When you think about a ponzi scheme, you typically think of Bernie Madoff. The thought of Silicon Valley being a giant ponzi scheme never really crosses your mind. And that’s perhaps exactly why Silicon Valley has grown to be perhaps one of the biggest ponzi schemes in human history.
It all starts with an idea, a new app, a new platform. A disruptive idea that will for sure turn this industry upside down. So the founder manages to get the startup going but they run into a problem. Their revolutionary idea needs a lot more up-front capital to get to the next stage. Luckily, that’s where the Venture Capital firms, or VC’s for short come in.
You come in and say “we wanna partner with you, you’re awesome, we backed this company”. You are what amounts to a fund manager who knows a lot of rich people. In exchange for a fee, Investors hand the VC firm money to be locked up in a fund for 10 years or more. So, if you raise a $100m fund, you’re guaranteed to make a minimum of $17m.
Grow super fast. The founders take the millions you gave them and shove it into things like Facebook ads, Instagram ads, YouTube ads, Amazon services. Basically, you want them to do whatever it takes to “grow” on paper. VC firms tell startups to not run at a profit.
Running out of money! So a year or so passes by and the founders have spent all your money. The startup you picked grew their user base by 400%! So you go back to the board meeting and say “hey guys, good job, but if we wanna keep this train going we’re gonna need to raise more money” Then they tell their buddies “look at the growth, you should invest in B”.
The Series B round, the second funding round a startup goes through is logically called the Series B. Series B money goes into FB, Goog, Amzn, buying more unprofitable growth, doesn’t matter if it’s sustainable, you’ve been told to grow.
Run out of money + Series C. So your friend, VC Bob, shows off their “returns” to his friends at another VC firm, and they raise a few more millions for the Series C funding round completing Step 7. And throughout all these funding rounds, since all the VC firms are buddy-buddy, they can value these companies at whatever valuation they want!
Look like a genius. That means on paper to your investment had a 4x ROI!
So for step 9, you start a second fund to invest in more startups, to have more money under management, collecting those management fees, starting the process all over.
The only reason this whole thing worked is because of the same reason why any ponzi scheme works: the money kept coming in.
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