Felix Salmon

Chart of the day, equity and GDP edition

Felix Salmon
Mar 22, 2012 14:25 UTC

The Epicurean Dealmaker has been watching global equity markets metastasize:

Over the past few decades, the public equity markets have evolved from a relatively staid and selective backwater, a playground for pension funds, insurance companies, and the idiot sons of wealthy men, into a gigantic global pool of capital, driven and supported by huge amounts of money from literally everybody… I will leave it to an enterprising PhD student to research the data, but I suspect the aggregate amount of equity market capitalization as a percentage of GDP has swelled tremendously over the past three decades. Equities have gone mainstream, and as they did, the size of equity markets ballooned.

To illustrate his point, TED talks of a fund manager who invests in no more than 100 stocks at a time. When he was managing $100 million in the 1980s, he could easily invest $1 million in a company; by the time his portfolio had grown to $10 billion in the 1990s, his average investment was north of $100 million per stock. That, in turn, makes it very hard for institutional investors to buy small-cap stocks, and helps to explain why small companies can’t IPO any more.

But that’s just anecdote; I wanted data. So I found an enterprising PhD student Ben Walsh, and asked him what’s happened to equity market capitalization as a percentage of GDP. And he, in turn, found Google:

There’s definitely an up-and-to-the-right trend here, but it’s very noisy, and we’re not talking orders of magnitude: global equity capitalization is probably about 50% higher now, relative to the size of the global economy, than it was in the 1980s. That’s an interesting trend, and a welcome one. But I don’t think it explains much about the IPO market. After all, the effective minimum size for IPOs has gone up much more than 50% since the 1980s.

I do think that maybe the distribution arms of the big sell-side equity underwriters have reached the point at which it just isn’t worth it any more for them to deal with any but the biggest accounts; I have a feeling that retail investors had much more access to IPOs in the 1980s and even during the dot-com bubble of the 1990s than they do now. But this is much more a function of the consolidation of the investment-banking industry than it is a function of the size of the equity markets as a whole.

Which opens up an intriguing possibility: is there some way in which the internet might be able to spawn a small, light broker-dealer which could underwrite IPOs aimed at retail, rather than institutional, investors? Think of it as fully SEC-compliant crowdfunding, without any need for a JOBS act. And if not, why not?


@EpicureanDeal, “the true ratio of equity dollars available for investment to gross economic activity”:

If that’s what you’re interested in, then the above chart seems largely irrelevant. MarketCap (a stock variable, see my comment re dimensions) reflects the value of past investments. It may vary without any change to investment or ‘equity dollar availability’.

In relation to investment, equity funding should be conceived as a flow variable, like investment. In macroeconomic terms:

Y = C + I or S = I and you’re looking for the equity part of S – or, more exactly, for the IPO part of the equity part.

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The ideal nominee for World Bank president

Felix Salmon
Mar 22, 2012 07:16 UTC

Now things are getting interesting. Lesley Wroughton has the wonderful news: two very highly qualified non-American candidates — Ngozi Okonjo-Iweala and  Jose Antonio Ocampo — are going to be nominated to be president of the World Bank. This really puts the pressure on the White House to knock it out of the park with their nomination, because Ngozi, in particular, is broadly regarded both within and outside the Bank as being pretty much perfect for the job. She’s a whip-smart economist, she’s honest, she’s imaginative, she’s dedicated, she’s expert at navigating the Bank’s labyrinthine bureaucracy and politics, and she’s passionate about the way that the Bank can really make the world a better place.

In 2008, I “interviewed” Ngozi for Portfolio magazine. Which means that I went down to Washington and got escorted in to her office. She then arrived, I asked her one short question, she gave me a fluent and wonderful 2,000-word answer while barely pausing for breath, and then she left for a meeting with Bob Zoellick.

It’s been five years since I first said that Ngozi would make an excellent World Bank president, and this nomination is long overdue. What’s more, she will have a lot of support within the World Bank’s board — the body which ultimately will make the decision as to whom to choose.

Of course, the board members do what they’re told to do by the bank’s shareholders — the world’s countries. And if the Europeans and the Americans all vote for the US candidate, then the US candidate will win. That’s the simple truth. But here’s the thing: everybody on the board pays at least a modicum of lip service to the idea that the job will go to the best candidate. When Christine Lagarde took over at the IMF, she got the job because she was European, and the European candidate always gets the job. But at the same time, everybody voting for her could say with a straight face that she was, in fact, the best candidate as well.

Now that Ngozi’s in the running, the US is going to find it incredibly difficult to nominate a relatively low-profile person like Susan Rice, because it’s almost impossible to make a credible case that Rice is a superior candidate to Ngozi on the merits. And other big names seem to be falling away:

U.S. Senator John Kerry and PepsiCo’s Indian-born CEO Indra Nooyi also made an Obama administration shortlist, according to a source, although Kerry has publicly ruled out the job and Nooyi is no longer in contention, according to another source.

This is really bad news, because by a process of elimination it more or less forces Obama to go with Larry Summers. Larry would be a dreadful nominee, and a worse president, in a job whose primary prerequisite is diplomacy. And before he’s even nominated, there’s already a website up, ForgetLarry.org, devoted to campaigning against him for the job. It covers pretty much all the bases, although it weirdly misses the Russia/Shleifer scandal: for that, check out Cathy O’Neil’s post from a couple of weeks ago.

I’ve talked to a fair number of people about this position, including a few who are quite sympathetic to Larry, and not one of them thinks that he would be good in the post. If the US forced the world to choose between Larry and Ngozi, it would have to expend an astonishing amount of diplomatic capital to twist the requisite number of arms to get him the job, just because no one would actually want to vote for him. Their hearts would be with Ngozi.

Remember that Larry has never held elective office: it’s pretty much inconceivable he ever could. And yet, in its own way, the president of the World Bank is indeed an elected office. The electorate is tiny and extremely elite, to be sure. But the board is still going to want to meet with him, and he’s going to give them his insincere I’m-just-humoring-you-because-I’m-smarter-than-you smile, and even the Europeans are going to start wondering whether they really have to give Larry the job, just because they want to retain their own grip on the IMF.

It’s entirely conceivable, in fact, that an anti-Larry faction might vote instead for Jeff Sachs, who has already been formally nominated by some very small countries, on the grounds that convention holds that the president of the World Bank has to be an American, rather than that it has to be the US nominee. Up until now, the US nominee has always been the only American nominee: this is the first time that isn’t the case. Which means that we might yet see Larry and Jeff split the status-quo votes, allowing unstoppable momentum to gather behind Ngozi.

So here’s one clever idea: Joe Stiglitz and Stan Fischer should throw their hats in the ring as well; I think that both of them would be able to find a country willing to nominate them. There would then be no fewer than four American nominees for the Bank’s board to choose from. Stiglitz is on the record saying that the most qualified candidate is likely to come from a developing country; his candidacy would be a way of providing the greatest possible range of candidates for anybody who feels like they have to vote for an American candidate but who doesn’t want to vote for Larry.

More realistically, Obama is going to have to come up with a real knock-out of a nominee, someone who would waltz into the job no matter who she was up against. Which is to say, Obama is going to have to nominate Hillary. Hillary has, we’re credibly told, ruled herself out for the job. Well, she might have to change her mind.

If Hillary is nominated, the job is hers: it’s as simple as that. And she would be very good at it, too. She wouldn’t even need to serve out a full term. While she had the job, she might even be able to engineer a way in which she could be succeeded by Ngozi, or some other highly-qualified candidate without a US passport. Which alone would make her one of the most important and revolutionary presidents in the Bank’s history.

Hillary is 64 years old — easily young enough to have one more big job before she retires. Does she want the job? Probably not. But she’d be great at it anyway. And she might have to accept the nomination, if only to ensure what she will be certainly working behind the scenes to achieve in any case — US continuity at the Bank at least through the 2012 elections. After that, I’m sure she can find a way to ease herself out if she really wants.


FifthDecade, that clarifies, thanks. I would suggest that while education is indeed paramount, “the way forward” in eliminating corruption, as you suggest, is not just education, but a firm grounding in ethics. That is arguably even harder to achieve, but may be driven locally and rely less on foreign tutoring, which should restrict itself to technical assistance if certain conditions (in terms of accountability and cooperation) are met.

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Why Twitter will get more annoying

Felix Salmon
Mar 22, 2012 05:21 UTC

Happy sixth birthday, Twitter! You’re the service which started off as a way for groups of friends to keep in touch with each other via text messages, and you’ve grown into a revolutionary platform for connecting and sharing with millions of people around the world.

And you’ve become more annoying, too.

For most of its history, Twitter was disliked overwhelmingly by people who weren’t on it, rather than people who were. It wasn’t enough not to join; if you weren’t on it, you had to kvetch incessantly about how you weren’t interested in what other people were eating for breakfast.

I’ve noticed a change, though, in the past year. The people who used to complain the most about Twitter have either capitulated and joined, or else they’ve quietened down — at least they know, now, how infrequently anybody tweets about what they are eating for breakfast. And now the primary source of complaints about Twitter is coming from people on Twitter, rather than off it.

During SXSW, for instance, there was a steady drumbeat of people on my timeline complaining about all the tweets from SXSW. (I was there, and even I got annoyed by the endless banal SXSW tweets; I’m sympathetic to their plight.)

We’re going to have to live with many more annoying tweets going forwards, if things like Amex’s “tweet your way to savings” campaign take off. The VentureBeat headline is “American Express transforms Twitter hashtags into savings for cardholders,” but another way to put it is that American Express is trying to make money by getting people to spam their friends with hashtags like #AmexWholeFoods which have no value to the reader whatsoever.

And then there are people like Porter Versfelt III, who will get annoyed if I dare to express a personal opinion on Twitter. For Mr Versfelt, I have a “core purpose” on Twitter, which is to provide him with financial news, and anything I do outside that purpose is annoying.

Going forwards, all of us are going to find Twitter increasingly annoying. The company has been in hyper-growth mode up until now, getting to its current astonishing scale. But it’s now getting serious about making money, which means selling us, the users, to people willing to pay lots of money to work their way into our timelines one way or another.

On top of that, Twitter is increasingly going to be a medium for following people you don’t know, rather than people you do. When that happens, it’s much easier to get annoyed at what they’re tweeting, especially when those tweets are somewhat personal in nature (check-ins, photographs, that kind of thing). We neither can nor should try to stop people from tweeting whatever they want — the way that Twitter works, if you don’t want to read someone’s tweets, that’s easy, just stop following them. But at the same time, nearly everybody’s follower count is rising steadily, and as one’s follower count goes up, the more that Twitter becomes a broadcast medium rather than a medium of conversation. And when you become a broadcaster, you have to be more careful about what you say, or risk annoying a large number of people.

Twitter’s still in its honeymoon period, but that won’t last forever. At some point, it’s going to be less of a wunderkammer, and more of a regrettable necessity. Which is probably the point at which it’s going to finally start making some real money.


I think the Amex campaign should have everyone worried. Twitter needs to make money and they’re trying to get creative, but I still feel even promoted tweets with actual “good” content vs. just “tweet to get this deal” can have both commercial and editorial value.

Also think how an influencer like Felix Salmon experiences Twitter is very different than people like the rest of us does. I still get excited about retweets and mentions, I still appreciate getting new followers, and I still get a tremendous amount of valuable information from people I don’t know but that I respect, every day.

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How the IPO market is broken

Felix Salmon
Mar 21, 2012 21:54 UTC

Pascal-Emmanuel Gobry has a very smart response to my Wired story about IPOs.

Gobry has one main point. VCs aren’t bad for pushing their portfolio companies to grow at all costs he says; indeed, they have to be that way.

Breakthrough technology startups are different from other kinds of businesses in that they either create a new market or violently disrupt an existing one. This means that they almost invariably require to spend lots of capital in order to stake out a defensible market position against their numerous competitors. In particular, many technology markets have winner-take-most or winner-take-all dynamics, either because of network effects or economies of scale…

Felix writes that Groupon had a profitable Q1 2010 and “it’s easy to see how it could have grown steadily from that point onward.” Except that given the characteristics of the daily deal business, particularly the need for scale, what would have happened if Groupon had tried to “grow steadily” and profitably, is that the company wouldn’t be around anymore.

It’s LivingSocial that would have raised over a billion dollars and be worth $10 billion today, Groupon would have been sold for scrap like BuyWithMe and plenty of other daily deals also-rans, and Andrew Mason would be back to doing yoga on YouTube. Groupon would be a footnote.

This is a good point. If you think about big technology companies, they’re very frequently in markets with just one or two players: if you’re not the biggest, you won’t succeed at all. And so it makes sense, in such markets, to aggressively push to get as big as possible as early as possible. One way of looking at Apple vs Microsoft in the 1980s is that Apple concentrated on quality and failed, while Microsoft concentrated on quantity and succeeded.

But the fact is that the overwhelming majority of VC-backed companies don’t become Groupon or Facebook or Microsoft. Indeed, most of them don’t even IPO. As I note in the piece, 52 VC-backed companies went public last year; 429 were acquired.

It’s certainly true that Silicon Valley is full of ambitious men (and a handful of women) wanting to build enormous companies which will change the world. But from a public-policy perspective, that’s not actually the best way to run an entrepreneurial economy. For one thing, it artificially maximizes failure — many more companies fail than need to. And even the companies that survive do so in a brutal fashion: according to Harvard Business School’s Noam Wasserman, the majority of companies getting to their Series C funding round have already fired their founder from the CEO position, and 18% are on their third CEO or more. Here’s the chart from his book:


This is why smart entrepreneurs avoid VC funding where possible, and if they can’t avoid it, try to maximize the amount of control that they have. They tend to want to build and run their companies for the long term; their backers just want to get the fastest and greatest possible financial return. Those two interests are rarely aligned.

It’s incredibly easy to overestimate the importance of huge companies in the US economy. Here’s a chart showing the S&P 500 as a percentage of total US GDP: I’m not entirely clear exactly what the numerator is, but I’m comfortable saying that the 500 biggest companies in America collectively account for less than 20% of GDP, and quite possibly less than 10%. Meanwhile, the contribution of small businesses to GDP, while shrinking, is still well over 40%


Another way to look at this question is to compare US fight-to-be-number-one capitalism with the kind of capitalism practiced in undeniably successful countries like Germany, Korea, Brazil, and Japan. Those countries don’t have nearly as many world-beating behemoths as the US does, but overall their economies and current accounts are doing very well on a bedrock of medium-sized firms and family-owned corporations.

So in a way, Gobry is making my point for me. The IPO market and the VCs who feed off it are playing a game which might make a small number of people extremely rich, and which will create a very small number of hugely successful world-beating companies. They’re not playing a game which is good for founders; they’re not playing a game which is good for healthy, long-lived companies; and they’re not playing a game which is good for the economy as a whole. That’s kind of the point I’m making in the piece when I say that “Silicon Valley is full of venture capitalists who have become dynastically wealthy off the backs of companies that no longer exist”.

I agree, then, with Gobry when he says this:

Felix also notes that according to a study, most of the fastest-growing (in revenue) companies in the US aren’t venture-backed. Here’s the thing, though: you haven’t heard of most of those companies. Not to diss any of them, which we’re sure are great businesses founded by great entrepreneurs, but when you take the world-changing companies, the ones that come up with radically new products and create new markets or disrupt existing ones, almost all are venture-backed. Those are the breakthrough technology companies. There’s nothing wrong with other kinds of companies. But breakthrough technology companies operate in a specific way which means they will have a huge appetite for capital, which means they’ll need VC and IPOs.

I just disagree with Gobry if he thinks that placing long-odds bets on breakthrough technology companies is a sensible way of running an economy. And certainly the IPO market, and the stock market more generally, should exist to do much more than just serve that tiny sliver of corporate America.

Gobry has some secondary points, too. I simply disagree with him on the degree to which private markets will ever display the kind of correlations we’re currently seeing in public markets. That’s one advantage of private markets: they’re off-limits to index funds, which drive correlations ever upwards. And yes, the HFT algo-bots also serve to increase correlations in the stock market as a whole.

And to answer another of his questions, yes, I’m still worried about the way in which the move to private markets will essentially remove from most of us the opportunity to invest in America’s fastest-growing companies. I say in the piece that the US stock market worked very well from about 1933 to about 1998; there’s no reason we can’t somehow return to those halcyon days. But as Gobry and I agree, the stock market is broken right now, at least with respect to its primary function of providing equity capital to growing companies which need it.

Gobry thinks that I want to make it harder for companies to go public; that’s not true at all. One of the main things I complain about in my piece is that it’s so hard to go public, the role of injecting equity capital into early-stage companies has been taken on by the VC industry instead. We would be better off if that role reverted to the public markets, even as many entrepreneurs managed to fund medium-sized companies without putting themselves on an IPO path, thereby remaining closely held and being much less at the mercy of violent market swings. That’s how other successful companies do it, and that’s how many successful medium-sized US companies do it, too. And even huge ones, like Mars and Cargill. It worked in the past; it can work again in the future.


How are any of the latest big tech companies IPO-ing “breakthrough” companies? Exactly what difference is LinkedIn, Zynga and Groupon bringing to the business world? Or Facebook?

VCs are pushing for “companies to grow at all costs” because that is what is going to give them a story to cash out – either by finding a greater fool privately or publicly.

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The problematic JOBS Act

Felix Salmon
Mar 21, 2012 14:42 UTC

I have a piece in the latest issue of Wired magazine on the problem with IPOs in general, and technology IPOs in particular. In it, the JOBS Act comes across rather well:

It’s about to get easier for tech CEOs to ignore the IPO’s siren song. Legislation wending its way through Congress would change SEC rules, meaning no tech company would find itself forced to go public in the way that Facebook has. The bills, which have been supported quite vocally by a number of CEOs at pre-IPO companies in Silicon Valley, as well as VCs who want more control over the timing of their companies’ IPOs, would not count employees toward a company’s 500-investor limit. The legislation would also raise that limit to 1,000 shareholders.

I do think these changes to the 500-shareholder rule make perfect sense. Right now, companies like Facebook (and Google before it) tie themselves up in knots when it comes to giving equity to employees, handing out variations on the stock-unit theme rather than actual equity, just to get around this rule. That benefits no one, really. And ultimately they’re forced to go public anyway, with the timing imposed upon them by SEC regulations rather than being a matter of their own choice.

But this doesn’t mean that I’m a supporter of the JOBS Act more generally, which has been vehemently opposed not only by the usual subjects (Eliot Spitzer, Simon Johnson) but also by the much more centrist editorial board of the New York Times, which almost never saw a bipartisan bill it didn’t like. Even Bloomberg View has come out strongly against the act, in an editorial which, it’s worth remembering, is meant to broadly reflect the views of Mike Bloomberg personally. The SEC opposes it, as do former SEC officials like Arthur Levitt and a long list of consumer organizations.

A lot of the act is very hard to defend. The crowdfunding (a/k/a crowdmuppeting) part, for instance, seems very badly thought out: it’s certain to create a whole new class of startups which raise substantial sums on some Kickstarter-like platform, without having anything like the controls and staffing necessary to do the investor-relations job they’re letting themselves in for. On top of that, of course, there’s enormous scope for outright fraud here, given the lack of real penalties for issuers who lie.

Higher up the food chain, companies going public in an IPO could not only put out incomplete information in glossy sales pitches for themselves; they could also outsource that job to investment-bank analysts hoping their bank will win lucrative mandates down the road. There’s no good reason at all for this: it’s basically a way for unpopular incumbent lawmakers who voted for Dodd-Frank to try to weasel their way back into the big banks’ good graces and thereby open a campaign-finance spigot they desperately need.

I don’t fully understand the political dynamics here. A bill which was essentially drafted by a small group of bankers and financiers has managed to get itself widespread bipartisan support, even as it rolls back decades of investor protections. That wouldn’t have been possible a couple of years ago, and I’m unclear what has changed. But one thing is coming through loud and clear: anybody looking to Congress to be helpful in the fight to have effective regulation of financial institutions, is going to be very disappointed. Much more likely is that Congress will be actively unhelpful, and will do whatever the financial industry wants in terms of hobbling regulators and deregulating as much activity as it possibly can. Dodd-Frank, it seems, was a brief aberration. Now, we’re back to business as usual, and a captured Congress.


Bill Black has come out strongly against this bill too, although he doesn’t clarify details of why.

As an entrepreneur, I am in favor of the innovations. It is just too hard to get in to even have a hearing with VCs these days. VCs are lemmings and always pursuing the latest “hot sector”.

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Annals of dishonest attacks, Stephen Dubner edition

Felix Salmon
Mar 21, 2012 06:53 UTC

Super Freakonomics came out in 2009, and Ezra Klein was not impressed:

The problem with Super Freakonomics is it prefers an interesting story to an accurate one. This is evident from the very first story on the very first page of the book.

Under the heading “putting the freak in economics,” the book lays out its premise: Decisions that appear easy are actually hard. Take, for example, a night of drinking at a friend’s house. At the end of the night, you decide against driving home. This decision, the book says, seems “really, really easy.” As you might have guessed, we’re about to learn that it’s not so easy. At least if you mangle your statistics.

Klein then does a very good job of explaining where and how Super Freakonomics mangles its statistics.

So far so normal: Klein is far from alone in his bashing of the book. Indeed, American Scientist recently ran a column by Andrew Gelman and Kaiser Fung attacking the book’s m.o. And the book’s co-author, Stephen Dubner, has now responded to that column at astonishing and mind-numbing length (7,500 words).

Dubner says at the top of his post that he tends “to not reply to critiques”. But buried further down you’ll find this:

Gelman-Fung write that our argument was “picked apart by bloggers.” Their American Scientist article includes only a cursory bibliography and no footnotes or endnotes, nor do Gelman-Fung cite any specific sources in this case, so it’s unclear who those bloggers were and what they picked apart. From what I can tell, this is the main critique; its author is reputable but he has also written things like this (NSFW!), so he too seems to be in the business of attacking at any cost.

To be clear: Gelman and Fung accused Dubner of some slightly intellectually-dishonest practices. And in his self-defense, Dubner engages in some of the most egregious and blatant intellectual dishonesty I’ve ever seen on a blog.

There are lots of ways that Dubner might have responded to Klein; most of them involve mentioning him by name. Only one of them involves exhuming a drunken and deleted tweet from January 2008. If you look at the URL of the tweet (which is actually a screengrab of the tweet, since, you know, the original was deleted), you can tell that Dubner got there from this post. But Dubner doesn’t link to the post, just to the image of the tweet. Maybe because he knows that if he linked to the post, his readers would find this comment from Ezra Klein:

You’re absolutely correct that this was patently offensive. It was a private text message to friends, an inside joke we have because it’s so over-the-top obscene. It was never, ever meant to be public, and I’m deeply apologetic that it crossed that barrier. It’s not the sort of work I publish as a writer, and not what I seek to contribute to the discourse. The other examples of my writing, those that appear on my site, were meant to be in the sphere, to be argued with, even mocked. But the Twitter was ripped from my private life, and it was never meant to be brought out of the bar-like context in which it was born. Guess those privacy settings are more important than I realized.

In January 2008, Twitter was not the broadcasting platform it is today: it still felt much closer to its roots as a way for groups of friends to communicate with each other via text message. Today, we live in a world where the Freakonomics twitter account has 415,000 followers despite following nobody at all. But when Klein put out the tweet that Dubner’s linking to, the Freakonomics twitter account hadn’t even been created. In no sense at all was Klein “writing” something for public consumption and thereby demonstrating that he is “in the business of attacking at any cost”.

Now it’s possible that Dubner is unaware of Wonkblog, or of Klein’s Bloomberg View column, and therefore is unfamiliar with his actual mode of writing. Possible, but unlikely. What’s impossible is that Dubner believes that Klein’s rapidly-deleted tweet is in any way representative of his work as a whole.

It baffles me why Dubner would engage in a low and dirty and deeply dishonest ad hominem attack on Ezra Klein at all — let alone in the middle of a post in which he’s trying to defend his reputation. The only reason I can possibly think of is that, to coin a phrase, he seems to be in the business of attacking at any cost. Even when the cost paid is that people are sure to take him even less seriously now than they did before.

Update, 3/24: Dubner emails to say that he agrees the link was “unnecessary”, and that he has removed it from the post. In fact, he’s removed not only the link to the screengrab of the tweet, but also the link to Klein’s blog post, with the result that he now pretends to have no idea what the criticisms of his drunk-driving chapter are, even though he linked to them in an earlier version of the post.


The note by Sprizouse about deletion of posts by Freakonomics is important. They do this. They censor. I can say “censor” because they don’t moderate for bad words or abusive attacks but for material that reflects badly in any way on them. That’s just not right.

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Buying equity in people

Felix Salmon
Mar 20, 2012 21:46 UTC

The idea of buying equity in individuals rather than companies has occasionally been the subject of dystopian satire. And when Michael Lewis wrote in 2007 about a nascent attempt to set up a market in sports stars, he was far too early: Protrade closed in 2009, never having come close to achieving its dreams. (There are lots of echoes there of HSX, but that’s a different story.)

More recently, however, the idea’s been trickling back. In October 2009, entrepreneur and part-time professional poker player Rafe Furst invested $300,000 in a person he called “Marge”, in return for 3% of her future lifetime revenues. Rafe’s partner in this investment was another poker pro, Phil Gordon, and in a way it’s unsurprising that the deal came out of the poker world, where rich individuals regularly “stake” players in return for a share of their winnings.

Furst provided a three page Personal Investment Contract for anybody else who was interested in doing the same thing, but a couple of years later, in August 2011, he revealed that “Marge” was in fact his brother-in-law Jon Gunn. Now if you want to help out a family member, and you know they don’t have the money to repay a very large loan, and you have faith that they’ll make a fair amount of money in the future, and you have a very strong relationship with them, then this kind of a contract might be an interesting way to go. But I’m skeptical: such arrangements very rarely go as intended, and usually end in tears.

Still, other people heard Furst’s story and tried to do much the same thing. Saul Garlick and Jon Gosier set up a website asking for the Marge deal: $300,000 for 3% of lifetime earnings. Their friend Kjerstin Erickson doubled up, asking $600,000 for a 6% stake in himself. (Evidently, the present value of a 20-something entrepreneur is generally understood to be $10 million.)

Now, however, a mysterious website has appeared, called Upstart, offering “capital in return for a small portion of your future income”, and claiming to be “backed by Kleiner Perkins, NEA, and Google Ventures”. The site’s slogan is “The Startup is You”.

In a world where venture capitalists increasingly invest in a startup’s management team rather than in its business model or underlying idea, this makes sense. Find the entrepreneur and invest in the individual directly, thereby guaranteeing that you’ll have a stake in their success if and when they finally hit it rich on their fifth or sixth attempt.

But given the long and sordid history of VC-backed entrepreneurs, I would never advise anybody to take Upstart’s money. The legal advice alone that you would need to protect yourself would probably consume most of what you raised. And there are lots of practical reasons why accepting this kind of funding is a bad idea, too. For one thing, at least if Furst’s document, is any guide, you have to pay out not only on your income, but also on all of your other capital gains, even any inheritance you might get from family members. For another thing, you have to pay out a percentage of your gross pre-tax income, but you have to make that payment out of your post-tax income. And most importantly, it’s far from clear which if any expenses can be discounted. Let’s say you’re a self-employed entrepreneur who runs a business which makes a profit of $100,000 on gross revenues of $1,000,000. Do you have to pay out on the $1,000,000 or just on the $100,000?

Equally, I wouldn’t advise anybody to go down the buying-equity-in-people road, either. It just doesn’t smell right: there’s a whiff of indentured servitude about it, and it makes the concept of the rentier, living off someone else’s hard work, all too real. The investor is also essentially levying a tax on the individual, and I can absolutely see a successful legal defense saying that only the government has the right to levy taxes. More generally, I can’t imagine that the contract would ever be particularly enforceable. There’s nothing in Furst’s contract saying what happens if the individual simply refuses to pay any more money to the investor, but if the investor tried to sue, I wouldn’t fancy their chances in court.

This is an idea, it seems to me, which many people have thought about, and a brave few have tried, but which has never really gotten off the ground, for very good reason. If you want to invest, invest in a corporation. If you want to raise equity capital, then create a limited-liability corporation, and get people to invest in that. Corporations exist for good reason. Circumventing them by investing directly in people is an idea whose time will never come.


We need a simple model to help us properly slice the pie. It needs to be flexible and fair. By fair I mean it needs to give each founder what they deserve. And by flexible I mean it needs to adapt over time to re-allocate the startup equity so that the distribution stays fair until the fledgling company takes flight. check out Mike Moyer’s book slicing pie it talks about 50/50 share and how to divide it through his grunt calculator.

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When journalists take money from Wall Street

Felix Salmon
Mar 20, 2012 15:11 UTC

Many thanks to Paul Starobin for getting to the bottom of the question of journalists being paid by Wall Street to give speeches. This is one of those issues, a bit like the exact meaning of “off the record”, where everybody thinks they know what the standard is, but everybody also thinks it’s different.

It turns out there are lots of different standards. At one end of the spectrum you have the Wall Street Journal which simply bans its journalists from accepting speaking fees at all. Interestingly, it’s also the most influential financial news outlet, according to Gorkana’s recent survey. Second on the Gorkana list is Bloomberg, which also bans its journalists from accepting speaking fees, but loopholes can be found. Bloomberg View editorial board member Clive Crook, for instance, is not a full-time Bloomberg staffer, and thus feels free to accept such fees.

Third on the Gorkana list is the New York Times, which has a slightly messier and more nuanced approach to speaking fees: basically, you’re allowed to take them, but only from non-profit organizations like universities. And even that rule can be bent: when Joe Nocera gave a speech to a securities conference in Miami, New York Times spokesperson Eileen Murphy told Erik Wemple that “there is some flexibility to our guidelines around speaking engagements”.

Fourth on the Gorkana list is Reuters, which isn’t mentioned in Starobin’s story. Our policy is that “payment should not be sought or accepted”, but travel and lodging reimbursements may be accepted.

After that, it becomes more of a free-for-all. At the FT, both Gillian Tett and Martin Wolf can and do accept speaking fees from anyone they want; Tett’s income from such things is “well into the six figures”, she says, and she has chosen to give “most” of it to a UK charity. And the FT seems to be more the rule than the exception, if Starobin is to be believed:

Many journalists give paid speeches to businesses and business groups. And Wall Street, as it happens, is probably the top source of such engagements. Household names like Bank of America as well as obscure hedge funds, private-equity firms, and others in the financial world frequently hire journalists—including scribes who regularly cover Wall Street—to deliver speeches at events ranging from publicized conferences to small private dinners with select clients. Millions of dollars have flowed to journalists in speaking fees in recent years.

We’re moving to a world where brands are more personal than they are corporate — where the likes of Michael Lewis and Malcolm Gladwell and Jim Surowiecki and Bill Cohan and Bethany McLean and Sarah Ellison and Niall Ferguson and so on and so forth are self-employed freelancers for various publications, rather than being full-time employees. As such, they have to make up their own rules about speaking fees, and it’s incredibly easy when you’re in that situation to tell yourself that you would never be unduly influenced by corporate interests and that therefore no harm could be done by taking Wall Street’s dollar.

Given that all these other stars are likely to be happy accepting paid speaking gigs, it’s easy to see how employers like the FT and CNN feel the need to allow their stars to give paid speeches too. (Fareed Zakaria has a rack rate of $75,000, and has given speeches to a long list of financial firms, including Merrill Lynch and T. Rowe Price.)

So what should be done? The vision of Gretchen Morgenson tying herself up in ethical knots before deciding what she can and can’t do is not a particularly edifying one: there’s got to be a better way than this.

On occasion she gives paid speeches to universities, as Times policy permits, and sometimes she appears, for free, at financial-industry events—but not without doing due diligence. “I did recently participate in a one-hour question-and-answer session about the state of the economy and markets with about 50 clients of First Long Island Investors, a small, local registered investment advisory firm,” she said in an e-mail. “It does business only in New York and Florida, has 200 or so accounts, and does not conduct securities underwriting or trading for its own account. As such, it would not be a firm I would cover. I received no honorarium for my participation in this session and before I agreed to participate, I checked that the firm had not been subject to any regulatory or disciplinary actions.”

My feeling is that for full-time employees of media organizations, a single, named ethics chief should make final determinations in all cases where a journalist wants to give a paid speech. It’s silly to ask the journalists themselves to make such determinations unilaterally, since they’re the ones being paid. The rules could be written or unwritten, but at least there would be someone being clear about what is allowed and what isn’t. Alternatively a blanket ban, like the WSJ has, works just as well.

For freelancers, however, things become a lot more difficult. The NYT, for one, tries to hold its freelancers to the same standards as its full-time journalists, but that’s hard, especially when the NYT isn’t paying them nearly as much. At the very least, we need more disclosure. This is very telling:

With the notable exceptions of Gillian Tett, Michael Lewis, and Martin Wolf, most of the journalists I tried to talk to about their speaking appearances resisted comment, or would only talk anonymously—which is a little ironic. One prominent scribe pleaded not to be mentioned at all. (Sorry, no passes.) I still have the bite marks on my neck from a telephone conversation with another who demanded to know whether he was the target of a “hostile inquiry.”

If you’re not proud to be giving a paid speech, and happy to be open about that fact, then it seems to me you shouldn’t be doing it. And that applies whether you’re self-employed or not.


“This is such a non-issue. I wonder if Gretchen Morgensen “ties herself up in ethical knots” when she decides to simply make up a “story”? (D.Black)

Nah – maybe the first couple of times it bothered her a little, but she’s an old hand at it now.

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SecondMarket’s unnecessary Facebook Fund

Felix Salmon
Mar 20, 2012 13:45 UTC

The latest sign that the Facebook IPO is going to be particularly bonkers comes from Jon Ogg, who has discovered a Facebook Fund over at SecondMarket.

This is odd, for a couple of reasons. For one thing, the SEC recently cracked down on two funds offering Facebook shares pre-IPO. (One of them was Felix Investments. No relation.) SecondMarket will obviously have learned from their mistakes, but why rock the boat like this? It’s pretty obvious the SEC isn’t a huge fan of people speculating in the pre-IPO markets.

More generally, SecondMarket has done a pretty good job of positioning itself as a way for people to trade shares in illiquid companies where they have no access to public markets.

This latest development, then, is more than a little off-brand for SecondMarket. Everybody knows that Facebook is going to IPO within a matter of weeks: it’s already started meeting with analysts. So if you want to sell your shares in the public markets, you won’t have to wait long.

But for some reason, there’s still a lot of institutional sell-side interest when it comes to Facebook. There’s a 180-day lock-up period after the IPO during which current shareholders can’t sell their stock, so if they miss the boat now, they won’t be able to sell until November or so. Clearly, that’s too long for some people to wait.

Meanwhile, there’s also buy-side interest in Facebook, from people who are convinced that they’re not rich or important enough to get an allocation of shares in the IPO. They’re not going to be able to flip their shares on day one: they, too, will be subject to the 180-day lock-up. But at least they’ll be buying in now, rather than after Facebook has already gone public.

So you can see where SecondMarket naturally comes in, here. There’s buy-side interest, there’s sell-side interest, and they’re a neutral intermediary broker-dealer which can provide weekly auctions where shares trade hand at a mutually acceptable clearing price.

But why the fund?

It turns out that SecondMarket is not like other auction houses. If I buy a Warhol from Sotheby’s, I write a check to Sotheby’s and they give me the painting. Meanwhile, Sotheby’s writes a slightly smaller check to the seller. I never deal directly with the seller. SecondMarket, however, refuses to face buyers and sellers in this manner. It acts more like a dating agency than an auction house: it works out who wants to transact with whom, and then ducks nimbly out of the way so that they can finish off the deal privately, facing each other.

And big institutional sellers, for one, are unhappy about this. If they’re selling $10 million of Facebook shares, they don’t want to have to sign lots of paperwork facing a long list of retail investors spending $200,000 or $400,000 on stock. SecondMarket tries to match up buyers and sellers in terms of the size of the deal they want, but right now the sellers all seem to be relatively big, and the buyers all seem to be relatively small. Which makes for awkward dates.

The obvious answer to this problem — insofar as it is a problem — would be for SecondMarket to act more like Sotheby’s, and face the sellers itself, while simultaneously selling the sellers’ shares to the buyers. But it didn’t go that route. Neither did it simply turn around to the sellers and say hey, if you want to play on our platform, you have to play by our rules, how much of a pain is it, really, to have to sign a dozen different identical sale documents rather than just one or two. One would think that’s why these companies employ lawyers.

Instead, SecondMarket created a fund. If you want to buy a relatively small amount of Facebook stock — say between $200,000 and $500,000 — then you’re no longer going to participate in the auction directly. Your only choice will be to place your money in SecondMarket’s Facebook Fund, which will buy shares on your behalf at the auction clearing price, and then hold on to those shares until 180 days after the IPO, at which point it will then transfer the shares to you, to do with as you wish. SecondMarket is going to continue its weekly auctions right up until the IPO; any smaller investors participating in those auctions will end up in this fund.

The cost of buying Facebook stock via the SecondMarket fund is double what other buyers pay: everybody pays SecondMarket a 3% fee when they buy stock, but participants in the fund will also pay a second 3% fee when they finally receive their Facebook shares, 180 days after the IPO.

All of the participants are still qualified accredited investors, with at least a million dollars to throw around or a salary north of $200,000 a year. And I’m pretty sure the minimum investment is still high, at $200,000. But this whole thing smacks of speculation to me, not to mention an attempt by SecondMarket to squeeze the last drop of revenue out of Facebook before it goes public.

Facebook has been incredibly lucrative for SecondMarket, despite (or maybe because of) the fact that it’s the exception to every SecondMarket rule, the single company traded on SecondMarket which isn’t itself a SecondMarket client. But this smacks of opportunism to me. I know that there are lots of people out there who are eager to buy shares in Facebook. But they’ll have their opportunity soon enough. The secondary market in Facebook shares right now serves no real public purpose at all. Instead, it’s just putting more money in the pockets of middlemen.


Shares Post has had a Facebook fund for a long time. I assume that this is a competitive response to their fund which accepts smaller dollar investments (I believe as low as $50k).

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