Be kind to your lawyers
And investing in startup secondaries
In this edition
Stuff you might like
Destiny Tech100 (DXYZ) and startup secondaries [Substack-exclusive]
International Be Kind To Lawyers Day [repost from LinkedIn]
Stuff you might like
This latest episode of Lenny’s Podcast on product-market fit is so rich with insights and tips, it’s one of the best yet (and I’ve listened to almost all of them). Todd Jackson from First Round Capital shares about First Round’s new PMF Method program (for very early-stage B2B startups) and also talks through their 4 Levels of PMF (see full open-sourced content) framework and explained how to use the 4 Ps (Persona - Problem - Promise - Product) to hunt for PMF and pivot. I can’t recommend it highly enough.
Here’s an absolutely wild story about a drug cartel head posting Google reviews! It turns out drug kingpins also want to be part of a community, just like you and me. The reviews themselves are strikingly normal, though.
I really enjoy reading Matt Levine’s Money Stuff newsletter, where he explains complex finance ideas in very understandable language with a healthy dollop of hilarious sarcasm. His recent articles (here and here) about Destiny Tech100 (DXYZ) really resonated with me, so I decided to write more about it and startup secondaries more generally.
Destiny Tech100 (DXYZ) and startup secondaries
This NYT article (paywall unlocked) explains what DXYZ is. It’s basically a publicly-listed fund holding positions in growth and late-stage startups, that retail investors can buy.
Matt Levine went much deeper than the NYT article. He pointed out both the potential risks with forward contracts, and more importantly the vast gap between its market cap and net asset value.
As Levine wrote on April 9:
It has a net asset value — its computation of the fair value of its underlying startup stakes — of about $54 million, and a market capitalization — the value that the market places on its shares — of about $875 million.
Somebody is wrong! One way to model this is that there is $875 million of demand from regular public investors to own shares in hot private startups, and so far only about $54 million of supply. But if each of this fund’s holdings goes up 1,000% by the time they go public, people who bought into the fund today will lose money. Weird!
(As I write this on April 12 Singapore time, DXYZ’s last close was at USD50.41, implying a market cap of USD548M, or around 10x NAV.)
I had read DXYZ’s prospectus back in Feb (it’s since been updated), which disclosed that they had spent around USD80M purchasing secondary positions in these startups in 2022, meaning the aggregate fair value of their positions is about 30% lower than the aggregate purchase prices:
Clearly, DXYZ’s price is divorced from fundamentals and valuations. Right now, I don’t see too much difference between trading DXYZ and Dogecoin.
I have some broader thoughts about startup secondary deals, specifically deals to purchase shares in individual private startups (i.e. the deals you frequently see on platforms like AngelList), as opposed to LP stakes in funds.
I did a couple of pre-IPO secondaries in 2021, and let’s just say they’ve not worked out. I don’t do them at all nowadays, primarily because I find it impossible to form a high-conviction opinion on the quality of a given deal based on the limited information that is typically disclosed.
Here are some important considerations if you want to do these secondary deals:
Ability to determine if the price is fair/reasonable. Sellers and promoters (the people trying to convince you to participate in these deals) will trumpet the large discounts off the most recent valuation. Obviously, any round from 2021 or so would have been extremely inflated. But these deals don’t include any financials from the company, so you can’t evaluate if the discounted price is reasonable or how the company has been doing. You might try to guesstimate revenue, but you usually can’t even do that for profitability metrics.
Size of and priority in preference stack. Investors in a startup typically have “liquidation preferences”, meaning a right to be paid first if the company is liquidated or sold. This means that if the company is sold at a low price, investors with more senior preferences than yours could take all the sale proceeds for themselves. These secondary deals never disclose the size of the company’s preference stack, or your position in it. Even worse, many deals are for common (employee) stock, which has the lowest priority. Purchasing shares without this information basically means a bet that the company goes public, and a willingness to accept the risk of getting zero in an M&A exit.
Legal risks in structuring. Sometimes (but not always) there are legal risks with the structure used, as Levine notes. Many deals involve the purchase of an interest in a SPV that owns the shares in question, which does carry some risk that should be manageable.
I’ve decided to avoid these deals due to these considerations. YMMV. But even if you do want to buy startup secondaries, don’t do it through DXYZ! At least until/unless the price gets much, much closer to fair value.
International Be Kind To Lawyers Day
[repost from LinkedIn]
I don’t usually post to commemorate occasions, but International Be Kind To Lawyers Day (this past Tuesday) is too good to pass up! 😛 (Yes I know it’s made-up.) Especially since I’ve been both a lawyer and a client.
This post is mainly for in-house lawyers and their internal clients, but some points might resonate with law firms as well.
For all the clients:
💞 Be kind to your lawyers — they just might handle YOUR employment matters in future (be it an investigation, negotiation or even termination)!
👂 Strive to understand what your lawyers are actually saying, since they tend to choose their words carefully. One of my pet peeves is junior people interpreting “there is some risk” (which to me usually means go ahead) as “legal said no”.
🔍 Your lawyers probably really do have more work than they can handle. Legal is a cost centre, which usually means less resources and smaller teams than you have. Help them prioritize by clearly defining what’s critical (and what’s not) — because if everything is important, then nothing is important.
🎯 Clarify your objectives, and distinguish that from the methods to achieve them. Your initial plan might be problematic, but good lawyers can usually find a lower-risk (albeit more complex or higher-effort) way to achieve the goal.
As a client, I’d also take this opportunity to ask all the lawyers:
🤝 Kindness is a two-way street, so please also be kind to your clients.
🤗 Empathize with your clients, because I assure you their jobs are much harder than you might think. Growth is hard. Sales is hard. Revenue is hard. Do what you can to help, because their jobs will never be easy.
✅ Don’t be a “wall of no”. Saying “no” might feel safer, because then you can never be blamed for a misstep. But try your best to find a way to “yes”, because that’s where you add true value.
🌱 I’ve always carried with me this invaluable lesson from my earliest in-house days (imparted by the inimitable Gez Clayton): “The only way to do business with no risk, is to do no business.” Remember — avoiding all risk means no business, and ultimately no jobs for anyone.
📈 To the startup lawyers, know this: startups either grow or die. You can protect against every risk, but if the startup doesn’t grow, it’s dead anyway.
Here’s a limerick from ChatGPT to close things out! 🎤
A dedicated lawyer named Boon,
Helped his clients sing a new tune.
With a heart wide and deep,
Promises he would keep,
Their gratitude hung like the moon.
Reach out if you need help working with your lawyers (or clients, I can help both ways 😛)!