A New Type Of “Trickle Down” Economics?

How 84 billion dollars made your lunch cheaper.

Last year, more than $84.2 billion was invested by venture capitalists in the US. For reference the New Zealand 2017 budget was $76.3 billion.

So where is this money going? Some of it is going into game changing energy, healthcare and robotics technology focused on innovation. But a lot of it is going to making things cheaper, or free.

VC investment has been growing in recent years

In 2015, financial analysis indicated that Uber was subsidizing riders more than 2 billion dollars annually. This money was being used to grow market share, hire top engineers and attract new drivers. This can’t go on indefinitely, can it?

The are five main ways a VC backed company can stop relying on their current investors:

1. Get Acquired
2. Get more VC money
3. IPO
4. Become Profitable
5. Go Bankrupt

For many companies, option 1 & 2 are the main goal. Early investors prefer these options as well: they have a limited time to make their return on capital based on their round of funding. Options 3 & 4 are also good, but harder to achieve especially in many industries. And option 5 … no one want’s to talk about option 5.

Many of the top VC backed companies are not profitable; Snapchat, Uber & Quora to name a few? So why do VCs invest in them?

Mmmmm free lunch ….

This idea is not new, subsidized food delivering services were written about in Quartz last year and we were discussing this topic at lunch today (Shout out to Braden, Patrick, Tyler and Aman on inspiring this post). The main reason why VCs’ are willing to subsidize unprofitable businesses is for growth. If a company is rapidly growing, it is more likely to become big & profitable someday (see Facebook). Many of these are technology companies that rely on data, networks and critical mass to achieve success, and the best way to do is this if often through unprofitable growth.

So next time you are taking an Uber ride, you can thank a VC for the cheaper fare.

You get subsidized by a VC, so who pays for the VC’s lunch?

That’s harder to track down. On aggregate, venture capital funds get money from pension plans, insurance companies, family offices, university endowments and funds of funds.

So where does trickle down economics come into play?

Let’s look at family offices as our first example. Family offices help wealthy people manage their money and often invest into venture capital funds. The exact amount of money is unknown but here are the top 10 from crunchbase:

This is definitely not an insignificant amount, amounting to billions of dollars.

So if money is moving from wealthy people to middle class people using VC backed services, we have a new era of trickle down economics!

But there are two main assumptions built into that statement;

1. Wealthy people provide most of the VC capital.
2. Less Wealthy people benefit from the subsidies.

In the case of Family offices, some say that $30 million is on the low end of starting a Family Office, so these people are wealthier than most of the consumers being subsidized.

So both our assumptions hold in the case of family offices. Article over!

But what about other sources of funding for VCs?

You’re very right. Family offices make up a portion of VC funding. But what about all the other investors into VC funds?

Let’s take a look at Pension funds and University Endowments.

Pensions & Venture Capital

Pensions are becoming a thing of the past with lower defined benefits pension and overall numbers. Many of the people who have pensions are better off financially and better educated as highlighted by a 2015 Stats Canada report.

“Among employed university graduates, 42% of women and 30% of men were covered by DB plans. This compared with coverage rates of approximately 18% among men and women with a high school diploma or less”

“Higher-paid workers had better RPP or DB coverage than lower-paid workers. For example, 60% of female employees (37% of males) in the top deciles of hourly wages were covered by a DB pension plan, compared with less than 7% of those in the bottom decile”

Many people with pensions are well off, and pension funds indirectly use their employees’ money (or rather opportunity cost) to invest, so there is a chance our New Trickle Down Economics Model works.

Conclusion: VC money from pension funds might represent a New Trickle Down economics model.

University & Venture Capital

Universities often aim to grow their endowments, so venture capital is a natural fit. Below are some numbers on University Endowments’ investments into the venture capital space.

2015 US University Endowments & Private Equity https://www.cambridgeassociates.com

Most endowments come from wealthy donors, so the source of the money is also from the wealthy. So almost directly, the VCs’ money is coming from top of food chain that ends up subsidizing many products.

Conclusion: VC money from University Endowments might represent a New Trickle Down economics model.

What about the consumer side?

It’s difficult to estimate this side of the equation because private companies don’t need to disclose consumer demographics. We can use some available data to extrapolate, in this case Uber.

Based on a report from Global Web Index, the number of monthly Uber users skews slightly to the Top 25%. But what about the total spending on Uber rides?

Looking at a more academic and robust data source, the results are even more skewed to the wealthy.

According to Kooti et al, “the average active Uber rider is an individual in his or her mid-20s with an above-average income”. The paper looked at 59 million data points, so these results are fairly robust.

Anecdotally this makes sense, ride sharing apps, food delivery apps and new tech are typically consumed by younger, less risk averse audiences, many of whom are quite well off. Uber isn’t exactly cheap.

There are also exceptions to the rule. Other super subsidized businesses like Movie Pass are cheaper to direct competition (single purchase cinema tickets) and similiarly priced as the competition (Netflix), but these services require some disposable income and free time.

$9.99 for unlimited movies, who’s paying? The VC of course!

Conclusion: Many consumers of VC subsidized products and services are younger and wealthier.

Is VC Money The New Trickle Down Money?

Maybe. With preliminary research it seems that the investment side is from wealthier people. From a consumption side, also wealthier people.

So … pretty inconculsive. This is an interesting topic and would need a lot more exploration! Some interesting dimensions that crossed my mind:

1. Opportunity cost of investing in VCs rather than other instruments.
2. Opportunity cost of investing in VCs rather than internally.
3. Tax breaks for capital gains & endowments and how they relate to VC investment.
4. Analyzing other sources of VC capital.
5. The externalities generated by VC investment.
6. Aggregate startup consumption spending demographics.

I’d be very interested to hear other’s thoughts on the topic, so if you have any ideas, make sure to comment below!

Thanks for reading!

Again, shout out to Braden, Patrick, Tyler and Aman on inspiring this post!