larger overhang in web3 right now when compared to the broader startup and tech sectors. There are entities that are insolvent but have not been restructured. There are funds that are so far under water that they may be forced to liquidate. These kinds of activities will produce ongoing sell pressure on web3 tokens for at least the first quarter of 2023 and maybe for much longer.

While there are compelling values out there in web3, I am not convinced that it is safe to go back into the water just yet unless you have a very strong stomach and a very long time horizon.

Climate, where USV has been actively investing for the last three years and now has two funds dedicated to the sector, has mostly been spared the carnage that has hit the other parts of USV’s portfolio. 2022 brought largely good news to the sector in the form of the oddly named Inflation Reduction Act (IRA) that will flow billions of dollars of capital into the sector over the next decade. Many leading VC firms have dedicated climate funds now and we see huge amounts of capital available for climate startups with strong teams and novel approaches.

Last year I predicted 2022 would be a big year for carbon credits and while we saw a lot of growth in the market for these credits, particularly among the large tech companies, I was way too optimistic about how fast the market would grow. That said, I think 2023 will bring more growth in this market which provides the underlying business model to many of the new climate startups VCs are funding right now.

We are also seeing a noticeable movement of tech and startup talent into the climate sector in search of new problems to solve, more meaning in their work, and many more job openings too. I think 2023 will be a big year for this talent migration.

There is a pattern to much of this and it is that 2023 is going to be a tough year for most but those that get through it should find themselves in a good place, with leaner cost structures, less competition, and healthier employer/employee dynamics. Surviving is thriving in 2023.

So to everyone who is reading this, Happy 2023. Buckle up, hang tough, and be smart.

I like to bookend the New Year holiday with two posts, one looking back at the year that is ending and one looking forward to the year ahead. This is the first of these two posts. The second one will run tomorrow.

What happened in 2022 is the bottom fell out of the capital markets and the startup and tech sector more broadly.

Back in February 2021, I wrote a post called How This Ends. In it, I wrote:

I believe it ends when the Covid 19 pandemic is over and the global economy recovers. Those two things won’t necessarily happen at the same time. There is a wide range of recovery scenarios and nobody really knows how long it will take the global economy to recover from the pandemic.

But at some point, economies will recover, central banks will tighten the money supply, and interest rates will rise. We may see price inflation of consumer goods and labor too, although that is less clear.

When economies recover and interest rates rise, the air will come out of the asset price bubbles that have built up and the go go markets will hit the brakes.

I went on to say that I had no idea when all of that would happen, but I was confident it would.

Well, it happened in 2022.

The air came out of the asset price bubbles that had built up over the last decade and were accelerated/exaggerated by the pandemic. There have been a number of other factors at work, like a war in Europe, that made things even worse, but it is my view that most of what happened in 2022 was entirely predictable, expected, and necessary.

In the areas that USV works in; tech, startups, and web3, there have been a number of important downstream effects of the popping of the bubble and they are worth enumerating.

As the capital markets, including crypto/web3, came undone, companies reacted by adjusting their burn rates to reflect that the growth at any cost phase was over and it was time to get on a path to breakeven. That has meant layoffs across the tech, startup, and web3 sectors. The voracious appetite for talent has waned. Spending for growth has largely stopped and most tech companies and startups are growing more slowly but with better unit economics and lower cash burn.

Some startups have failed, particularly the ones with upside-down unit economics or with a lack of product market fit. I think we have just seen the start of this trend and I plan to talk more about this in tomorrow’s post.

The sector with the largest impact, obviously, has been web3. Many large centralized entities; lenders, exchanges, crypto funds, etc, blew up when the value of web3 assets declined 70-90% over the course of 2022. The carnage has been massive and reminds me of what happened to the web sector in 2000/2001. Some of this has been markets doing their thing, but not all of it was. There was fraud, mismanagement, irresponsible risk-taking, and more, at play in the web3 sector.

And yet, I am not aware of any leading decentralized protocols blowing up in 2022. The smart contracts that run these protocols did what they were programmed to do and they have come through intact. It is a testament to the power of decentralized protocols over centralized entities and, for me, the major lesson of 2022 in web3.

I used the word necessary a few paragraphs ago to describe what happened in 2022. I understand that this year has been painful for most and devastating for many. I am not immune to it. Our family’s net worth has taken a massive hit. The carrying value of USV’s assets under management has been cut in half this year. And yet, I am fine, my family is fine, and USV is fine. Many are not. I understand that and have a lot of empathy for those who lost so much, including their jobs, this year.

And yet, I know that the unwinding of an unhealthy and unsustainable growth at all costs/cheap capital environment was necessary and will be healthy in the long run. We already see many of our portfolio companies operating at much more sensible cost structures with clear paths to profitability at much lower growth rates.

The ending of the war for talent in tech also is incredibly healthy. Some leading tech company CEOs I know believe they can operate with much lower headcounts in product/engineering/design than they have been for the long term. That talent can move into new startups and new growth areas, like climate and healthcare, that need it.

Like all transitions, this is messy, painful, disruptive, and ugly. And this year has been all of that and more. I am happy to see it in the rearview mirror and looking forward to better things in 2023. Which will be my topic for tomorrow.

Tech:NYC is the industry association for NY’s tech sector. They play a number of important roles and one of them is to educate and inform about the impact of the tech sector in NY. To that end, they launched a valuable resource last month called Innovation Indicators.

Innovation Indicators is a dashboard that shows the latest data on the impact of the tech sector on the NY economy. Here is some of the data you will find there:

Innovation Indicators will be updated regularly and will be a valuable resource to entrepreneurs, academics, policymakers, journalists, and anyone else who is interested in the development and growth of the tech sector in NY.

The Gotham Gal and I own five EVs and have been driving electric-powered cars since 2014. I don’t drive gas-powered cars and haven’t for a few years now. We have purchased two Chevy Bolts, two Tesla Model Ss, and one Rivian truck.

I love the instant acceleration you get from an EV, I enjoy driving mostly with just one foot due to the fact that EVs accelerate and brake using the accelerator pedal, I like that I can charge my car every night at home (using solar panels on our roofs) and don’t have to go to the gas station anymore, and I like that the maintenance costs and hassle are much lower with an EV. There is certainly an environmental benefit from driving EVs, but in my view, EVs are also better cars (and trucks).

But EVs remain expensive and “risky” for most folks and only 9% of global car sales are electric and that percentage is smaller in the US (more like 5%).

So how do we change that?

With gas prices sky-high, policymakers are looking to do something about the cost of driving. They are talking about short-term solutions like gas tax holidays that will do little to reduce the price of gas. I believe they should spend that money on longer-term solutions that will accelerate the conversion to EVs and reduce our reliance on the fossil fuel industry.

So what would those things be? Here is a list:

1/ A government-backed loan program (like student loans) that makes buying an EV less expensive to the average car and truck purchaser.

2/ An incentive program for merchants (think Starbucks or 7-Eleven, but it could be any merchant) to install and offer fast-charging stations.

3/ Subsidies to build battery manufacturing facilities (80% of EV battery manufacturing is in China).

4/ Policies to produce more cathode materials (which are roughly half of the cost of an EV battery).

Most automobile manufacturers are making EVs now. They understand EVs are the future. But there remain real impediments to consumer adoption of EVs. We need policies that work to reduce those impediments and speed the adoption of EVs and we need them now.

Back in February of last year, I wrote a blog post with the same title and said this about the asset price bubble we were living in and investing in over the last few years:

The big question is how does this end?

I believe it ends when the Covid 19 pandemic is over and the global economy recovers. Those two things won’t necessarily happen at the same time. There is a wide range of recovery scenarios and nobody really knows how long it will take the global economy to recover from the pandemic.

But at some point, economies will recover, central banks will tighten the money supply, and interest rates will rise. We may see price inflation of consumer goods and labor too, although that is less clear.

When economies recover and interest rates rise, the air will come out of the asset price bubbles that have built up and the go go markets will hit the brakes.

Well now the markets have hit the brakes and the new question is how that ends.

I have been using the early 80s as a bit of a mental model. The late 70s saw oil prices rise and stagflation emerge and while that is not exactly what has happened with COVID and the war in Ukraine, there are some similarities.

In the early 80s, the G7 economies tightened the money supply, raising interest rates dramatically, in an effort to bring inflation under control. You can see the effect in this image:

The early 80s had a double dip recession (one in 1980 and another one for 18 months in 1981 and 1982). The economy was weak for three years at the start of the decade. But the latter half of the decade was one of the best economies in modern times.

So I suspect we are either in a recession right now or headed to one, brought on by tightening money supply/higher rates that are being used to control inflation. That recession could easily last until the end of 2023. But we don’t really know how long it will take for this cycle to play out.

Markets have already corrected and I think that public tech stocks have already seen most of the damage they are going to see. I don’t know if we have hit bottom but I think we are closer to the bottom than the top now. But that does not mean they will turn around and go right back up.

This is a price chart of the NASDAQ during the early 80s recession and you can see that prices did not start to move up until the second half of 1983, when the recession was starting to end.

So how does this market meltdown that we are now in end?

First, we need to see the economy slow down and inflation slow down. We need to see stocks bottom out and hang out there for a while. And we need to be patient. None of this is going to happen fast.

I would be planning to ride this thing out for at least eighteen months or more.

In my Jan 1st post talking about what I expected to happen this year, I wrote:

I think we will see the end of the Covid Pandemic in the US sometime in the second quarter. I believe the US will work out the challenges we are having getting out of the gate and will be vaccinating at least 40mm people a month in the US in the first quarter. When you add that to the 90mm people in the US that the CDC believes have already been infected, we will have well over 200mm people in the US who have some protection from the virus by the end of March.

Seven weeks later, it seems like that is pretty much what is playing out. I have read that about half of the population of the US now has some protection against the Covid 19 virus, either via having had the disease or by being vaccinated at least once. At the current vaccination rate of 1.8mm a day, the number of people who have at least some protection against the Covid 19 virus will be about 70% by the end of March.

What that means is the virus will spread less, infecting less people, and less folks in the hospital or worse. I believe that means a gradual re-opening of the economy throughout much of the US in the second quarter with schools, stores, restaurants, and nightlife coming back. I am sure that precautions will continue for much, if not all, of 2021 because nobody wants to take this lightly after what we have all been through.

If that is in fact the case, and we don’t know for sure that it is, what does that mean for the economy, businesses, tech, and more?

I wish I knew. But I have some suspicions.

As I have written here quite a few times, I believe that habits that we have formed in the last twelve months will stick with us even when we don’t need to use them anymore. I believe work from home has proven to be very effective for some, possibly even a majority, of knowledge workers. E-commerce has delivered (no pun intended) and the gains it has made against in-store retail will not be given back much, if at all. Remote learning is here to stay. So is telehealth.

I also believe that the things we have not been able to do in the last year; travel, be tourists, see live music, live theater, live sports, and all of that will be in more demand than ever. As Joni Mitchell said, “you don’t know what you got until it is gone.” We want all of that back and I think we will embrace being with others experiencing things in the real world with a passion.

But where all of this lands is anyone’s guess. And there are many businesses whose near-term fortunes depend on how the balance of remote vs in-person lands over the rest of 2021.

I also think a re-opening may not be great for the stock market, which was a major beneficiary of the pandemic. The NASDAQ is basically up 100% since March 20, 2020. I wrote a bit about why I think that might be the case last week. I don’t know how quickly a re-opening will impact the stock market, but I do think it could.

But let’s not get negative here. And end to the Covid pandemic and a re-opening of the economy would be about the best thing that could happen to the US and the world and I am becoming more and more optimistic that it will start happening in the second quarter of 2021.

We are in the middle of one of the great asset bubbles of modern times. It has been brought on by the easy money policies of central banks around the world aimed at weathering the global Covid 19 pandemic. Interest rates are near zero or negative in most developed economies and asset prices have gone way up as a result.

When interest rates are zero or negative, the value of future cash flows is huge and that is how you get PE and EBITDA ratios of over 100 and price/revenue multiples approaching 100.

The big question is how does this end?

I believe it ends when the Covid 19 pandemic is over and the global economy recovers. Those two things won’t necessarily happen at the same time. There is a wide range of recovery scenarios and nobody really knows how long it will take the global economy to recover from the pandemic.

But at some point, economies will recover, central banks will tighten the money supply, and interest rates will rise. We may see price inflation of consumer goods and labor too, although that is less clear.

When economies recover and interest rates rise, the air will come out of the asset price bubbles that have built up and the go go markets will hit the brakes.

When will that happen? Your guess is as good as mine. It could be later this year. It could be in a few years. It could take longer. A lot of damage has been done to the global economy and it is unclear how quickly it can recover.

A good chart to watch is the one year treasury bill.

When the one year treasury yield gets back above 2%, we are leaving the easy money era. We aren’t close to that right now.

A number of people have been asking me what I think of the Game Stop situation. This is not really my world. I don’t trade stocks, we hold them. I don’t use Robinhood, though I have an account thanks to my friend Howard. I don’t hang out on Reddit, though I visit it from time to time.

So I have not paid enough attention to this one, but it certainly is fascinating. The generational aspect of this is important. Boomer hedgies getting crushed by young folks self-organizing in social media. It feels like a moment where you realize that the power structure has shifted and things won’t be the same.

The financial system in the US, and in other developed countries, is a rigged system and has been for a very long time. Only big institutions can get into hot IPOs. Only rich people can invest in startups. Many of these rules are designed to protect “widows and orphans” but all they really do is make the rich richer and keep those without money out of the game.

Not anymore. Whether it is crypto (Coinbase) or day trading (Robinhood), the retail investor now has the tools to get into the game and win the game.

The new startup investing is buying into the Ethereum crowdsale. Had you done that in the summer of 2014, you would be looking at roughly 1,000 times your money right now. And that crowdsale was launched by a team led by a 20 year old. Though the SEC and others would like to impose the same rules on crypto that protect the rich and keep out everyone else, that has not happened and I pray that it won’t.

The new hedge fund is the Robinhood army self organizing on Reddit. They can move a stock more easily than the largest hedge fund.

There will be calls to regulate this “madness.” But it is the same madness we have always had. It is just a different crowd in charge.

I do worry that this Game Stop short squeeze will end badly and not only the hedge funds will get hurt. Markets can be brutal. But regulating markets to protect the small investor is not the answer. As we can see, the small investor is often a lot smarter than the large investor.

What we need to do is stop printing money to stabilize the economy. And start addressing the real economic issues that exist on main street, not wall street. Monetary policy is not the answer. Fiscal policy is. That won’t stop more Game Stops from happening. They are a by-product of markets. But it will get the money to where it is needed versus where it is just gameplay.