Money Stuff: Musk Has Money and xAI Wants Some

One model you could have is: Tesla Inc. is a big car company. Last year it had $97.7 billion of revenue, up about 1% from the year before. It had about $14.9 billion of cash flow from operations and spent about $11.3 billion on capital expenses. It has about $37 billion of cash and short-term investments. That is: It is a big, stable, slow-growing [1]  old-economy industrial company with good cash flow and limited need for reinvestment. I understand that nobody experiences Tesla this way, and I feel dumb for writing it, but, you know, a little. 

And then there is xAI, which is an artificial intelligence company, meaning that (1) it is currently a gaping maw for swallowing up money and (2) perhaps one day it will fulfill any economic or other fantasy you can think of. Maybe one day xAI will produce the only computer program that anyone uses, and will intermediate all of commerce, and will satisfy every human want, and will rule humanity with an iron fist. I mean! There are like five candidates and xAI is one of them; the probability of this outcome is not zero. And then you’d be stoked to be an xAI shareholder. [2] But, right now, gaping maw for capital.

That is: Tesla has $37 billion and no pressing need for it; xAI has not enough money and a pressing need for as much as you’ve got. Should Tesla just take some of its $37 billion and invest it in xAI? Ordinarily one does not ask this sort of question. Ford Motor Co. also sells cars and has a lot of cash; OpenAI also builds AI models and is a sinkhole for cash; nobody is like “Ford should invest $5 billion in OpenAI.” Why would car-company executives be good at evaluating speculative venture-type investments in AI labs? Why would car-company investors want exposure to AI labs, or rather, why would they want their AI exposure through their car stocks? If you want to invest in AI, buy Nvidia or whatever; if you own Ford stock it’s because of cars. 

But of course if you own Tesla stock it’s not because of cars. It’s because of Elon Musk, the chief executive officer/TechnoKing of Tesla and the principal owner/whatever-he-is of xAI, and of SpaceX and Neuralink and Boring Co. and some others I’m forgetting. It’s because you think that Musk is a really good allocator of capital to futuristic endeavors, and Tesla is his only public company, which just happens to be a car company. If Tesla was “an index fund for Musk’s futuristic endeavors,” you’d probably be fine with that, probably happier with that than “slow-growing car company.” And, again, nobody experiences Tesla as “slow-growing car company”: Tesla is that plus somewhat hypothetical futuristic endeavors like robotaxis and humanoid robots. Truly, the more hypothetical futurism the better. If Tesla could chuck that $37 billion into xAI’s gaping maw, everyone would be better off: xAI would have money to pursue world domination, and Tesla would have more entertaining things to do with its money than making cars.

Obviously there is a question of valuation — how big a stake in xAI’s future world domination should Tesla get for $37 billion? — but let’s not worry about that. We are all family here. The heuristic is “if you invest alongside Elon Musk, you will get rewarded when he achieves futuristic world domination”; you can’t get on the rocket ship if you’re negotiating every last basis point of your economics.

I talk a lot around here about the “Musk Mars Conglomerate,” the idea that really Elon Musk runs one giant company that makes cars and rockets and tunnels and brain implants and social media posts and large language models, but it happens to be organized into different divisions with different (though overlapping) shareholders. It is in some ways useful for the brain-implant company to be separate from the rocket company: It helps to align employee incentives (if they are paid in shares of only their company) and insulates each company from the others’ potential liabilities (a lot can go wrong with brain implants or rockets or for that matter social media posts). In theory it also allows investors to pick and choose only the exposures they want, but in practice no one seems to care about that. People (used to) buy Berkshire Hathaway Inc. for Warren Buffett, not for its candy business.

Anyway SpaceX has some spare cash, xAI needs it, so:

Elon Musk’s SpaceX has agreed to invest $2 billion in his artificial-intelligence company xAI, investors close to the companies said, nearly half of the Grok chatbot maker’s recent equity raise. ...

The SpaceX investment is part of xAI’s $5 billion equity fundraise announced by Morgan Stanley last month. It is the rocketmaker’s first known investment into xAI and one of its largest in another company. …

SpaceX recently had more than $3 billion in cash on hand, the Journal has reported. The company has rarely made investments in outside ventures. ...

At xAI, Musk is spending billions of dollars every year training AI models, an effort that mirrors the high spending levels at rival AI startups, which have similarly garnered high valuations but face almost constant pressures for cash.

And Tesla has even more spare cash, xAI needs it, so:

Tesla Inc. shareholders will vote on whether to invest in Elon Musk’s xAI, the billionaire said, after the Wall Street Journal reported that SpaceX agreed to pump $2 billion into the artificial intelligence startup.

Musk made the statement in response to an account on X that said the carmaker must be able to invest in xAI to be fair to Tesla retail investors.

“It’s not up to me. If it was up to me, Tesla would have invested in xAI long ago,” Musk replied. He didn’t say when the carmaker will have a shareholder vote or offer other details, beyond saying in a separate post that he didn’t support a merger of the companies.

Notice the difference here, which we talk about from time to time. “It’s not up to me,” says Musk, about Tesla. With SpaceX it … is? I mean. With SpaceX, Musk can go to the board of directors and say “hey can we chuck all the spare cash into xAI?” and they say “of course.” Is there a shareholder vote? I dunno, maybe he calls a few of the bigger shareholders — longtime Musk fans who are probably xAI shareholders too — and says “hey, heads up, we’re gonna chuck the SpaceX spare cash into xAI” and they say “great, of course.” SpaceX is a private company, meaning both that there aren’t too many formalities and that everyone — Musk, the board, the shareholders — are pretty aligned on what they want, which is Elon Musk futuristic capital allocation.

Tesla is a public company, meaning that there are formalities. Two years ago, I would have described them roughly like this:

1. If Elon Musk wants Tesla to invest a ton of money in another company he owns, that is a conflict of interest.
2. Tesla has thousands of shareholders and they are not all aligned. Some of them don’t particularly like Musk and will sue over a conflicted transaction like this.
3. If he wants to do it anyway, there are best practices: a special committee of independent directors empowered to consider the transaction, a shareholder vote with full disclosure of the economic terms and negotiating dynamics, approval by a majority of the outside shareholders. But all of these points are debatable, and a shareholder who sues could argue that the board committee was not independent, the disclosure was not accurate, etc.
4. If he doesn’t follow those best practices, a court will review the deal for “entire fairness,” and might unwind the deal or require Musk to pay the shareholders back.

That’s how other conflicted transactions (Musk’s own pay package, Tesla’s purchase of SolarCity) were reviewed by Delaware courts. But Musk didn’t like it, and so last year Tesla moved its state of incorporation to Texas, and now Texas law applies and I’m not sure what the rules are. (Not a ton of conflicted public-company investment deals get litigated in Texas.) But, sure, Musk is probably right: It would be at least best practices, if not actually required, to put it to a shareholder vote. And then I’d bet some shareholders would sue, though I would not bet on them winning. And I would definitely bet on the shareholders voting yes. What is the point of investing in Tesla, if not to also invest in xAI or whatever else Elon Musk is cooking up?

It’s a little weird that the Silicon Valley startup ecosystem still works. Like roughly the way the artificial intelligence business works now is:

1. You have some good experience working in AI.
2. You launch a startup and raise $200 million from venture capitalists in exchange for 20% of your company.
3. You build a cool product: Maybe it’s not commercially viable, and certainly it is not a sustainable business yet, but it’s cool.
4. You get a call from Google or Meta, offering you $1 billion to quit your startup and come work for them building AI products.
5. A billion dollars is more than you’ll likely make at your startup, plus Google and Meta have the enormous resources required to actually build the products that you want to make, so you say yes.

Traditionally, the next step of the process is:

• Google pays $1.25 billion to acquire your startup. You get $1 billion of that, and your venture capital investors get $250 million, a 25% return on their money. Your startup ceases to exist, and you and your colleagues go work at Google, though maybe your product does get incorporated into Google’s offerings.

This is called an “acqui-hire,” but it is out of fashion now, largely because US antitrust regulators have become more suspicious of acquisitions by big tech companies. Actually buying your company now is a bit taboo.

On the other hand, you could imagine the next step of the process being:

• You go to the board of your startup and say “hey, sorry, here’s my two-week notice, I’m going to work at Google.” And your directors say “well what about the startup” and you say “yeah, it’s a bummer.” And they say “well but what about all the equity that we paid $200 million for” and you say “yeah good luck with that.” And they say “but you own 80% of this company that was valued at a billion dollars last month, are you really leaving that behind,” and you say “yeah see Google is paying cash?” And they say “we will sue you” and you say “For what? It’s a free country, I’m allowed to quit my job, and noncompetes aren’t enforced in California. I raised money from you in good faith, I worked hard at this startup, but now I quit, good luck.”

Like, why should Google cash out your investors? It doesn’t care about the corporate shell of your company; it might not even care that much about your product. It just wants you. Because you own a lot of equity in your company, it has to cash out your equity to get you to move, but why does it have to cash out your investors’ equity? 

You could imagine this being the norm, but it’s a bad norm. Who would ever invest in a hot AI startup, if they knew that their investment would become worthless if Google made the founder a better offer? If the venture capitalists are giving you money, it’s because they want to bet on you, not just whatever product you happen to be working on right now. If Google could buy you away without paying them, that would not be a very good bet.

And so, with really quite striking consistency, the big tech companies that hire AI startup founders throw in a parting gift for the venture capitalists. I do not quite understand why. I suppose that, while the startup can’t enforce a noncompete against its founders, it probably can enforce some intellectual property rights, and Google doesn’t want to get sued because it hired an AI startup founder who then reused some ideas from the startup. But it is also a small world of repeat players and strong social norms, and everyone does understand that an equilibrium where startup equity was worthless would be a bad equilibrium. How are Google and Meta going to find promising AI researchers, if venture capitalists won’t fund their startups?

Anyway Google bought Windsurf, sort of:

Google is paying $2.4 billion for an nonexclusive licensing fee that will pay for Windsurf’s technology and multiple years of compensation for Windsurf staff coming to the company, according to a person with direct knowledge. It will not take a stake in the company, Google said.

The deal will generate a return for at least some of the startup’s investors, according to a person familiar with the deal. Employees with vested shares will receive cash, but those without vested equity—many of whom joined in the past year—will not receive a payout, according to a person who spoke to leadership at Windsurf.

The deal represents a quick payout for investors in the four-year-old startup, which raised $240 million from Greenoaks Capital Partners, General Catalyst, Kleiner Perkins and others.

Windsurf had been in talks to sell itself to OpenAI for $3 billion, but those fell apart and it went with Google. The deal is apparently:

• Google will pay $2.4 billion.
• For that money, it will get (1) 0% of Windsurf, which will stick around as an independent company, (2) some of Windsurf’s top staff, who will go work at Google and (3) a nonexclusive license to the technology, why not.
• The founders and employees who are going to Google will presumably get a big chunk of that money.
• The venture capitalists who put in $240 million will also get a chunk of it; Kleiner Perkins “is expected to receive around three times its investment.”

As far as I can tell, OpenAI wanted to buy 100% of Windsurf for $3 billion; Google bought 0% of Windsurf for a 20% discount to the price of the full company. Seems right. 

Not everyone likes this. At Stratechery, Ben Thompson notes that it’s rough on the employees who aren’t going, arguing that it “breaks the implicit social contract that made startup employment significantly less risky for rank-and-file employees”:

The fact of the matter is that picking-and-choosing who to hire from a failed startup is great for Big Tech: they get the IP they want and the employees that matter, and get to jettison everyone else without having to do a future layoff. That they never thought to do so previously was, in retrospect, downstream of “the way things are done”, not some sort of legal requirement; once the law, in the form of over-eager regulators who didn’t understand what they were regulating, gave them no choice, it’s not at all clear why they would go back to the old model.

This, in the long run, is very bad for startups. The incentives for founding a company do still remain. ... The people who are getting screwed, however, are the folks who were never necessarily going to get rich — that’s reserved for founders, and appropriately so — but who could justify rolling the dice on a positive outcome as long as they had downside protection in the form of guaranteed employment with a Big Tech company if things didn’t work out. 

I argued above that, if Google could just hire away the founders without paying the investors, why would anyone invest in startups? But a similar argument can be made about employees: If Google could just hire away the founders and abandon the employees, why would anyone go work for startups? The ecosystem might be breaking down for employees.

But why hasn’t the ecosystem broken down for the investors? Did Google have to pay the venture capitalists anything just to hire the top employees? Maybe — for intellectual-property and investor-relations reasons — but maybe not. John Luttig worries:

Silicon Valley built up decades of trust – a combination of social contracts and faith in the mission. But the step-up in the capital deployment is what Deleuze would call a deterritorializing force, for both companies and talent pools. It breaks down the existing rules of engagement, from the social contract of company formation, to the loyalty of labor, to the duty to sustain an already-working product, to the conflict rules that investors used to follow.

Trust can no longer be assumed as an industry baseline. The social contracts between employees, startups, and investors must be rewritten. In the age-old tension between mission and money, missionary founders must prepare themselves for the step-function increase in mercenary firepower. …

Historically, the social contract of starting a company meant the founders would see it through to an exit. But how big do the numbers need to get before that breaks? People didn’t used to leave companies they founded, especially when they’re nascent and/or highly valued, but the AI talent war is deterritorializing. This fragility enables a CEO or key execs to leave their company with minimal recourse. …

Investors need protection against extreme instances of talent departure, particularly when it involves the founders. One instantiation could be that founders taking new jobs would qualify as an M&A event, or allow investors to redeem their capital.

One possibility here is that the norm of paying off investors is a fragile one: Not that long ago, Google would have bought Windsurf to acquire its founders, so getting the founders at a 20% discount to the whole-company price seems like a good deal. But in a few years, will Google think “hey we could get the founders without paying the VCs anything”? Will that look like a better deal?

I feel like I read an article every week about search funds, where recent business school graduates raise small funds from investors so they can go out and buy pest control companies in Missouri. I have written about these funds as a sort of prestige arbitrage. In theory, the value of business education is that it makes you good at running businesses, and lots of (pest control) businesses need running. But in our modern superstar economy, it is hard to attract fancy business-school graduates to work for pest-control companies in Missouri. “I am using my Wharton MBA to get into pest control”: No, bad, not prestigious. But “search funds” (and, more broadly, “private equity”) are a more prestigious rebranding of “pest control.” “I am using my Wharton MBA to raise a private fund to go out and do a leveraged acquisition of a business with strong cash flows and use that as a platform to roll up an industry”: Yes, good, now we are cooking. And if the business is pest control that’s fine!

What I would really like to read, though, is an article about what it is like to be the founder/owner/CEO/exterminator of a regular pest control business. Are you constantly getting automated cold emails from recent Harvard MBAs? Is it endless business lunches at the local diner? Do you need to hire an intern to sift through the mountain of termsheets? Also are valuations up? I feel like, 10 years ago, the average local pest-control company probably got fewer than, you know, three takeover bids per month. Now, many more. Surely you could get an auction going? Sell to the very most overconfident Stanford MBA? I guess I would also like to read an article about what it is like to be the sell-side investment banker for all these pest control companies. Could be fun.

Anyway here’s another Business Insider article about search funds, which pleasingly does get into what the sell-side experience feels like:

[Atlantic Duct Cleaning CEO/owner Tom] Keys was used to receiving emails like this. He had started Atlantic in 1995 as a 28-year-old with several years of experience in the heating, ventilation, and air conditioning industry. Even today, duct cleaning is pretty obscure. But back then, virtually no one thought about the dust, bugs, pet hair, skin cells, mold spores, and all the other gunk that piles up inside a building's ventilation system — and the occasional need to clean it out. Keys had the idea to do it with newer equipment than the tiny operations he knew of that ran on bare-bones crews. He grew the company painstakingly, bit by bit. By 2021, Atlantic was bringing in $4 million in annual sales, with impressive profit margins and a few dozen people on staff.

Many of Keys' suitors were private equity firms with deep pockets that were consolidating HVAC shops in the area. They offered Keys huge sums of money for his business, but he knew the PE playbook: They would almost certainly fire many of the employees he would leave behind. Other suitors were young searchers like [Columbia MBA Dan] Schweber who would, in theory, be less likely to strip his company into pieces. ...

Upon receiving the 12th email from Schweber, Keys finally picked up the phone and called him.

All he wants to do is clean gunk out of ducts and his phone keeps buzzing with desperate emails from private equity and search funds. Anyway eventually Schweber bought the duct cleaning business and is now ecstatically happy. (“I will never work in a corporate job ever again. There's no amount of money that you could give me.”) I do wonder, though, how many cold emails he’s getting now. Do search-funders flip their companies to other search-funders?

I think there are two meanings of the word “tokenization”:

1. One idea is that there are some technical benefits to wrapping various financial instruments in tokens that trade on a blockchain. These tokens would be interchangeable with each other in ways that existing financial instruments are not; they would be composable and programmable; they would trade around the clock on crypto exchanges; they could be financed in new ways; it would be easier to build derivatives and trading strategies on them; I don’t know. Stuff like this. 
2. Another idea is that if you say the word “blockchain” then regulators will get confused, traditional securities laws won’t apply, and you’ll be able to sell financial assets — private-company stock, real estate, etc. — without complying with the US Securities and Exchange Commission’s registration and disclosure requirements.

My view on the matter is that No. 1 is mostly a nice distraction and No. 2 is obviously the goal, which is why we keep talking about efforts to tokenize the stocks of private companies. You don’t need to tokenize the stocks of public companies! Public stocks trade electronically on the stock exchange, and tokenizing them doesn’t solve any real problems for anyone. But if you let anyone buy the stocks of private companies, you have filled a real business niche. And if you let them do that without public disclosure, you have … well, you have evaded the securities laws, is my view, but other people have different views.

Pleasingly, Hester Peirce, an SEC commissioner and the leader of its Crypto Task Force, seems to take my view. Last week she issued a statement on tokenization:

Distributors of tokenized securities must consider their disclosure obligations under the federal securities laws and may wish to refer to the Division of Corporation Finance’s recent staff statement on this topic.

Market participants who distribute, purchase, and trade tokenized securities also should consider the nature of these securities and the resulting securities laws implications. For example, depending on the particular facts and circumstances, a token could be a “receipt for a security,” which is itself a security but is distinct from the underlying security held by the distributor of the token. Alternatively, a token that does not provide the holder with legal and beneficial ownership of the underlying security could be a “security-based swap” that cannot be traded off exchange by retail persons. While blockchain-based tokenization is new, the process of issuing an instrument representing a security is not. The same legal requirements apply to on- and off-chain versions of these instruments.

I think that this is obviously true, but it must have disappointed some of the more aggressive tokenizers.

This keeps working huh:

Sonnet BioTherapeutics, Inc., (NASDAQ: SONN) (“Sonnet” or the “Company”) today announced that it has entered into a definitive agreement (the “Business Combination Agreement”, or the “BCA”) for a business combination (the “Business Combination”) with Rorschach I LLC (“Rorschach”), a newly-formed entity formed by an entity affiliated with Atlas Merchant Capital LLC (“Atlas”), an affiliate of Paradigm Operations LP (“Paradigm”), and additional sponsors (all together, the “Sponsors”), to transform its business by building a reserve of HYPE, the token of the Hyperliquid Layer-1 blockchain.

At the closing of the Business Combination, the newly-created entity is to be named Hyperliquid Strategies Inc (“HSI”), which is expected to hold approximately 12.6 million HYPE tokens, representing $583 million in value (based on the spot price of HYPE shortly before the signing of the Business Combination Agreement) and gross cash invested of at least $305 million, for a total assumed closing value of $888 million. 

We talk all the time about how the US stock market values $1 of crypto at $2 or more, but it keeps happening. Sonnet’s stock closed at $5.17 per share on Friday (a market capitalization of about $16 million). The new, HYPE-based investors are buying stock at $1.25 per share. The stock got as high as $19.30 this morning; at noon it was trading at about $10.83. This means that the stock market is valuing an $888 million pool of HYPE at around $7.7 billion. I do feel like the name here is particularly on-the-nose. 

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