Wednesday, January 20, 2016

Reports of the Startup Valuation Bubble are Greatly Exaggerated

... Or not.

Along with many others, over the past few years, I've been worried about the growing dissonance between startup valuations vs. the actual (intrinsic) value they were creating. (This is the definition of an economic bubble). However, many in both the startup and financial/VC world have been consistently downplaying the high valuations and amount of money being pumped into the industry. (There are now 229 unicorn startups, with $175B in funding and $1.3T valuation).

I don't think this bubble popping would result in a total economic collapse like the Dot Com or Housing crashes (it is a much smaller, private market and not as many people or as much money is involved), but I'm surprised that more people were not worried about how high valuations are for relatively young companies and products. Last year alone, a record $128.5 billion was invested into startups and 71 became unicorns (valuations of $1 billion or more).

Fortunately, it seems the angels and VCs investing in startups are smarter than those investing in sub-prime mortgages and internet IPOs, and there are strong signs that valuations are coming down and investments are decreasing. One report estimates a sharp decrease in VC funding from $38.6 to $27.2 billion, Q3 to Q4 in 2015. However, there is often reduced spending late in the year; I suspect the holidays have something to do with that.

Slightly off topic, but this was a surprisingly good post by Tucker Max on "Why I Stopped Angel Investing (And You Should Never Start)". It does note the fact that a large portion of VC firms lose money and the most successful VCs owe their success to their network which leads to having the "first pick" of emerging startups.

Further off topic, but for those who grew up in the late-90s/early-00s, will remember Tucker Max's name from his well-written and incredibly amusing, but vulgar/graphic blog about his exploits with liquor and women. His turn-around into a successful businessman, entrepreneur, and VC is the surprising part of his post.

Anyway, that's not to say there won't be blood spilled on the way down. As I wrote about before, unicorns like Theranos will be increasingly pressured to validate their valuations and investors will feel the pain and lose money in the next round or when IPOs open at less than private valuations. The New York Times also had an interesting piece on LivingSocial's downfall as a cautionary tale to current-day free-spending startups flush with cash.

He-who-must-not-be-named hunts for unicorn (and Theranos?) blood (Harry Potter, Warner Bros. Pictures)

Jason Calacanis's most recent post agrees that the valuations are being deflated in a controlled fashion, but I disagree that they are completely back to earth and that all the "kvetching" about the bubble has been annoying. I don't want to be Chicken Little on this, but I believe the worrying has been fully warranted and has, rightfully, worried investors to be more conservative about valuations and investments.

Side note: It is interesting that in this private market, with little government oversight, investors are able to correct themselves; whereas in public, heavily-regulated markets, there is a significant boom-bust cycle. But that is a subject for another post and its causes are vigorously debated.

Another interesting coincidence, to start the year, is decreasing valuations and falling global stock markets. I'm no expert on global markets, so I wonder how they will affect each other. An obvious, impact will be on the number and size of IPOs. There is already a debate surrounding startups and when they should go public. Most investors, not surprisingly, push to file earlier; but that is countered with founders' desire to stay focused on product, not profits, and keep control of their companies without having to report to shareholders. 

Without getting into a whole other topic, HBR has an interesting article on finding that "sweet spot" based on a company's age.

I think there's consensus that there was a startup valuation bubble (I think it's still partially inflated), but it is continuing to correct itself.

I don't know how this will affect startups seeking funding in the future, but I doubt we will see as many unicorns develop this year.

1 comment:

  1. Related: