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Opinion: This Is The Best Big Short For When The Silicon Valley Bubble Pops

Opinion: This Is The Best Big Short For When The Silicon Valley Bubble Pops

foreign money, usually in the Middle East or Asia. In the 2007 mortgage subprime crisis, investors in Germany were the preferred fools to be found as the music started to turn down in volume. There are fewer and fewer fools to find here in the U.S. to write checks at current bubblelicious valuations.

If the price of Uber’s private stock gets cut by 50 percent, this has big implications for Silicon Valley Bank as the fish stinks from the head down.

Uber is not the only unicorn darling whose stock may slip into bear market territory. The online lender Prosper saw its valuation plummet 70 percent on its most recent funding round. Fidelity marked down Pinterest 17 percent last month.

You would see more down rounds in private tech but there is a nefarious game being played, where “dirty terms” are traded in exchange for a higher valuation to make it appear that the valuation trend is going in the right direction.

If the term sheets were clean and normal, the mark on the valuation would be lower, or a down round. As the market deteriorates, there are more and dirty terms hiding the fact that there is actually a bear market in the stock, or that the valuation has stopped increasing.

Venture capital legend Bill Gurley has repeatedly warned of a pending bubble bust and the increasing popularity of dirty terms:

Who are the Sharks? These are sophisticated and opportunistic investors that instinctively understand the aforementioned biases of the participants and know exactly how to craft investments that can exploit the situation, Gurley said. They lie in wait of these exact situations, and salivate at the opportunity to exercise their advantage.

“Dirty” or structured term sheets are proposed investments where the majority of the economic gains for the investor come not from the headline valuation, but rather through a series of dirty terms that are hidden deeper in the document. This allows the shark to meet the valuation “ask” of the entrepreneur and VC board member, all the while knowing that they will make excellent returns, even at exits that are far below the cover valuation.

Examples of dirty terms include guaranteed IPO returns, ratchets, PIK Dividends, series-based M&A vetoes, and superior preferences or liquidity rights. The typical Silicon Valley term sheet does not include such terms. The reason these terms can produce returns by themselves is that they set the stage for a rejiggering of the capitalization table at some point in the future. This is why the founder and their VC BOD member can still hold onto the illusion that everything is fine. The adjustment does not happen now, it will happen later.

Dirty term sheets are a massive problem for two reasons. One is that they “unpack” or “explode” at some point in the future. You can no longer simply look at the cap table and estimate your return. Once you have accepted a dirty offering, the payout at each potential future valuation requires a complex analysis, where the return for the shark is calculated first, and then the remains are shared by everyone else. The second reason they are a massive problem is that their complexity will render future financings all but impossible.

Any investor asked to follow a dirty offering will look at the complexity of the previous offering and likely opt out. This severely heightens the risk of either running out of money or