The a16z Show - a16z Podcast: Of Policy, Capital, and the Startup Ecosystem

Starting point is 00:00:00 Hi, everyone. Welcome to the A6 and Z podcast. I'm Sonal, and we're continuing slash starting our series today on how the outcomes of the election and beyond affect tech in this episode, in particular capital markets, VC, etc. Joining us to have this conversation, we have our managing partner, Scott Cooper, and we have Bobby Franklin, the president and CEO of the National Venture Capital Association. Welcome, guys. Great. Thanks, Sonal. Thank you for having us. I mean, one very obvious question to just kick things off is how do elections affect markets, like market behavior in general? You know, and obviously, look, whether it's a Democrat or Republican, certainly and what their ideas are obviously matters, but at a higher level, what you tend to see is, particularly when you have new administrations coming in, this kind of excitement about what new policy can do to help stimulate growth in the overall economy. You see this a lot in what's playing out today in the Trump rally, right, that a lot of people on Wall Street talk about, which is if you look at

Starting point is 00:00:52 the major stock market averages over the last two months in general, it's been pretty much. much and up and to the right. And a lot of that is kind of excitement and saying, hey, based on what we heard in the campaign, if they actually do some of these things, they might be, you know, net stimulative to the economy. And then I think what happens is reality sets in. The reality of the Washington process, which is these things take time to get done. And there's reconciliation and all these other things that have to happen. Yeah. The way we think about it in Washington is when you, when you have an election, and particularly when you have results of election, where the White House and Capitol Hill, both House and Senate, are all now controlled by the same party.

Starting point is 00:01:29 There's this optimism that, okay, less gridlock, actually things will get past, things will get done. When you actually get people in place and when you put a bill on the floor of the House or Senate and you start to deal with the White House, now you're starting to realize that, well, that's actually harder than it was talking about it on the election trail. So that's where the reality sets in and it starts to get really difficult. Could there be a relaxation on things like Volker Rule in the capital markets? The Volker Rule was something that had been put in place which effectively kept banks from being able to make investments into VC funds or other funds into startups. So for a large spot of the country, between the coast, frankly, a lot of the so-called red states, States have felt a little left behind from the economy. And you don't see as much activity there as you do in California, New York, and Massachusetts and other places.

Starting point is 00:02:32 God, that's fascinating about the Boko rule because I finished reading the Hamilton biography. And one of the things, it's just was mind-boggling to me reading it is how things that were playing out 200 years ago are absolutely playing out today. And one of the biggest conflicts was between the creation of banks in New York versus in, like, rural areas. areas and how to participate in the capital, you know, means. Anyway, it's just fascinating. Yeah, it turns out, all right, what's the saying? There's no new problems. There's just new solutions over time, right? Exactly. Bobby, you and the organization that you represent, obviously, have been in D.C. for a long time. So you have a lot of inside baseball probably on how this stuff

Starting point is 00:03:06 works. But one of the things that I find interesting when I talk to people out here in Silicon Valley is, you know, it's great to read the headlines. But how does this stuff actually work? How do you think about what happens in the first 100 days? What happens in the first 12 months? The actual mechanics of going from what is possible to actually rolling out, you know, a signed piece of legislation. Full disclosure, the NVCA is a lobbying organization. Absolutely right. The NVCA is created in the 70s and we're the lobbyists for this industry. So when you think about a transition and a new administration coming in and what happens in the first few months

Starting point is 00:03:42 and what happens first 100 days and six months and 12 months, what we know is for a four-year presidential term, The first two years are where the big things happen. And then the next two years is when you're thinking about, you know, running for a second term. So from the White House perspective, having a new administration, it's first all about your cabinet picks. So we're in the midst today of all of the confirmation hearings in the Senate for cabinet picks. And that's what all the talk is.

Starting point is 00:04:18 then once they get in, they'll start picking assistant secretaries and deputy assistant secretaries. So the staffing up, at least at the political level, which is the leadership level of agencies and departments, takes some time. What are the specific agencies and or cabinet picks that actually affect the things that we've been talking about in this podcast, just so we know with who they are and who to kind of watch? Sure. Well, obviously, who is running the Department of Treasury has a lot to say about tax reform. I mean, that's where the IRS sits under. That's where the Assistant Secretary of Tax sits. So when the administration weighs in on what they would like to see in tax reform, that's the department that will come forward.

Starting point is 00:05:10 There are also these independent agencies like the Securities and Exchange Commission. when we're thinking about rules around capital markets and we're thinking about crowdfunding and we're thinking about what that on-ramp and the IPO market looks like. A lot of things happen at the SEC. And the SEC Securities and Exchange Commission like the FCC Federal Communications Commission typically are what are known as independent agencies with five commissioners. And three, no more than three, can be from the same political party. So the way you think about it is whoever is the occupant of the White House will get three picks.

Starting point is 00:05:51 Now, there are staggered terms, et cetera, but they're likely to be three Republicans, commissioners at the SEC, the FCC, the FTC on privacy and other tech-related issues. So that's how we think about staffing up a new administration. But if we kind of, you know, drop down to our ecosystem, the broader venture ecosystem, we think about kind of younger, early-stage companies, how do you, think about kind of what, if anything, might be of interest for people to follow? You have to recognize Washington is really a big company town. I mean, if you think about it, once you become a big company, you're going to have a Washington office. You're going to have a lot of

Starting point is 00:06:29 folks running around. And when you have so many voices talking to policymakers on the tax writing committees about what's important to this Fortune 500 company or that Fortune 500 company, it tends to sort of drown out everything else. And I think that's one of the biggest challenges for the startup community is until you get to be a big company, you don't have the resources to really engage in this. We have to make sure that as policymakers are thinking about tax reform, that we don't forget that tax reform could be used to encourage capital formation. and entrepreneurs to take risks over long periods of time. And let's not forget that, you know, or do something for current companies at the expense of future companies.

Starting point is 00:07:23 Break it down for me because all I know about taxes is I file a tax return. How do taxes actually affect company creation? You know, if you're a startup, right, what's the most critical resource you have? It's basically your cash, right? And, you know, every conversation, of course, we have with our companies is how do you get to the next milestone, understanding the fact that you've got limited amount of cash. So one of the things we could do from a capital formation perspective is, you know, think about things like R&D tax credits, for example.

Starting point is 00:07:47 So, for example, in Canada today, many companies, when they hire engineers, they're able to deduct a lot of the expenses associated with those engineers from their taxes. Sort of like a credit for investing in the long term. That's exactly right, yeah. I'm sure there's kind of other ideas, but, you know, that's at least one. It's a great example of that and, you know, well, limitations. There are a lot of very technical rules in the tax code, as I said, that were really developed and thought about when they're thinking about some big company that's already turned to profit. How can we make it equally important for those startups to benefit? These potential benefits don't necessarily only apply to venture-backed startups. It would

Starting point is 00:08:30 apply to any small and medium-sized business, a mom and pop business, a family-owned business, a family-owned business, a three-person business, and it would apply to any basically non-large for-profit entity. That's right. Bobby mentioned this word NOL and just to break it down. NOL stands for this concept of net operating loss. Years ago, there was an effort in Washington to limit what those losses, how they could be carried forward to an acquiring company or change of control,

Starting point is 00:08:59 which could be in our case a new financing round. But the purpose of that was really to get at a lot of established companies buying what you might want to refer to as a zombie company. And they were simply doing it to lower their taxes. So there were all these net operating losses on the books. And so another company would come in. And it was purely for a tax benefit. And so Congress and others went in and said, okay, we're going to limit how much you could do it. So they put all these tests and rules in there.

Starting point is 00:09:31 And once again, it's thinking about established companies and what happens. And the unintended consequence of that was to make it more difficult for startup companies who are doing all the things that we would want them to do, right? Hiring all this stuff. And so for them to take this, you know, haircut, so to speak, when they are being acquired, just doesn't make sense. It does in the context by which those rules were passed, but it's an unintended consequence on the entrepreneurial ecosystem.

Starting point is 00:10:05 So my understanding is that there's not a one-size-fits-all that, I mean, yes, there might be some good reasons for not having large companies do sort of the shake and bake with their P&L. But for small companies, you might want to think about this case where, by the way, you do want to incent, because it really boils down to incentives at the end of the day. That's exactly what we're saying is, look, let's start from the premise that, as a general matter, It's a good idea for, you know, competitiveness for the U.S. economy for us to be investing in R&D and trying to build new technologies. And that creates jobs. And that's what creates, obviously, broader equality and everything else in the world. And so what are the things that government can do to, number one, hopefully at least not disincent to that activity and then to actually encourage activity, which we all agree is actually net positive. Believe it or not, actually tax policy can incent behavior. Another really interesting area that we should talk about is kind of this concept of capital formation and capital markets, right? And to, give, you know, everybody a broader context. We've got two things going on in the U.S. One is the number of publicly listed companies continues to fall. And, you know, if you look at the numbers

Starting point is 00:11:05 kind of over the last 20 years, the number of companies in the public markets is closer to 3,500 to 4,000 today versus 7,500 to 8,000, about 20 years ago. We probably shouldn't debate how we got here. We have a ton of, we put out a big deck that analyzes a lot of the phenomenon. We have a lot of stuff that already comments a bit on that. Companies are not going public either at the, you know, size and scale that they used to, which as many companies used to, which as many companies used to go public at an earlier stage in their life cycle, and we have a smaller number of companies. And by the way, why does that matter beyond like investors getting their money out? Companies do die. They do fail. And so we have to think about how are we creating more companies.

Starting point is 00:11:41 And part of creating more companies is having an opportunity for those companies to graduate and go do something else, right? Or get bigger. Like the Jobs Act a couple of years ago, what could the next Jobs Act look like? since you brought up the J-word, when companies are public, they generate jobs at a much faster pace than when they stay private. Because as a public company, you've got access to a very, very broad base of money out there to fuel your growth. I was also going to say that the difference between M&A and an IPO is that like a broader swath of the American public gets to participate in that capital. Like you get to invest in a Google, whereas before you would have no access to that potential growth, which is amazing. That's certainly true.

Starting point is 00:12:19 If you look at the numbers, right, you know, I think it's like 95, 96 percent of people in the U.S., the only access they have to capital appreciation is through the public markets. And so if all of this growth, you know, is accruing to, you know, the benefit of, quite frankly, you know, largely wealthy institutions who can afford to invest in venture capital as an asset, then you're right. You kind of leave out a very, very broad cross-section of people to be able to benefit from hopefully what is appreciation in their 401K accounts and other retirement accounts and things that sort. You know, another interesting thing about the Jobs Act was around crowdfunding.

Starting point is 00:12:50 Yeah. How do we get more people to be able to participate in fundraising and access to some of these private market opportunities. So like not just VCs, right? So individuals who may have excess cash that they think, you know, there's a great investment opportunity in this market. And so you can also pool people together into syndicates. I mean, which is what happens on Angel List, for example. That's exactly right. Now, there's the idea behind the new crowdfunding rules that are coming out in the Jobs Act is number one is allowing people who are what we call unaccredited investors, basically, right? Accredited investor really just basically means you're rich. It's a simple way to describe it. I thought it made it pass some kind of special

Starting point is 00:13:22 test or certification. There's no test. But, but, you know, the simple thing is, hey, you're rich enough that if you lose this money, you know, you're going to survive. You're not going to go under. Right. And so the idea, one of the ideas behind the crowdfunding rules is to allow people who, you know, may not yet be at that state of, you know, financial success, but to be able to say, hey, look, I'm, I'm, you know, going to try and, you know, figure this stuff out. And in limits, so there are constraints on how much money you can invest if you're not accredited, which is probably a smart thing to do. That is a really interesting kind of opportunity, actually, because it's a sort of democratizing venture capital and new company formation in a way. Yeah. And I understand that there are concerns as well. It's a new thing. So there's probably a lot that needs to still happen. Yeah. But it's an interesting. It is an interesting. This is a really risky asset class, right? So we want to be careful that we don't have people losing money that they actually really truly need. And then there's some other regulatory things, which are still working their way through it. Yeah. It's a really interesting testament to the formation of law and regulation in general is ever evolving as things, you know, unintended consequences as Bobby talked about, intended consequences, finding things.

Starting point is 00:14:22 out, kind of figuring things out as you go. It's a super fascinating process. Back to the Jobs Act, though, because we hear a lot about it. I'd love for you to actually break down, like, what is the Jobs Act, the high level, why it matters. We hear so much about it. It's a simple way to think about the Jobs Act, and there were lots of people who were involved in that is think about it as kind of, how do we improve the on-ramp to getting onto the freeway that is the IPO? There's a lot of things you have to do, right? You have to do all kinds of filings. And one of the things the JobDact did was kind of modified the regulatory requirements around those filings to kind of right-size it for what is appropriate for an earlier stage company instead of what might be appropriate, for example,

Starting point is 00:14:57 for a GM or a Goldman Sachs or a Ford, right, companies who do this. So the other thing the Jobs Act did, and we see this today, for those of you who follow this, is this concept of confidential filings that companies can do. So in the old days, companies, when they were going to go public, they would file with the SEC, and then while they were waiting for the SEC to kind of greenlight them to go do their process, their filing was out there in the public domain. And so lots of their competitors, would kind of take pot shots at him, but the company were in what was called a quiet period, which is the SEC doesn't allow you. Right. So it's kind of like, you know, fighting with one hand tied behind your back. Right. And what the confidential filing does is allow people to kind of start that process of the SEC reviewing the documents, but doing it a confidential way so that the companies kind of, you know, don't feel like their business gets impacted while they're kind of waiting for that. The other big piece I think the Jobs Act did was allow kind of more conversations with the research and the institutional community before you go public. They call it testing the waters. Why wouldn't have that been there before? The SEC was very worried about this idea, which is, are you trying to kind of hype your IPO before it goes out and kind of, you know, tell people how wonderful you are, but without the full benefit of all the documentation and everything else that would allow them to make an informed decision, right?

Starting point is 00:16:02 But what the SEC, I believe rightly so said is, hey, look, in a limited context, it's okay for you to go talk to the research analysts at Fidelity or at TROPrice or others and get feedback from them on how you're thinking about the business and how they, as public market investors, might think about it. So if you kind of put all that together analogy, that works quite well, which is as you're going on to the freeway to the IPO, how do we get rid of the potholes and make it a much smoother drive on that on ramp? The other thing that the job Zach did was it looked at, well, okay, once you're on that public, you've gone on the on ramp, you're on the highway, how can we make it smoother to be successful on that highway? So not like crash into some other cars while you're driving fast. Exactly. Exactly. And one of the things that it was called for in there, and it's currently being done right now, was let's do a pilot project and see if we went back to tick-sized trading, meaning, you know, we went to decimalization. And so stocks are traded at pennies as opposed to the old way of certain tick size. Is there anything else to improve the on-ramp? I mean, one very concrete example comes to mind for me is, wasn't there a provision of the Jobs Act that you don't have to, comply with Sarbanes-Oxley until a certain point because in the past, tiny startups would

Starting point is 00:17:20 literally not have the kind of regulatory apparatus in place to do all the paperwork. And they're trying to build their freaking business for God's sake. And they don't even have the kind of scope that you're talking about that Sarbanes-Oxley was intended to help regulate. But now they have like a little bit of a little bit of runway to use your on-ramp analogy before they have to actually worry about Sarbox. That's exactly right. Once you're on the freeway, what's it like to be a public company? And you're right. One of the areas that they did was to kind of, again, right size the regulatory requirements, you know, as it relates to Sarbanes-Oxley, for what is appropriate for a company that is obviously a smaller company. Which makes a lot of sense. You just is another recurring theme besides the incentives so far is this idea that there's no one-size-fits-all. That's exactly right. Yeah. It really depends on company size to a great extent, which is really the difference between a startup and a big company at the end of the day.

Starting point is 00:18:06 But then the next phase, okay, great. What else can we do to make that experience of being public, you know, more, again, size appropriate and regulatory programs? What are some of the things that people think about here? Should they have like three quarters before they report instead of one quarter? I mean, what are some of the ideas? I'm just thinking out loud. Yeah. Well, so big picture, number one, and Bobby mentioned this concept of this tick-size pilot. I actually didn't quite get the implications of the tick-size pilot.

Starting point is 00:18:28 Yeah. The big picture idea behind the tick-size pilot was if you could improve what's called the trading liquidity for the stock, right? So kind of make these things, you know, more liquid in the sense that one of the reasons why institutions don't want to buy these stocks is because if the stock's trading at a dollar, and I get it. go in and buy 100 shares, I'm going to probably drive the stock price up to $2 or $3 just because my small...

Starting point is 00:18:50 It's like a Schrodinger's cat type of thing. Right, right. And then when I try to sell on the other end, right, every time I try to sell, I'm going to drive the stock price down because it's not a very liquid market. There's not a lot of transactions. It's a disproportionate effect due to that. Whereas, look, if you own Apple or Google stock, we could trade 100,000, 10,000 shares. You know, it's not going to move the price very much because there's so much volume happening

Starting point is 00:19:09 in those trades. So the big picture of theory behind the tick-size pilot was, are there ways to kind of, you know, kind of constrain the pricing around how these things work and limit the increments at which people trade so that you kind of get a lot more volume at fixed price points, and that helps alleviate some of this kind of illiquidity problem that you have. Interesting. Another thing, we talked about the on-ramp to the public markets. There are a number of people that are trying to think about, is there a better place

Starting point is 00:19:37 by which these small-cap companies could go and be on an exchange that look different than those exchanges where the largest companies are. The idea is that the companies that would be listed on this exchange might have sort of a different set of rules. For example, it might be more long-term in nature as we think about it as opposed to, you know, high-frequency trading or quarter-to-quarter results or things like that. And there might be benefits to which people that were trading on this type of exchange might be saying to those companies, look, we want you to think more long term and not just about what your

Starting point is 00:20:20 earnings are this year or that year. And so people have given thought to what could an exchange look like. Particularly for tech companies, look, these are product companies, right? Because they're product examples, they have things called product cycles. And, you know, revenues go up in those cycles, but then there's times where you have to invest, you know, more R&D to kind of get to that next product cycle. And as a public company, it can be challenging sometimes because by definition, those investments are dilutive to your earnings in the short term with the hope, of course, that, you know, they create long product cycles that are very positive from earnings. And so these kind of exchanges that might better orient and take into account the fact that we're trying to accomplish

Starting point is 00:20:53 a long-term goal and how do we affect trading and other stuff. You know, there's somebody who I'm sure many people have heard from Eric Reese, you know, who's, you know, very famous for the lean startup activity he did. That on our podcast. Eric is working with a lot of folks in D.C. to think about this concept of he calls the long-term stock exchange. But again, similar idea, which is how do we incent both management teams and employees as well as incent shareholders to kind of think longer term around these product cycles as opposed to the daily and, you know, minute by minutes? So that all the benefits of being public and the discipline that comes with it, but optimized for the sort of long-term type of business, an early stage company versus a much later

Starting point is 00:21:31 mature company. I think that's a really important point. I just want to underscore that because, you know, a lot of people hear this stuff and they say, hey, look, this is, you know, this is kind of a way for people to kind of, you know, not have to follow the rules and stuff like that. Your point is exactly right, which is we've said this publicly as a venture capital from a lot of times. Going public public is a really important thing for companies to do. And it's not just because, you know, it creates access to capital, but it's a good discipline around how do you think about really running your company in a way that's responsive to a very broad cross-section of public investors. And so everything that we're talking about here, whether it's long-term stock exchange or some of these other ideas,

Starting point is 00:22:03 this is not to say, hey, let's have a sloppy public market. The idea is, hey, we can do this and we ought to have that discipline of being a public company. But let's make sure that people understand the incentives and align the incentives around more long-term behavior as opposed to short-term behavior. That's great. So maybe just to wrap things up, if you're in this tech ecosystem, if you're a venture capitalist or you're an entrepreneur, what do you actually do with all this information? When you realize the point that the first two years of a new administration is when most big things happen. And so you think back over the last eight years of President Obama's term and now the next four years of President Trump's term. and now the next four years of President Trump's term,

Starting point is 00:22:39 these next two years will be the most active in a decade spanned because the second term usually isn't as active as the first term. And so this next two-year period is when big things will happen. And it's rare that you have that two-year period with the total control of one political party, in this case, the Republicans. So things are going to happen. I think it's extremely important for entrepreneurs, for investors, for everyone to pay attention and make sure you're up to date on what's happening and make sure you're participating in what's

Starting point is 00:23:16 happening. If people want to be a part of those discussions, you know, they should definitely plug in. At the same time, certainly for all people out there who are doing the hard work of building businesses, look, the most important thing still is to go build your business and do what you have to do. Back to work. These things will happen one way or another, and you'll react to them and you'll do the things you have to do to run your business, but there's no substitute for actually building a successful business, regardless of what the political landscape looks like. Well, it sounds like

Starting point is 00:23:38 2017 to 2019 is going to shape up to be incredibly interesting, the second season after 2016, the show. Let's see what happens next. Thank you for joining the A6 and Z podcast. Thank you.

The a16z Show - a16z Podcast: Of Policy, Capital, and the Startup Ecosystem

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