Banning Crypto (Continued); Search Funds
buy the rumor, sell the news
Banning Crypto (Continued)
I recently posted about India’s threats to outlaw cryptocurrencies and blockchain technology. Though I noted in the post that the reported explanation for this move was that India’s central bank wants to tokenize its currency, I also noted that I was hesitant to comment on it in depth due to a lack of familiarity with India’s banking system, government, and politicians.
Not so with the United States. Ray Dalio, founder of hedge fund Bridgewater Associates, recently argued, in an interview with journalist Andy Serwer, that the United States may outlaw bitcoin. An accompanying article notes:
Billionaire investor Ray Dalio, the founder of the $150 billion hedge fund Bridgewater Associates—the world’s largest—made a case that there’s a “good probability” bitcoin could be outlawed, similar to when the U.S. government made it illegal to privately own gold.
As Dalio points out in his upcoming book “The Changing World Order,” the Gold Reserve Act of 1934 made it illegal for individuals to own gold “because government leaders didn’t want gold to compete with money and credit as a storehold of wealth.” Something similar could happen with bitcoin, which has surged against a backdrop of high levels of debt, low interest rates, a lot of liquidity and stimulus, and investors seeking alternatives to bonds and currencies.
The United States banning bitcoin is a lot different from India banning bitcoin. This is due to the United States’ state capacity and the long arm of its law. While a technically literate resident of a developing country could simply offshore his wallets or mining operations, a developed country like the United States has the resources (and often the will) to pursue cases in jurisdictions beyond its borders. If the United States bans bitcoin, it would be much harder for American citizens to evade the law by offshoring their operations or holdings.
I’ll repeat what I said in my last post, which is that the cryptocognoscenti refuse to engage with the very real threat that bitcoin poses to states’ sovereign rights. Which rights states are aggressive about protecting. I think it would be stupid for any state to move to ban bitcoin, and even in the United States I suspect that the enforceability of such a law would be far harder than bureaucrats and politicians surmise. But enforceability of stupid laws has not stopped governments from banning other things.
Cryptocurrency advocates had better get much smarter, very quickly, about government relations and lobbying.
Search Funds
This morning on Twitter I saw someone express either skepticism at or confusion about search funds. Why, this person asked, would you found a search fund and then spend a couple of years searching for an acquisition target, when you could build a business from the ground up and retain full ownership?
I think this misconstrues the issue. Following is a discussion of what search funds are, the purpose they serve, and how they differ in function from an entrepreneur who creates a business from nothing.
Search funds are a special kind of private equity fund, in which the fund is created with the express intent of finding a company, acquiring it, and running it for the benefit of the fund’s investors. The search fund typically plans to sell the company to tertiary investors (another acquirer) after a set number of years or after certain growth benchmarks are reached, and distribute profits to the investors. In this sense, a search fund is a private market equivalent to the SPACs that are all the rage right now.
This is, essentially, a classic private equity play. But the difference between a search fund and a more conventional private equity fund is that the latter makes bets in a variety of different companies. A search fund has only one target: a company to acquire.
Typically, the founders of the search fund create a fund shell and then raise capital from investors. They tell the investors what type of company they are looking to acquire: size, industry, geographic location, possibly age, and, if the investors like what they hear, they will commit some capital to the fund. Once the founders have raised a sufficient amount of commitments, then, as with SPACs, they have a limited window of time to search for their acquisition.
This strikes some people as backwards. Why acquire a business with which you are unfamiliar when you can just found a business from the ground up, and retain a 100% ownership stake? The easy answer is that the skills required to found a company and acquire your first customers are different from the skills required to scale a company from dozens of customers to thousands. Some rare founders, like Bill Gates and Mark Zuckerberg, are able to meet this challenge. But far more founders are not able to do this, or have no desire to do this.
Some founders, presented with the opportunity to realize liquidity after having worked hard for a number of years, jump at the opportunity to sell their company. And, if they’re smart, they can structure the acquisition such that they retain a small stake in the company.
That means, in principle, that the original founder can realize two liquidity events, spread over a number of years. Further, the whole point of the search fund acquisition is that the acquisition is (usually, but not always) fueled by cheap debt. If the search fund can grow the company, using that debt capital, to a much larger size, then the second liquidity event may be materially larger for the founder, than the initial liquidity event. And this is where some founders miss the mark. Some founders think it preferable to retain 100% of a small pie, than to sell a portion of the small pie to investors, and reap the benefits of a much larger pie in the future.