How the U.S.A. Abandoned Capitalism, Part III
Want to be a billionaire? It's simple, don't be a capitalist.
This series, “How the U.S.A. Abandoned Capitalism,” explains (at a very high level) how the advent of authoritarianism in America is closely connected to a fundamental shift in how government, business leaders, and many Americans think of capitalism.
In Part I of this series, I summarized the political shifts in both major parties since the 1980s that created opportunities for America to abandon capitalism. In Part II, I described how federal policies over the past 40 years had encouraged the formation of monopolies and pluropolies in business.
I intended to use Part III to explain how these factors worked together to change the nation’s economic system away from capitalism.
But then I watched Elon Musk single-handedly tank a bipartisan budget deal, and I realized I needed to explain a little more.
So, Part III goes into some of the details of how entrepreneurship—once the backbone of traditional capitalism—has been replaced by something else.
To summarize, entrepreneurs in the 21st Century don’t become billionaires by creating highly profitable ventures that customers love. They become uber-wealthy by partnering with venture capitalists to create companies that are unprofitable but worth billions on paper, then cashing out before the house of cards collapses.
Profit is for Suckers
I’m not an economist, but I’ve always assumed that the point of having a business is for it to be profitable. Profitability seems like a pretty good measure of success in business, right? Isn’t that somehow fundamental to capitalism?
Maybe, but profitability isn’t that important in the U.S. anymore.
I’m a business owner. I understand that sometimes a business has to make investments that cause it to lose money in the short term. I’ve done that with my own businesses.
That’s not what’s happening with modern venture capital and tech entrepreneurship. They aren’t accepting short-term losses to achieve greater profitability in the future; they are encouraging long-term losses to achieve greater valuation as soon as possible and cashing out before the unprofitable business has a reckoning.
In some cases, this takes only a few years. Others can ride this gravy train for decades.
The key point here is that the modern path to wealth is based on ensuring the playing field isn’t level.
The traditional approach to entrepreneurship works like this: You have a good idea and start a business to turn it into reality. You have to win customers and out-compete your competitors. There are three typical outcomes for most businesses:
You’ll run out of money before you can grow your business to a sustainable level. This is the most common outcome for startups because starting and growing a business is very, very hard.
You’ll grow slowly but consistently, maybe taking out a loan or getting some friends and family members to invest, and eventually have a nice “lifestyle” business that earns you a good living without too much stress. This is the second most common outcome for new business ventures.
You’ll grow quickly and start becoming a player in your sector, maybe getting some professional investors to put up big money to fuel that growth, at which point a wealthier competitor may offer to buy your company. You’ll probably say yes and make a few million dollars. Maybe you retire young. This is the least common outcome, but what many entrepreneurs hope for.
Sure, you may be the rare individual who builds a massive company from scratch. But that’s not how most billionaires are created these days.
The modern “Silicon Valley” approach to entrepreneurship is very different. In the new model, an entrepreneur with access to venture capitalists looks for industries that can be “disrupted” (pretty much any industry with a stable business model.)
The entrepreneur creates a product or service to compete in that industry and raises money from venture capitalists to build out the business. Their product or service begins to take market share from their traditional competitors — not because it’s a better product or service, but because the venture capital allows them to compete without having to make a profit.
As the company gains market share, its valuation increases, and as valuation increases, the founders’ and venture capitalists’ wealth increases. However, because the business is losing money, the company must bring in new investors to maintain operations.
This cycle continues as long as the founders’ and investors’ wealth increases. Money comes in, and market share grows because the company can compete without having to be profitable. Thus, the valuation increases, and new investors come in at this higher valuation, etc.
Eventually, one of two things happens. Either the company’s market share reaches a point at which it can become profitable, usually by raising prices, (because so many people now use the product or service that they just have to pay the higher prices), or the company begins to collapse.
In either case, the founders have probably already cashed out. They’ve sold enough of their stock at high valuations to be billionaires, and the early investors have made 10 or 20 times their initial investments (or more). What happens to later investors isn’t their problem.
Is this capitalism?
Today, profitability is just one factor—albeit an important one—for institutional investors in stock markets looking for solid returns over the long term. After all, roughly 80%- 90% of the stock market is owned by institutional investors like banks, mutual funds, pensions, and trusts. The stock market is not a place where individual investors get rich quickly.
People seeking real wealth know that. They’ve figured out how to create wealth out of thin air, usually by saddling late investors with most of the risk. Here are some examples:
In 2019, Adam Neumann was paid nearly $1.7 billion to resign and sever ties with the company he founded, WeWork, after its attempt to go public uncovered serious governance problems. The Japanese investment firm that bought WeWork also hired him as a consultant with an annual salary of $43 million. In 2023, WeWork filed for bankruptcy. It’s currently worth less than $40 million. The company never earned a profit.
Remember Travis Kalanick? He was the CEO of Uber who had to resign after the public learned what a toxic boss he was. But that’s not all you should know about him.
The first business he was involved in, a peer-to-peer sharing platform, was sued first by investors and then by the MPAA before declaring bankruptcy. He claims he was a co-founder, but others dispute that.
The second business he was involved in, which he co-founded, failed to pay employees for months and then used payroll tax funds for day-to-day operations, which is tax fraud. (It eventually paid the government back.) Five years later, he sold the business for nearly $19 million, from which he made $2 million after taxes. I can find no evidence that the company ever made a profit.
He invested in a few startups before he and two friends founded Uber in 2009 in San Francisco.
Uber secured hundreds of millions in private investment and had a valuation in the billions. The culture was so toxic that, in mid-2017, investors demanded Kalanick’s resignation, but they let him keep his seat on the board. His continued bad behavior led to them suing him a couple of months later.
Kalanick announced that he would resign from the board at the end of 2017, less than a decade after the company was founded. In the weeks before that announcement, he sold 90% of his shares in the company for more than $2.5 billion.
The company went public in 2019 but didn’t become profitable until 2023. It was never profitable while Kalanick was CEO or on the board.
These are high-profile companies with particularly bad CEOs who made the news. Still, the economics that enabled them to become billionaires in less than a decade through companies that never earned a profit aren’t unique.
Valuate me, baby!
You see, the goal of modern tech entrepreneurship is not profit, it’s valuation.
Startup founders and the venture capitalists who back them aren’t in the business of finding the most efficient way to deliver a product or service to customers who are willing to pay a fair price. They only care about growth.
If the customer base, the revenue, (or, hopefully, both) are growing, that’s all you need to succeed because that growth will allow them to get more investment — at a higher valuation.
Here's an example of how this works in real life.
You’ve probably heard of FTD, the business that makes it possible for you to send flowers to someone in a distant town without having to identify a local florist there. Basically, florists join the FTD network, and when someone orders flowers through FTD, they forward the order to a local florist in the network and take a cut of the sale.
If you’re a Silicon Valley entrepreneur, you might see this as a business model that can be “disrupted.” How do you do it?
Simple. You just start a company with its own florist network. Let’s call it “Flowr Powr.” You call up your venture capital friends, show them your business model, and get some seed money, maybe $500,000.
Next, you go to some local florists in, say, Sacramento and tell them that they can join Flowr Powr for free, and you’ll take a smaller percentage of each sale than FTD does. And they can stay members of FTD, too. If you’re a decent salesperson, they agree.
Now you start advertising Flowr Powr as a discounted way to send flowers locally in Sacramento. You can undercut FTD’s prices and even the prices of local florists because you don’t have to make a profit.
Soon, lots of people in Sacramento are buying flowers through Flowr Powr, thanks to its low prices. You’ve proved that the model works, and you go back to your venture capital friends and get some serious investment, like $10 million.
You use that to expand Flowr Powr across California. The model keeps working because, again, your prices are lower than your competitors since you don’t have to make a profit.
As the customer base grows, the value of your company goes up, and more investors keep coming in to capitalize on your success. Flowr Powr goes nationwide.
At this point, FTD is worried. You’re cutting into their business. Maybe they sue you for unfair business practices. You don’t care; your company keeps pulling in new investors to support your “disruptive” business. Your company is worth tens of billions, and your personal net worth is over $1 billion.
Now you and your early investors start cashing out. Maybe, like Ek, you sell a few hundred million worth of stock in your company. You’re uber-wealthy.
What happens next? Flowr Powr raises its prices to become profitable. Maybe that works, and FTD falls by the wayside. Maybe it doesn’t, and your company eventually goes bankrupt.
The point is, it doesn’t matter to you or your venture capital investors. You got rich.
You didn’t get rich by providing a better service. You didn’t get rich by creating an innovation. You got rich by using other people’s money to duplicate an existing business model and out-competing everyone by removing the most critical indicator of success in a capitalistic system: profit.
As a reminder, the deciding factor is valuation, not profitability. Even if the company is not profitable, the founders and investors will make money as long as the valuation is there. The venture capitalists will get 10 to 20 times their initial investment, and the founders will walk away with hundreds of millions, if not billions, of dollars.
The executives and investors who come later must determine how to make Flowr Powr profitable, but the founders and original investors don’t care. They already got rich.
In some cases, the founder stays on and keeps getting richer. Take Spotify’s CEO Daniel Ek, for example.1 2024 is on track to be the company’s first full year of profitability in its 18-year history, and Ek is celebrating in true tech entrepreneur style. As Ted Gioia points out,
On February 7, Spotify’s CEO sold 250K shares for $57.5 million.
On April 24, Spotify’s CEO sold 400K shares for $118.8 million.
On November 15, Spotify’s CEO sold 75K shares for $35.8 million.
On November 20, Spotify’s CEO sold 75K shares for $34.8 million.
On November 26, Spotify’s CEO sold 75K shares for $36.1 million.
On December 4, Spotify’s CEO sold 75K shares for $37 million.
On December 11, Spotify’s CEO sold 60K shares for $28.3 million.
Deejay Alan Freed couldn’t dream of such riches. In fact, nobody in the history of music has made more money than the CEO of Spotify.
Taylor Swift doesn’t earn that much. Even after fifty years of concertizing, Paul McCartney and Mick Jagger can’t match this kind of wealth.
I’ll spare you the math. In 2024 (so far), the first year in its 18-year history that Spotify was profitable, Ek has sold shares worth $348.3 million.2
As I said, profits don’t make people rich; valuations do.
By the way, it was recently revealed that one way Spotify may have achieved profitability is by filling playlists with stock music for which they pay low or no licensing fees. In other words, instead of paying artists for their work, the company is simply replacing them with cheap imitations.
One guy found 49 different instances of the same song on Spotify, all purportedly by different, non-existent artists:
Daniel Ek’s net worth is estimated to be $4.8 billion. He’s achieved this massive wealth through a business that took 18 years to become profitable, and only after it started providing unknowing customers with cheap fakes.
What does this have to do with Politics?
In Part IV of this series, I’ll explain how this new class of uber-wealthy individuals is fueling the rise of authoritarianism in the U.S.A. and beyond.
You can probably guess where this is going. When people become billionaires by tilting the playing field in their favor instead of actually competing, they expect that every playing should be tilted in their favor…including the government.
I know Spotify is a Swedish company, not American, but it’s listed on the NYSE, and the entrepreneurial focus on valuation is global.
In fairness to Ek, his salary is a measly $1.4 million per year, so who can blame him for cashing out some of his stock?