One of Silicon Valley's most outspoken investors slams the 'bizarre Ponzi balloon' of the start-up economy

Key Points
  • Palihapitiya said venture capital firms are "creating a dangerous, high stakes Ponzi scheme" for which their limited partners and tech employees are left "holding the bag."
  • Palihapitiya's comments come after a tough year for his firm, Social Capital, which has seen the departure of several employees. 
Chamath Palihapitaya speaking at the 23rd Annual Sohn Investment Conference in New York City on April 23, 2018.
Heidi Gutman | CNBC

Chamath Palihapitiya, one of Silicon Valley's most outspoken tech investors, doubled down on calling the venture capital and tech start-up economy a Ponzi scheme on Wednesday.

In a letter released by Social Capital, his venture firm, Palihapitiya wrote that "the dynamics we've entered is, in many ways, creating a dangerous, high stakes Ponzi scheme" and a "bizarre Ponzi balloon."

Palihapitiya argues that "start-up valuations are massively inflated" as venture firms invest in each others' companies, push start-ups to use their funds to pay for user acquisition, and then raise investments from more firms. All the while, the venture firms can profit from management fees long before any of the start-ups they bet on are successful.

"These markups, and the paper returns that they suggest, allow VCs to raise subsequent, larger funds, and to enjoy the management fees that those funds generate," he wrote.

The cycle hurts two groups in particular, Palihapitiya wrote -- the so-called "limited partners" who invest money in venture capital funds, and the employees of the tech start-ups supported by those funds.

Limited partners don't see returns until "many years down the road," as the typical venture fund runs seven to ten years. Meanwhile, start-up employees give up the cash compensation they'd earn at a big company for stock options, which are difficult to cash out and often end up worthless, as later investors dilute their value or the start-up fails.

This is not the first time Palihapitiya, who was an early Facebook employee, has called Silicon Valley's start-up ecosystem a Ponzi scheme.

"We are, make no mistake … in the middle of an enormous multivariate kind of Ponzi scheme," Palihapitiya said at a San Francisco conference three weeks ago.

Palihapitiya's comments come after a turbulent year for Social Capital. The firm has seen the departure of numerous employees, and in September, Palihapitiya said Social Capital would no longer accept outside investment from limited partners.

"We think not, and we believe it's time to wait patiently as the air is slowly let out of this bizarre Ponzi balloon created by the venture capital industry," Palihapitiya wrote in his letter.

Start-up economy nothing more than a Ponzi scheme: Palihapitiya
Start-up economy nothing more than a Ponzi scheme: Palihapitiya