What Is ZIRP And How Did It Poison Startups?

Alright. This is Dalton plus Michael. And today, we're gonna talk about what is Zerp and why.

did it mess with the startup world? I love the term Zerp. Explain to everyone what Yeah. Zerp. The actual term. Zerp is one of those words that I find myself using a fair amount that I often will be asked to pause and explain Yes. What was that word you just said? Yes.

And so we are saying the word zirp. Z I r p. Yeah. You gotta say it like that. You gotta say it like that. Z I R P. Yes. And that is an acronym, right?

Yes. For zero interest rate phenomenon.

Yes. That's the period we lived through that ended as COVID was fading. Yeah. So if in this time, the interest rate.

set by the Federal Reserve in The United States was was zero. Yes. Some banks.

in Europe, you had to pay them. Yes. They had no interest Yes.

And so look. We're not economists. We're bankers. I think sometimes people think venture capital is the same thing as banking and private equity. I don't even think I'm a venture capitalist. It is definitely not an economist. Well, our industry is pretty like, we don't know anything about this stuff. We are not Wall Street people.

We we worked on building websites basically Yes. Was what we did. Let's explain Zerb to you now. Yeah. So we don't know anything about this. So we're gonna explain to you this is YouTube. Right? That's.

how this works? Yeah. That's exactly how this works. Well, I'll say this. You know why we know about this? We've been victims. Yeah. We we have seen the downstream effects.

That's I can confidently tell you. We've been zerped on quite a bit.

Alright. So how did zerp affect the startup world? And then we could talk about Let me set this up even before. Oh, please. Let's talk about the flow of money. Oh, Let's talk about the flow of money. Wiser. Okay.

Yes. So there's money from the Federal Reserve and banks could basically get it for free. Again, you can so if you're interested, you should research this from someone much smarter than me on this topic. Banks had to put it somewhere Yep. And it was hard to find a place to get yield, which was higher interest rates. Everyone had to dumped it into stuff like mortgages.

This is why mortgage interest rates were so low Yep. For banks like First Republic or SVB. Yep. And all these people were searching for yield, like the money needed to find a place to go. And by yield you just mean like, I wanna make more money Than zero. Zero percent. Which is what you could get from a bank which is zero. Yes.

Okay. And so what happened is a lot of this money ended up in alternate strategies which include things like real estate Yeah. WeWork.

Yeah. Or.

buying wacky stuff, again, that has nothing to do with us. But Uh-uh. One of these sinkholes, so to speak, that the money could go into is the asset class.

known as venture capital. And sinkhole it is. It will consume any amount of money it is presented Exactly.

What happened is all of this money floating around in the world ended up going to VC funds or family offices who suddenly dramatically ramped up their rate of investing Yes. Because they had access to it because the money had to find a place to go. Yes. And so, you know, the spice must flow. Like, it found it found a place to go. Well, and let's be clear.

Their motivations are that the more money they're managing, the more money they make. Yep. So the more money they're distributing out to investments,.

the next time they can raise the fund, they can Yes. Form management fees, stack those fees. And so there was a whole.

downstream effect of this money coming from wherever directly into people at demo day.

Well, you could drop at demo just just the whole you know, it was thinking as you said this, I was thinking about analogy. America subsidized corn. And then suddenly, everyone was motivated to figure out, like, what can we do with corn? Like, can we use corn to make this? Can we use corn to make that? High fructose corn syrup. Yeah.

Like, we can find if you have a problem, we can find a corn based solution.

Hey. You guys want some corn? We got we got corn. Yes. Yeah. That was money. You want money? That money.

Hey. There's I see a problem. Let's put some money on it. Do you not have product market fit? What if we throw some money at it? I'm like, are your margins negative? What if we threw money at it? Like, do you not know what you're working on?

Money?

Well, again, what's fascinating is a lot of these folks had not done startup investing before either. No. And so a lot of imagine someone that all they've done is run like a hedge fund trading stocks. Yes. Where they're like, oh, go buy 50,000,000 of Yes. Google stock or or whatever. They were treating investing in startups like investing in stocks.

Well, I loved it because there was one firm we interacted with who was like, well, you would value, you know, public market companies using this rubric. You know, companies generating, like, 500,000,000 plus in revenue, but often billions. We will just downsize that rubric to companies generating a million dollars in revenue. Because they're both companies,.

why wouldn't we just analyze them the same? I don't know if your argument will be self evident to our viewers. Okay. To us, that is crazy. Why that is crazy? Because.

needless to say, like, the failure rate of companies that are at 1,000,000 Yes. In revenue today, getting to 500,000,000 revenue ever is massively high. Yes.

Like, there aren't as many publicly traded companies that just, like,.

die. No. Whereas million dollar revenue companies are dying out minutely. Yeah. Minutely. So, you know, this investor was like, wow. And I remember we were talking to them and I just remember just being like, so you're just going to give these folks that don't know what they're doing a lot of money. And they were like, yes.

Well, because they were running their own arbitrage because they had hot money from other people. They're middlemen, but they were a good sinkhole for money. And again, what's fascinating to kinda complete Michael's story Yes. Is once the market turned and interest rates went back up They got out. They're done. They got out of the business. They're gone. As anymore.

They were just out of town, blew out of town. But hey, during this time, it was fucking it was amazing. Like, we had founders who would ask for introductions to these people, but these are the founders who go. This is how this is how the founder would say it. I heard if I talk to these folks for thirty minutes, they'll just give me a, like and then, like, in multiples of $10,000,000.

And and and I remember because, like, other VCs were trying to kinda compete, and they were just like,.

how do we compete with this like thirty minutes forty million dollars? What? And and Michael, I bet there's a lot of people watching this Yes. Saying to themselves, this sounds great.

Yeah. Why are these guys laughing about it? Why wasn't it great Michael? Or like what was the downside of this? It turns out that if money was the only variable to making your company work, one, startups wouldn't work because all the incumbents have way more money. It's true. Apple has a lot of money. Like, all the money.

Like, all the money effectively. Right? Two, it turns out that like when you give money to someone, they stop innovating and they start spending more money. Why do we have to have better software? We can just hire more people to fill in the blanks. Why do we have to do things better? It turns out when you give people more money, they start acting like the big companies they're trying to disrupt.

But also it turns out the opposite's true. When they can't afford shit, they figure out how to do without, and that often creates the innovation. So this is kind of like, we're gonna give you money. It's it's poison. Like, would you like Yes. How much poison would you like? You can drink as much as you want. It's like, we have infinite poison in the back.

Why? Can I give you more poison? It's shaped like money. It's gonna kill you, but and let's be clear. Some founders, for them, the money wasn't poison. Yeah. Right? But that was a smaller percentage than you might think.

So that's also when we saw the explosion of the unicorns. Remember when unicorns used to be rare magical.

think why they were called that. Yeah. That was the the name was it was meant to be a rare Yeah.

Infrequently cited thing. As as as unicorns are, rare and infrequently cited. Well, that ended. Yeah. We.

would see them on a weekly basis, basically. Again, I I would have to get the exact numbers, but I seem to recall on a weekly basis. It was a marketing thing. Right? It was like, well, I'll give you a billion dollar valuation and you can be a unicorn.

Yep. The second you name something, you like begin to destroy an idea. It's like It was interesting because I remember during this time, I was sitting in a board meeting and the founder was complaining that all the companies were too expensive. This company had cash, they wanted to buy a company, and there was just everything was too expensive.

And he said something that like tricked me a little bit. Got my thinking. Was like, the revenue to valuation multiple. And I was like, yeah. That that seems to make sense. Right? The amount of revenue you're making versus your valuation. Like, that would be an easy way to tell whether something's cheap or expensive.

Like, if your company's making like a billion in revenue and it's worth like, I don't know, 5,000,000,000 in valuation, that's cheaper than if your company is making 5,000,000 in revenue and it's got a $5,000,000,000 valuation. And then I thought, I should just like look around at some of these startups that are raising unicorns.

I should kinda like check out TechCrunch and see what is this revenue to valuation multiple. When I saw that a company just raised at a 350 x multiple, 3,000,000 revenue, billion dollar valuation, I was like, I remember when Justin TV and Twitch had 3,000,000 revenue. Like, I'm like, Like, did we have what percentage of things figured out did we have? Like, maybe 1%.

And man and then suddenly it hit me. I was like, oh, no. Like, this is not gonna this is not gonna last. And remember, like, this was the start of the new y c standard deal when we were to think about this. Right? Like the this is not gonna last. Yeah. I mean, for what it's worth, you know,.

founders that were in The Bachelor in those times or people we did office hours with could probably pack us up here. But we were definitely advising founders that the music would probably stop. Yeah. There's something about what was going on felt like Zerp again, which is the title. You know, it was like, this is there's a lot of side effects of this zero interest rate thing going on. Yes.

Let's not count on it lasting. No. And so make some smart moves now Yes. To prepare for the winter that will be coming. Yeah. Right?

And I can't tell you how many founders were just like, no. This this isn't winter. This is just We're just getting started. This we're Zurp is we're just This is great. It's gonna go. I don't know what you're talking about. Crazier than this. And it's weird because I don't, you know, I didn't live through the nineties.

Right? The nineties in my life, the nineties tech boom was just like a Yeah. A story other people told. And it is so f ed up that, like, we saw it wasn't an exact replica. It happened in the private markets, but damn near.

It was it was wacky. Mean It brought just to give a concrete example for folks Please. Because money was so cheap, so to speak Yes. Lending companies made a lot of sense. Because when you're doing lending, you need a lot of capital to lend out to people and then Yes. They pay an interest rate. Right? Yep.

And so if your cost of capital is very low and you just lend it a lot Boom. It works. And as it would turn out, money has product market fit. Always. And lots of companies were like, oh, we're just gonna do lending for x. You know, you name it. Yeah. And they're like, wow, we got product market fit.

A lot of people want this thing called money. We're product geniuses. Unbelievable that people want this money thing Yeah. That only we have, and it's very defensible. And then what happened is when interest rates went back up, the cost of capital for these businesses went up. Yeah. Was hard for them to pass that along to their customers. Yep.

And so kind of like overnight, there was a whole Yeah. Class of types of businesses that.

became very challenging. Well, it was sad too because I think that it it also screwed with the people who were observing this and thinking about doing a startup. Everything got so inflated that you started seeing founders coming into YC being like, oh, well my seed round should be $10,000,000. And it's like, what are you gonna do with $10,000,000? Well, yada yada just raised a $10,000,000 seed.

Yeah. They were entirely.

keeping up with the Joneses. Like, the entire conception of startups is to, like, read articles about what other companies are doing Yes. And being like, I want that. But I wanna top it. And there was a lot of trying to top everyone else going on. And it was sad too because I.

would say I I observed two types of VCs during this period of time. Three types. Let's Okay. Okay. Three types of VCs. Type one was like, there isn't a problem. Like, this is tech's heyday, and we're just we're providing very real valuations to these companies. We just understand the tech is going through a heyday.

Interesting group. Group two. I know this is screwed up, but I'm gonna do it anyways. Right? Like like like like like, you know, it's the game we play. Like, if you get me in a room in private, I'm gonna be like, eight of the last deals I did, I priced really dumb, but, you know, my LPs are cool.

And then there's a third group, and and this group was small, and we know some of them who were just like, count me out. Yep. Like, I'm gonna hold on to my capital. In the investment game, you invest when things are undervalued and you don't so high. Yeah. That's I heard that somewhere. I'm not an economist. And there were some of them who did that and who were rewarded for it.

Yeah. People who knew it was a problem Yeah. Were still participating. But Michael, here's a question I imagine someone might be wondering. Yeah. Weren't you guys part of the program? Yeah. Yeah.

And it's tricky. Right? Because, like, on the early stage, one of the things that insulated us is we have a standard deal. Right? So we don't have to deal with this Yeah. Valuations. But we had a growth fund. Yep.

And, yeah, like, that demo day auction during those primo times were crazy. Well and I think.

we always suggested to folks that the key to greatness is to build a great business. Yes. Makes the main people want. We really believe this stuff. Yes. And so we were advising people even at the height of the stuff, hey, everyone, like, don't pay attention to all this noise. Yeah. Try to build something enduring Yes.

Because the the waves of the larger economy go up and down, and it's gonna take a long time to build a startup. No matter what. So if you're Yeah. If you're in the batch, trying to time the market is like the silliest thing of all time because Yes. You need ten years. Does the marketing look like ten years from now? Different. Different.

And so it was always like, yeah, you know Yeah. It is unlikely that anything going on now in the wider world will affect you current batch startups. Yeah. And that was a very consistent message Very consistent. We had for folks. I think though that the.

bigger lesson though happened when the market corrected and we started to see what people did with that money. Yep. And I will say like some companies, they took that capital and like they can run their business profitably. They don't have to raise another round until they IPO. Those founders were very smart. Other founders, they spent that money. Yep.

And then when they tried to get more and and it's sad because if you build your business around an unsustainable phenomenon and then that phenomenon goes away, what happens to your business?

You know, move fast. You don't have anything. It's like platform risk almost. This is like Yes. Platform risk on the Fed. Yes. Yes.

Your business only worked when there was nowhere else to invest in the universe. Of Yeah. It's true. The second there's anything better to invest in Immediately, all the money will come out. Yeah. It's like, oh. So I think that, like, you know, in this aftermath, you know, what's interesting is there are still some industries that maybe are have some zurpy qualities. Right?

How do you think about that? Like,.

are hype y industries right now. I think as a founder, job is to just balance optimism with realism Yeah. And be exactly on the right balance level. Yes. And the folks that even at the height of this stuff, they were always optimists. They're like, hey, my company could be great. Yes. And they took advantage of some of the stuff on offer.

Fair enough. Yes. But they knew that this wasn't gonna last. Yeah. And they planned they were such a great balance of optimism and realism. Yes. And I think regardless of what the time period is, that's where you wanna be. Yeah.

Yeah. And you if you're too, you know, if you're too negative, if you're too you're like, this is a bubble, you know, the the US government's gonna collapse or, you know Yeah. Okay. Good luck with that. Yeah. But that's that's an extreme over here on the negative side. Yeah. But if you're like too optimistic,.

that's bad too. Yeah. I like that optimistic but real and like understanding that you have to build your business in many different economic climates. Or like hell, like why not not build your business so that it works in bad economic environments? So when times are good, it's even better. Yep. So there you go.

So that's ZERP, zero interest rate phenomenon, and here are two highly trained economists who have now build you a website. I don't know. You need a website. Is this like the big short movie where like they have all these like actors explaining to you like how like.

the o eight crisis I can write some Python code if anyone I can I can make you I can write Python? Anyone out there that wants We can make really good blocks. Dalton. Great chatting. Thanks.