Is There a Bubble in Paradise?

Is There a Bubble in Paradise?

In December of 2010, the NYT published an article called “Silicon Valley Bubble Shows Signs of Reinflating” citing quotes from investors like Fred Wilson, Dave McClure, Chris Sacca, and more that set the tech world abuzz with repressed memories of 2000’s dotcom bust. Then Newsweek fanned the flames. Groupon turned down a $6 billion acquisition offer from Google, prompting Google CEO Eric Schmidt to comment that “there are clear signs of a bubble, but valuations are what the are”. The hand wringing in startup land reached a fever pitch when Color.com raised $41 million without even a whiff of revenue last month. So with Facebook valued at $75 billion, Groupon at $10 billion, and Twitter over $4.5 billion with almost zero revenue, can anyone deny that there is a bubble blowing in Silicon Valley?

The always thoughtful Ben Horowitz doesn’t think so. Ben argues that 2011 is very different from 2000 for several reasons:

  1. Public market valuations are presently much more in line with rationality.
  2. Venture funds today have raised only about 25% of the money they raised in the late 90’s, and have deployed less than half of the cash they did last time around.
  3. This time, the Internet boom has actually arrived.

Are these fair arguments? Is there a bubble in startup land? Let’s break it down.

Public market valuations are more rational today than in 2000, so there is not a bubble

On the surface, this seems to make a lot of sense. Looking at the table above (borrowed from Ben’s post), you’ll see that valuations of large public tech companies are certainly more in line with reality than they were in 2000. However, I don’t think that public market valuations of large companies with thousands of customers and hundreds of millions of dollars in revenue are necessarily a proxy for startup valuations (often pre-revenue, pre-customer base). Startups are notoriously difficult to value on objective metrics. Startup valuation is as much of an art as a science, and quality of the founding team or competition between venture firms is as often a driver of valuation as underlying financial fundamentals. I just think there are different dynamics at play in private early stage valuations than there are in the public markets.

Venture firms have deployed a smaller amount of capital, so there is not a bubble

Again, this stat is compelling on the surface. There can’t be a bubble if 2008-2010 saw such a relatively small amount of venture capital dollars deployed vs. 1998-2000 right? Sure, there may have been less capital invested, but into how many deals, and in what types of deals? In 1999, we saw tons of companies like Kozmo, WebVan, eToys, Pets.com, and more that raised and burned hundreds of millions in venture capital trying to build online businesses. They spent their money on expensive servers, bandwidth, and traditional media advertising. That’s no longer the case – startups are cheaper to start than ever before now that we have things like on-demand cloud computing, commoditized bandwidth and hosting, and the viral spread of hot ideas through social media. As Fred Wilson puts it, “you can now bootstrap yourself into existence”. In a world of less capital intensive startups, it makes sense that less VC money would be deployed. It doesn’t preclude those investments that are made from being at bubble-like valuations.

This time, the Internet boom has arrived, so higher valuations are justified

This one might hold a little more water. I agree with Ben that last time people’s expectations of the speed and scale of the internet’s takeover were vastly overinflated, which led to some crazy valuations that were based on a hope and a prayer rather than hard data. Ten years later, we have a much more realistic mental map of how internet technologies are developed, adopted, and integrated into existing industries. Today there are over 2 billion people in the world with internet access (30% of the world), and that number is growing by about 15% per year. Compare that with a worldwide internet user base of only about 360 million in 2000. It’s clear that maybe finally in 2011, the internet has begun to reach the global scale investors expected from it ten years earlier.

So, is there a bubble or not?

It depends on how you define “bubble”. Is there a bubble in the 1999, economy-wide, dotcom boom sense? I don’t think so. As Ben proves above, valuations for large public companies remain relatively rational. Retail investors are not betting their life savings on companies that have never earned a dime of revenue. At least in the public markets, signs of a technology bubble are tough to find. However, the private markets are another story. During the financial downturn of 2009 and 2010, tons of private equity and venture capital money sat on the sidelines in cash. Eventually though, that capital needs to be deployed so investment firms can deliver a return to their limited partners. As the economy has thawed a bit in 2011, a lot of that capital has started to come back into the market. This has led to a lot of capital chasing the same number of deals, and that drives valuations up as investment firms compete to get into the hottest deals. Are some of these valuations reaching bubble-like levels? I think so. However it’s important to remember that this bubble is specific to a small segment of investors, unlike the one in 2000. If/when startup valuations come back down to earth, a lot of venture guys and their limited partners may lose a fair chunk of change, but there’s very little danger of contagion to the greater public markets and economy. If anything, we’re seeing a bubble in the venture capital and angel investing communities, not the tech industry as a whole. So in the end TechCrunch will get all worked up for several more months, but in my opinion, the sky remains firmly in place.

About the Author

Bill DAlessandroI'm the CEO at Elements Brands - a company I built from scratch that sells branded consumer products online and in national retail stores. I ship thousands of orders each month, and focus on automation, technology, and digital marketing. I write about my experience with e-commerce, product creation, and lifestyle design, with lots of personal bits thrown in. More about me.

Comments

  1. I have no idea how groupon got so big… wow.  Also, Its looking a lot like a bubble to me!!

  2. Thanks Bill for the post. N0thing is really certain. They are all giants.

  3. Ehtesham hyder says:

    Thanks for post. You are doing great.

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