One of the sinkholes, so to speak, that the money could go into is the asset class known as venture capital.
All right, this is Dalton plus Michael.
And today we're going to talk about what is Zerp and why did it mess with the startup world?
Explain to everyone what's the actual term.
Zerp is one of those words that I find myself using a fair amount that I often will be asked to pause and explain what was that word you just said.
And so we are saying the word Zerp.
ZIRP, yeah, you got to say it like that.
You got to say it like that.
ZIRP, and that is an acronym, right?
For Zero Interest Rate Phenomenon.
That's the period we lived through that ended as COVID was fatal.
So in this time, the interest rate set by the Federal Reserve in the United States was zero.
Some banks in Europe, you had to pay them.
Yes, they had negative interest rates.
And so look, we're not economists.
I think sometimes people think venture capital is the same thing as banking and private equity.
I don't even think I'm a venture catalyst.
It is definitely not an economist.
Well, our industry is pretty, like we don't know anything about this stuff.
We are not Wall Street people.
We worked on building websites, basically, was what we did.
But let's explain Zerp to you now.
So we don't know anything about this.
So we're going to explain to you.
You know why we know about this?
Yeah, we've seen the downstream effects that I can confidently tell you we've been served on.
So how did Zerp affect the startup world?
Well, then we can talk about let me say this will be before.
Let's talk about the flow of money.
Oh, let's talk about the flow of money.
So there's money from the Federal Reserve and banks could basically get it for free.
So if you're interested, you researched this from someone much smarter than me on this topic, banks had to put it somewhere.
And it was hard to find a place to get yield, which was higher interest rates.
Everyone had to find a place to go.
And so they dumped it into stuff like mortgages.
This is why mortgage interest rates were so low for banks like First Republic or SVB.
And all these people were searching for yield, like the money needed to find a place to go.
And by yield, you just mean like, I want to make more money than zero percent, which is what you could get from a bank, which is zero.
And so what happened is a lot of this money ended up in alternate strategies, which include things like real estate.
We work or buying wacky stuff.
Again, it has nothing to do with us, but
One of the sinkholes, so to speak, that the money could go into is the asset class known as venture capital.
It will consume any amount of money it has presented.
And so what happened is all of this money floating around in the world ended up going to VC funds or family offices who suddenly
dramatically ramped up their rate of investing because they had access to it.
Because the money had to find a place to go.
And so the spice must flow.
Their motivations are that the more money they're managing, the more money they make.
So the more money they're distributing out to investments, the next time they can raise the fund, they can get more management fees, stack those fees.
downstream effect of this money coming from wherever, directly into people at demo day.
Well, you could draw just people at demo, just the whole, you know, it was thinking, as you said, I was thinking about analogy, America subsidized corn.
And then suddenly everyone was motivated to figure out like, what can we do with corn?
Like, can we use corn to make this?
Can we use corn to make that?
Yeah, like, we can find, if you have a problem, we can find a corn base.
Hey, you guys want some corn?
Hey, there's, I see a problem.
Let's put some money on it.
Do you not have product market fit?
What if we throw some money at?
Are your margins negative?
Do you not know what you're working on?
Well, again, what's fascinating is a lot of these folks had not done startup investing before either.
And so a lot of imagine someone that all I've done is run like a hedge fund trading stocks.
Well, they're like, oh, go buy 50 million of Google stock or whatever.
They were treating investing and startups like investing in stocks.
Well, I loved it because there was one firm interacted with who was like, well, you would value public market companies using this rubric.
Companies generating like five or two million plus in revenue, but often billions.
We will just downsize that rubric to companies generating a million dollars in revenue.
Because they're both companies.
Why wouldn't we just analyze them the same?
I don't know if your argument will be self-evident to our viewers.
Explain why that is crazy.
Because, needless to say, like, the failure rate of companies that are at one million revenue today, paying a 500 million revenue ever, is massively high.
Like, there aren't as many publicly traded companies that just like,
Whereas million-dollar revenue companies are dying out minutely.
So, you know, this investor was like, wow.
And I remember we were talking to them and I remembered this being like, so you're just going to give these folks that don't know what they're doing a lot of money.
Well, because they were running their own arbitrage because they had hot money from other people.
They're basically middlemen, but they were a good sinkhole for money.
And again, what's fascinating to kind of complete Michael's story is once the market term and interest rates went back up.
They got out of the business.
They don't keep interest anymore.
They were just out of town, blew out of town.
But hey, during this time, it was amazing.
Like we had founders who would ask for introductions to these people, but these are the founders we got.
This is how the founder would say it.
I heard if I talk to these folks for 30 minutes, they'll just give me a like, and then like in multiples of $10 million.
And I remember because like other VCs were trying to kind of compete and they were just like,
How do we compete with this like 30 minutes, $40 million?
And Michael, I bet there's a lot of people watching this saying to themselves, this sounds great.
Why are these guys laughing about it?
Why wasn't it great, Michael?
Or like, what was the downside of this?
It turns out that if money was the only variable to making your company work, one, startups wouldn't work because all the incumbents have way more money.
Apple has a lot of money.
All the money, effectively, right?
Two, it turns out that when you give money to someone, they stop innovating and they start spending more money.
Why do we have to have better software?
We can just hire more people to fill in the blanks.
Why do we have to do things better?
It turns out when you give people more money, they start acting like the big companies they're trying to disrupt.
But also it turns out the opposite's true.
When they can't afford shit, they figure out how to do without, and that often creates the innovation.
So it's just kind of like, we're gonna give you money, it's poison.
Like would you like, how much poison would you like?
You can drink as much as you want.
We have infinite poison in the back.
Why could I give you more poison?
It's going to kill you, but let's be clear.
Some founders for them, the money wasn't poison, right?
But that was a smaller percentage than you might think.
That's also when we saw the explosion of the unicorns.
Remember when unicorns used to be rare, magical beasts?
That was, I think, why they were called that.
The name was meant to be a rare, infrequently cited thing.
As unicorns are, rare and infrequently cited.
We would see them on a weekly basis, basically.
And I would have to get the exact numbers, but I seem to recall on a weekly basis.
It was a marketing thing, right?
It was like, well, I'll give you a billion dollar valuation and you can be a unicorn.
The second you name something, you like begin to destroy it.
It was interesting because I remember during this time I was sitting in a board meeting.
And the founder was complaining that all the companies were too expensive.
They wanted to buy a company and it was just everything was too expensive.
And he said something that like tricked me a little bit.
Got my thinking he was like the revenue to valuation multiple.
Yeah, that seems to make sense, right?
The amount of revenue you're making versus your valuation.
Like that would be an easy way to tell whether something's cheaper expensive.
Like if your company's making like a billion in revenue and it's worth like, I don't know, five billion in valuation, that's cheaper than if your company is making five million in revenue and it's got a five billion dollar valuation.
I should just look around at some of these startups that are raising unicorns.
I should kind of like check out TechCrunch and see what is this revenue to valuation multiple.
When I saw that a company just raised at a 350X multiple, 3 million revenue, billion dollar valuation, I was like, huh.
I remember when Justin TV and Twitch had three million revenue.
Like I'm like, huh, like did we have what percentage of things figured out?
Did we have like one percent?
And man, and then suddenly it hit me.
I was like, Oh no, like this is not going to, this is not going to last.
And remember like this was the start of the new YC standard deal when we were starting to think about this, right?
Like the, this is not going to last.
Yeah, I mean, for what it's worth, if founders that were in the bachelor in those times or people we did office hours with could probably pack us up here, but we were definitely advising founders that the music would probably stop.
There's something about what was going on, felt like Zerp again, which is the title.
It was like, there's a lot of side effects of this zero interest rate thing going on.
Let's not count on it last day.
And so make some smart moves now.
To prepare for the winter that will be coming.
And I can't tell you how many founders were just like, no, this, this isn't winter.
We're just getting started.
This, we're, Zerp is, we're just, this is great.
I don't know what you're talking about.
And it's weird cause I don't, you know, I didn't live through the nineties, right?
The nineties in my life, the nineties tech boom was just like a story other people told.
And it is so effed up that like we saw, it wasn't an exact replica.
It happened in the private markets, public markets, but damn near.
Just to give a concrete example for folks, because money was so cheap, so to speak, lending companies made a lot of sense because
when you're doing lending, you need a lot of capital to lend out to people and then they pay an interest rate, right?
And so if your cost of capital is very low and you just lend it a lot, it works.
And as it would turn out, money has product market fit.
And so lots of companies were like, oh, we're just going to do lending for X. You name it.
And they're like, wow, we got product market fit.
A lot of people want this thing called money.
They can't get it anywhere else.
Unbelievable that people want this money thing that only we have.
And it's very defensible.
And then what happened is when interest rates went back up, the cost of capital for these businesses went up.
It was hard for them to pass that along to their customers.
And so kind of like overnight, there was a whole class of types of businesses that became very challenging.
Well, and it was sad too, because I think that
It also screwed with the people who were observing this and thinking about doing a startup.
Everything got so inflated that you started seeing founders coming into YC being like, oh, well my seed round should be $10 million.
What are you going to do with 10 million dollars?
Well, you had to just raise the 10 million dollars.
Yeah, they were entirely keeping up with the Joneses.
Like the entire conception of startups is to like read articles about what other companies are doing and being like, I want that, but I want to top it.
And there was a lot of trying to top everyone else going on.
And it was sad too, because I would say I observed two types of VCs during this period of time.
was like, there isn't a problem.
Like this is tech's heyday.
And we're providing very real valuations to these companies.
We just understand the tech is going through a heyday.
I know this is screwed up, but I'm gonna do it anyways, right?
Like, like, like, like, like, you know, it's the game we play.
Like, if you get me in a room in private, I'm gonna be like, eight of the last seals I did, I priced really dumb, but you know,
And then there's a third group.
And this group was small.
And we know some of them who were just like, count me out.
Like I'm going to hold on to my capital.
In the investment game, you invest when things are undervalued.
And there were some of them who did that and who rewarded for it.
People who knew it was a problem, they're still participating.
But Michael, here's a question I imagine someone might be wondering, weren't you guys part of the problem?
On the early stage, one of the things that insulated us to be of a standard deal, right?
So we don't have to deal with this.
But we had a growth fund.
And yeah, like that demo day auction during those times were crazy.
We always suggested to folks that the key to greatness is to build a great business, make some main people want.
We really believe this stuff.
And so we were advising people even at the height of the stuff, hey everyone, don't pay attention to all this noise.
Try to build something enduring because the waves of the larger economy go up and down and it's gonna take a long time to build a startup.
So if you're in the batch,
Trying to time the market is like the silliest thing of all time because you need 10 years.
What does the marketing look like?
And so it was always like, yeah, you know, it is unlikely that anything going on now in the wider world will affect you current batch startups.
And that was a very consistent message.
The bigger lesson though happened when the market corrected and we started to see what people did with that money.
And I will say like some companies, they took that capital and like they can run their business profitably.
They don't have to raise another round until the IPO.
Those founders were very smart.
They spent that money and then when they tried to get more and it's sad because if you build your business around an unsustainable phenomenon and then that phenomenon goes away, what happens to your business?
This is like platform risk on the Fed.
Your business only worked when there was nowhere else to invest in the universe.
The second there's anything better to invest in, immediately all the money will come out.
So I think that in this aftermath, what's interesting is there are still some industries that maybe are
have some zirpy qualities, right?
How do you think about that?
Like, there are hypey industries right now.
I think as a founder, your job is to just balance optimism with realism and be exactly on the right balance level.
And the folks that, even at the height of this stuff, they were always optimistic, like, hey, my company could be great.
And they took advantage of some of the stuff on offer, fair enough.
But they knew that this wasn't going to last.
And they planned, they were such a great balance of optimism and realism.
And I think regardless of what the time period is, that's where you want to be.
And if you're too, you know, if you're too negative, if you're like, this is a bubble, you know, the US government's going to collapse or, you know, okay, good luck with that.
But that's extreme over here on the negative side.
But if you're like too optimistic, that's bad too.
I like that optimistic, but real and like understanding that you have to build your business in many different economic climates or like hell, like why not?
Why not build your business so that it works in bad economic compliance?
So when times are good, it's even better.
So that's Zerp zero interest rate phenomenon.
And here are two highly trained economists.
We can build you a website.
This is like the big short movie where like they have all these like actors explaining to you like how like the 08 crisis happened.
I can write some Python code if anyone... I can make you... I can write Python if anyone out there that wants it.
We can make really good blocks.