Assume a spherical cow

May 3, 2019 (1659 words) :: If you ignored all the important details, you could end concluding that the economy is going great and everything is fine.
Tags: gig-economy, jason-calacanis, startups

This post is day 123 of a personal challenge to write every day in 2019. See the other fragments, or sign up for my weekly newsletter.

There’s an old joke about physics (at the expense of physics, rather) that goes something like this: a farmer is having issues with his dairy farm, so he asks for help from a local physicist. The physicist considers the problem for a bit, then writes back: “Assume a spherical cow …”

The point is to lightly poke fun at physics’ tendency to build theories that require oversimplified assumptions, rarely actually met in real life: if your gas behaves like an ideal gas, then the PV = nRT formula will hold. If your pendulum is composed of a massless mass attached to a frictionless string, then it’ll go on swinging back and forth forever. Assume that this ray of light is traveling through a vacuum. Etc, etc.

And of course, physics has been able to make tremendous advances despite having often ridiculously idealised assumptions. The trick lies in identifying when the ideal case does not apply, and when you thus need to come up with a whole new theory to explain a phenomenon. The joke isn’t really about the failures of physics, but more about a common tendency within the discipline that could be disastrously unhelpful if applied unchecked.

Consider the (much-maligned, in these fragments) mechanism of venture capital funding for startups: VC firms invest money in startups, and if the startup sees a successful exit (acquisition or IPO), then the firm gets a return on their investment. But where do VC firms get the money they invest in the first place? Usually from outside limited partners (LPs), like pension funds, university endowments, insurance companies, sovereign wealth funds (Saudi Arabia’s has been especially active in Silicon Valley lately), or the excess cash hoard of a highly profitable corporation (e.g., Google Ventures).

Okay, so the latter three might be sketchy sometimes, but the first two, those are good, right? Surely we’d want pension funds and university endowments to get a return? So isn’t it a good thing when a company like Uber or Lyft has a multi-billion dollar public offering?

I thought about this because I came across Farhad Manjoo’s critique of Uber in the New York Times this week, and one of the replies to Manjoo’s tweet suggested that Manjoo is being disingenuous in his critique of the massive wealth generated:

Now, the standard critical view of venture capital (as I often espouse in my writing) is that venture capital both creates and maintains extreme wealth inequality, partly because it makes a few individuals (founders, early employees) incredibly wealthy while also preserving the wealth of the already wealthy (by giving them returns). Of course, among venture capital’s defenders, the real story is much less sinister: venture capital is providing an important service to society at large. They will wave around feel-good messages about helping pension funds and university endowments, presumably in the hopes that critics will assume that those are the main beneficiaries, and therefore give up, because how do you criticise pensions or universities?

But that approach feels a little like the apocryphal physicist’s tendency to assume a spherical cow. If 100% of the returns were going to pension funds and university endowments, and moreover, these pension funds were for teachers or nurses or some other job role that’s socially important but underpaid, and the universities were spending their money on paying workers a living wage and funding creative endeavours, then sure, maybe we could uncritically support venture capital as a system. But Michael Dearing here isn’t even claiming that it’s 100% of the profits - rather, that 70-80% is going to limited partners, which are largely non-profits and universities. This might still be reasonable, but it’s also pretty vague, because what about the remaining 20-30%? Is it going to arms dealers and human traffickers? What about the limited partners that are not non-profits and universities? And what are these non-profits and universities going to spend this money, on anyway?

So let’s fill in the curves of this spherical cow, by following the trails of where the money’s going, to see if this “wealth engine” is really working the way we’d hope.

Here are Uber’s biggest shareholders in terms of its pre-IPO cap table, as stated in its IPO prospectus:

That only accounts for about half the total. The rest is made up of other investors (not disclosed explicitly since they’re below the 5% threshold), including angel investors like friend of this blog Jason Calacanis, and the CEO of a certain logistics company who is already the richest man on Earth. Executives and non-employee board members (including Ariana Huffington) will walk away with millions - the top 5 executives made $143m in total compensation (mostly stock) in just 2018. Non-executive employees will get some stock as well, but the size of the grants are usually tiered by seniority and closely tied to non-stock compensation, which means comparatively little of it will go to later-stage employees and those who aren’t making that much to begin with (those in non-engineering roles, especially). Some drivers will get some stock as well, depending on how many trips they’ve made for the company, with a 3% pool (initially valued at around $300m set aside for about 1m drivers. (To be clear, this comes out to about $300 per driver. Travis Kalanick, who doesn’t even work for Uber anymore (he’s founded a new startup called City Storage Systems which sounds like it’s trying to be ‘Uber for food’, as terrifying as that sounds) … is going to make several billion (he’s already a billionaire).

The story of Uber is a story of a company that has callousness and greed built into its DNA, and which has been enabled by a broader socioeconomic system that rewards all of those things. Uber’s VC-fueled growth took advantage of both underfunded public transit in many cities (increasing the demand for Uber) and a combination of threadbare safety nets and a shortage of decent jobs (increasing the supply of drivers). It’s still not profitable, but it’s going to IPO for billions of dollars nonetheless, making a few people at the top unfathomly rich, and creating sizable returns for various investors. Meanwhile, drivers are already struggling to stay afloat as is, but if Uber had it their way, drivers’ wages would only go down further as a cost-cutting measure in pursuit of profitability, or be rendered non-existent through self-driving cars.

What kind of person looks at this situation and thinks ‘Ah, but a small proportion of the returns goes to non-profits and universities, therefore it’s good’? It would be making a huge reach to seek out the tiny bits of good in all this - the wealth gains that aren’t going to go towards making a few rich people richer - and pretend that they offset the bad, like making grade-A asshole Travis Kalanick even wealthier than he already is. It’s not like non-profits or university endowments are an uncritical good, either, but that’s probably beyond the scope of this post.

To sum up: saying that the Uber IPO is good because some of the money goes towards so-called good causes is about as helpful as assuming a spherical cow. If you ignored all the details, then sure, IPOs are a reasonable way to fund good causes. But how much of the money is actually going to good causes, and how much of it is going towards allowing rich people to buy yachts and put their names on hospitals and start vanity foundations in the hopes of achieving a weird sort of immortality? Is funding good causes the ultimate goal, or is it just an attempt at whitewashing, designed to distract people from the wastefulness of the system in its entirety? Is the current system really the best way to ensure that workers get pensions and research gets funded?

I don’t think it is, no. The people who are doing well under the current system may not be inclined to agree, but why does it matter what they think? Those on top of any hierarchy will always come up with ex post justifications for why their continued dominance (and the accompanying power & wealth) is necessary for the system to function smoothly.

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