A Freaky Circle
March 9, 2021·3 comments·Money
Big institutions vote on transactions that benefit those same institutions. Portfolio companies sue their own financial sponsors. Retail investors discover they're paying fees to both sides of a deal. The structures designed to protect everyone from conflicts have instead become the mechanism through which those conflicts operate invisibly.
• Equity ownership stakes create voting power that looks independent but isn't. When large pension funds receive management company equity as part of their seed deals, they gain incentives to vote yes on the exact transactions that benefit those management companies, collapsing the separation between investor and vendor.
• The complexity itself is the point. Nested SPACs, portfolio company stakes held by advisors, PIPE investments from the same institutions voting on the advisory contracts. None of this is illegal individually, but stacked together it creates a structure so obtuse that opposition becomes structurally impossible.
• Smaller investors face a choice that isn't really a choice. Vote against deals managed by the only firms capable of delivering returns, and lose access to better terms on future deals. Vote yes and accept that your interests may not be what's being optimized.
• The "broad support" being engineered isn't conspiracy, it's incentive alignment working exactly as designed. Big institutions with equity stakes aren't being pressured. They simply have rational reasons to support outcomes that benefit them, which happens to align with supporting the deal.
• The promises about alignment and democratization become the cover for the oldest financial game. Sponsors extract their cut, large asset pools extract theirs, GPs who lent clients' money to themselves extract theirs. Retail investors and smaller LPs get what's left. Same outcome as always, just with better obscuring machinery.
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Comments
@Rusty This piece is right on the money for me. I’ve had a lot of experience in this space and I think you nailed it. Same as it ever was. And also, completely agree that there is nothing illegal going on here if you want to have clear eyes.
We could have a whole separate conversation about the suckers at the game (the garden variety LPs who don’t get the special gimmes) - however it seems to me that we are already having that conversation elsewhere in the comments sections and forums. That is the raison d’etre for the pack (very loosely defined).
A-propos robustness of the system and tying this idea into other ET ideas…the institutional response to Gamestop is now shaping up along the lines of “Yay, Regulations”. Apparently we are going to tighten restrictions on broker-dealers, blah, blah. Shocking. I know. Same as it ever was.
https://www.bloomberg.com/news/articles/2021-03-09/gamestop-prompts-u-s-to-consider-new-rules-for-options-shorts?srnd=premium&sref=9XsJozxv
This resonated. I am involved with a non-profit with a very modest endowment. The alternatives piece of the asset allocation did not have any real Private Equity/Private Credit/ Venture Capital when I joined. All of our outside advisors point to the success of Yale in the space and consider adding exposure like its a “no-brainer”. Look at those Sharpe ratios! (and the fees the brokers will earn). But, we will pay multiples of the fees, have no access to the insider streams of revenue, and get to buy in now, AFTER the trailing 10 year record of IPO’ing Unicorns. Has everyone so quickly forgotten how disgusted these plans were with the 10 year returns and illiquidity from the 1999-2009 experience? Few confidently projected the unique confluence of factors that drove this cycle’s returns. The safe asset class of Fixed Income destroyed as an unlevered return stream by Central Banks. The flood of capital desperate for a return stream earning above the actuarial rate for underfunded plans. The ability to offload private businesses at unheard of revenue multiples in spite of modest or no profitability.
The pack is trying to identify winners in an inflationary environment. These sectors miss all of the boxes. Reliance on overpriced capital to fund losses. At risk of rising labor costs from higher wages or work avoidance due to UBI. Needing ever higher multiples of revenue to drive future returns when inflation depresses valuation. Long lockups and large bid/ask spreads if the future script flips inflationary and the boards lose patience.
You should check out the Coinbase S-1. As Evan Lorenz points out in the most recent issue of Grant’s, democratize/democratized/democratizing is mentioned 11 times. Yet, there are super voting shares and longer terms for certain board members. Clearly, it takes an aristocrat to democratize correctly.
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