Why We Do What We Do

We want to reintroduce transparency to venture capital.

Companies are based on agreements between people: each participant knows the answer to “what do I give you, and what do you give me, over what period of time?”

Today, much of the “what do you give me” is value created by taking risks, captured as equity. To answer that question accurately, each participant needs to know what the equity is worth. That requires transparency—an honest and realistic account of a company’s value. We create that transparency.

Where shared company ownership comes from

In Europe, companies were never “invented”—they emerged out of necessity, with legal mechanisms growing in parallel to the expanding scale and reach of governments, starting in the High Middle Ages. Royal and feudal agreements solidified power and privilege by creating permanent, usually hereditary records of ownership and responsibility, beginning with William the Conqueror’s 1086 Domesday Book. Later kings expanded this practice through royal charters—essentially public declarations granting power. Some of the first explicitly authorized commerce: in 1155, Henry II granted a group of textile manufacturers (the Worshipful Company of Weavers, a guild) a monopoly on the textile industry, one of the most important industries of London (in exchange, of course, for a small revenue share).

The royal charter of 1155 granted the guild members the exclusive privilege of Local Commerce.

This was probably Europe’s first incorporation. Henry II’s agreement with the weavers went well, and the model expanded to eventually include 109 other core guilds in London.

But charters weren’t just for permitting commercial activities. Henry I had bound the Crown to one, the Charter of Liberties, in 1100—so, when economic and military losses shook the landed class’s faith in the Crown, King John had precedent to enter in 1215 into a more holistic agreement with his subjects, known as the “great charter,” Magna Carta. It didn’t just empower his subjects to act or obligate them to pay taxes—it explained what their rights were in return, and described how disagreements would be resolved. It was, quite literally, an important and new type of social contract.

Magna Carta granted people the privilege of predictable rules to live by and providing them with a transparent answer to:

“what do I give to you, and what do you give to me, over what period of time?”

Trade became more sophisticated and far-flung throughout the Middle Ages and Renaissance, especially as ocean navigation improved. Led by the Spanish, Portugeuse, and Dutch, European economies began to integrate with Asian trade, especially in spice, opium, and other exotic commodities. Meanwhile, the emerging economic philosophy of mercantilism led to the existence of a class of people with capital to kick around who believed it was for spending and growing rather than hoarding. So, when England enjoyed a series of naval victories over the Spanish and Portuguese in 1588 and captured their fleets (also known as piracy), they finally had both boats and capital to deploy in global trade.

By 1599, a group of English merchants with capital they wanted to “adventure” in backing trade voyages to the East were petitioning Queen Elizabeth I for the right to do it. In 1600, they got their charter for the “Governor and Company of Merchants of London Trading into the East-Indies,”  a.k.a. the East India Trading Company.

The royal charter of 1600 granted the international merchants the privilege of Exploration.

By this time, the Crown had almost 600 years of experience in “trading” and contracting with priests, merchants, and barons. One of the advantages of the East India Trading Company which set them apart from their counterparts, the Dutch and the Portuguese, was their corporate structure: the ability to create a network of collaborators amongst a wide range of merchants, explorers, and the public and private sectors. And at its height, the EITC commanded as much as half of global trade.

From those original weavers’ payments to the king (i.e. return on investments), to initial formation contracts (i.e. articles of incorporation), and stories of new lands and riches (i.e. the pitchbook), the seeds for venture capital and collaborative risk-taking were being sown.

What company ownership looks like today

Today, the process of taking risks is built by and between a new set of kings, lords, merchants, and laborers—it’s between institutional investors, VCs, founders, and employees:

  • Institutional investors provide capital commitments to VCs to find and fund new explorers,
  • VCs find and back the most promising founders,
  • Founders set sail on new explorations,
  • Employees join the journey to carry out the expedition.

At every step of this collaborative risk-taking, those same questions need to be answered:

“what do I give to you, and what do you give to me, over what period of time?”

The East India Company endured 274 years, longer than the Russian Empire’s 204 years. Lessons it has to teach us around collaborative risk-taking and strategy are intertwined with tales of ruthlessness and complete disregard for human life. In the end, it fell victim to mismanagement leading to “financial woes:” the unit economics no longer made sense, net income was red for too long, and funding had dried up.

But almost 500 years after the incorporation of the EITC, the mechanisms for making clear agreements between participants seem to have broken down. As an example, look at WeWork:

  • In the 6 years between 2013 and 2019, thousands of people went to work for WeWork. During this time, they worked their ass off at the hopes that the stock and options that they were granted would be worth something.
  • The employees were granted stock options with strike prices way above what the stocks were actually worth.
  • So after 5 years, thousands of employees who were banking on these options having value walked away with empty hands.

The “what do I give to you, and what do you give to me, over what period of time” agreement between employees and the company was—by and large—violated.

And it’s not just WeWork. Let’s look at Casper.

  • During the 3 years until 2020, the management team at Casper had an obsession with a $1 billion dollar valuation. So they kept trying to raise money from VCs at that amount.
  • VCs were skeptical of Casper's $1B valuation but tried to put economic and legal restrictions around their investment so that they could go back to their own Institutional Investors and say "hey, we invested in a company that is worth $1B, they are doing great, and we have a bunch of downside anti-dilution protection."
  • Fast forward to February 2020, Casper goes public, and their stock crashes.

When VCs “lie” about the value of their investments, trust erodes in the startup ecosystem, which means less money from Institutional Investors for VCs, which means fewer VCs putting money into companies, which means less exploration and progress.

The “what do I give to you, and what do you give to me, over what period of time” agreements between VCs and the institutional investors are being—by and large—violated.

Everyone in the venture capital system suffers from misrepresentations of value created. To prevent long-term damage, we need to be headed for a new era of accountability and performance visibility. We at Preferred Return want to be the company that reintroduces that transparency to make “what do I give you, and what do you give me, over what period of time” clear and fair. Investors will readily be able to see the performance of any company and readily report on the value of their investments. The best companies get access to capital and resources, and the others reallocate resources to improve. True, honest, and ongoing valuation exercises will allow for such a world. We’re committed to continuing to provide the best valuation compliance experience to our clients, and through that process, we’re setting off on a journey to organize private company performance and valuation.

Why We Do What We Do