Technophiles, set aside your New York versus Silicon Valley squabbling for a moment and stop hand-wringing over IPO-shy start-ups long enough to consider something potentially more dire: Is the current boom turning into a bubble?
In case you hadn’t noticed, tech is cool again in a way it hasn’t been since those halcyon days when dot-com entrepreneurs realized that people might actually be willing to share their credit card numbers online. This time around, it’s the intersection of smartphones and social networks that is creating a bubblicious glint in investors’ eyes. Union Square Ventures’ Fred Wilson warned of “unnatural acts” like entrepreneurs showing up to pitch meetings with lists of financial demands, and small teams getting valued at more than $30 million. GigaOm’s Om Malick thinks Google paying an engineer $3.5 million dollars not to defect to Facebook demonstrates a return to irrationality. And IA Ventures’ Roger Ehrenberg likens the influx of hobbyist angel investors, eager to jump into the overheated market, to the guys in Bubble 1.0 whose obsession was slapping “dot-com” onto just about anything and watching the dollars roll in. After all, no one wants to be the guy that missed investing in the next Facebook.
The warning signs are so pervasive that they even made their way onto last week’s episode of The Office when Ryan tried to explain why running out of cash for his start-up was no cause for alarm. “The first lesson of Silicon Valley is that you only think about the user, the experience, you actually don’t think about the money … ever.” Does the increasingly frothy market mean we’re doomed to repeat the mistakes of our tech ancestors?
Here’s what’s similar.
Like the late nineties, deal flow is up. More than 5,100 tech mergers and acquisitions were made so far this year, the highest since 2000. In New York City alone, venture-capital investment is up 22 percent over last year. “When I look at where we are right now, it reminds me so much of 1999 and frankly it scares me,” Wilson blogged yesterday, after looking at his own portfolio.
Back then, buzzwords like “e-commerce” were used without a clear idea of where the profits would come from or how big they would be. In the past few years, terms like social media, augmented reality, and location awareness have generated similar levels of hype. Once again, entrepreneurs are telling themselves, “If you build it, they will come” — delaying concerns about revenue in favor of growing a dedicated user base. Cool companies with happy users but no clear path to profitability are having an easy time finding money. For example, see Friday’s announcement that Tumblr, a start-up with “rocket-trail” growth but no defined revenue strategy, picked up an additional $25 million to $30 million in investment from its recent trip to Silicon Valley.
There are also some familiar faces back on the scene. Morgan Stanley’s star analyst, Mary “Queen of the Internet” Meeker, whose bullish research fell out of favor after the bust, resurfaced with another bullish prediction last week: advertising for mobile web would become a $50 billion business.
Here’s what’s different.
The biggest change, of course, is the size of the potential market. During the first bubble, only 5 percent of the population had Internet access. A decade later, almost 30 percent of U.S. consumers have a smartphone, and services like Facebook and Twitter have gone mainstream.
“Get big fast” might still be the entrepreneur’s mantra, but the amount of capital that’s required is drastically reduced. Start-ups can launch and test their concept for a lot less cash. With platforms like Twitter, Facebook, and the iPhone, which all allow third-party developers to build for their systems, it’s a lot easier to get distribution and reach millions of consumers quickly — something companies from the dot-com bubble got tripped up on.
Another important distinction this time around is that entrepreneurs aren’t necessarily looking for a get-rich-quick exit. Back then, founders cashed out on sky-high IPOs, leaving their start-ups without a dedicated visionary to see the concept through. As Wilson explained at the Web 2.0 conference, back then, 30 to 40 percent of a VC firm’s investment portfolio would go public, whether the start-ups deserved to or not. The NASDAQ still hasn’t recovered. With the horror stories in mind, companies are now much more reticent, and happy to stay private. Early investors that want their money have an easy time selling shares on the secondary market. That’s good for market volatility — if they fail, the whole stock market won’t come crashing down.
Unfortunately, all those unsupported valuations (is Facebook really worth $41 billion?) and unproven niches (will people still care about “check-ins” in 2011?) means that breakout companies are rapidly being cloned. Gilt Groupe, the designer discount site, and Groupon, which is currently being courted by Google, have both seen a slew of copycats, who are then getting funded in turn.
Here’s why it’s not all bad.
Fears about a tech bubble are as cyclical as markets themselves. And they don’t always lead to a bust. At Web 2.0, John Doerr, “the Michael Jordon of venture capital,” tried to convince Wilson there was an upside to the overheating, arguing that a better caliber of entrepreneur and the size of the market mean it might not be all froth. “We’re right in the middle of a huge third wave — the entrepreneurs are better, the ideas are better, the markets are larger … I prefer to think of these bubbles as booms. I think booms are good. Booms lead to over-investment, booms lead to full employment. Booms lead to lots of innovation.” Crashes, of course, do the opposite. But it is true that this wave of entrepreneurs, who grew up steeped in Internet culture, seems to have a better idea of who to build for: themselves.
Despite the inevitable “hangover associated with the party” (i.e. lost fortunes and failed companies), Wilson himself concedes every bubble has its silver lining:
In short, if investors temper their exuberance with a tiny bit of rationality, they might actually make it out the other side with enough cash to invest in the next Facebook — whatever that might be.
As Technology Deals Boom, the Talk Turns to Bubbles [Deal Book/NYT]
Wilson Vs. Doerr. Bubble Vs. Boom. [TechCrunch]
Don’t Blow It! New York Tech’s Top Investors Have Bubble Trouble on the Brain [NYO]
