Narratives and Reflexivity in Venture Capital
Why perception is often more important than tech
How much should Tesla be worth? It currently trades at ~8x sales. GM trades at 0.3x sales, a 26x gap. Is Tesla overvalued? What about NVIDIA, which trades at 30x sales? It’s closest comp, AMD, trades at 10x sales…is AMD undervalued?
The dynamic in these two examples illustrates one of the most fundamental aspects of investing…perception matters. And in early-stage venture, perception really matters.
In extreme cases, perception can also begin to influence fundamentals in a way that justifies the seemingly high valuations. This concept is referred to as reflexivity. There’s a great post I found that explains reflexivity in detail, linked here. From that piece:
“Reflexivity is an economic theory that states - investors' perceptions affect economic fundamentals, which affects price, which in turn affects perception in a feedback loop. Reflexivity theory states that investors don't base their decisions on reality, but on their perceptions of reality instead.”
Viewed through the lens of reflexivity, we can understand why narrative (not to be confused with its sinister cousin, hype) is so critically important for technology businesses. Uber (~$60B EV) was a digital logistics network, not a taxi business. SpaceX ($180B EV) is colonizing Mars, not launching rockets. Their valuations reflect this, and those high valuations allow them to access the capital required to achieve their lofty ambitions, in a feedback loop that may continue for decades.
But narrative is a double-edged sword. WeWork was “elevating consciousness” after all, and we know how that ended. What we can learn from the Ubers and the SpaceXes is that successful founders create a compelling company narrative without allowing that narrative to devolve into hype. This is an art, but done well it’s the key unlock that allows companies to achieve the massive ambitions that we aim for as early-stage venture investors.