Tech Startups Face Fresh Pressure on Valuations
wsj.com
wsj.com
That is an entirely expected and reasonable thing for them to do. And it's going to force some IPOs on companies that are not ready for it, and it will cause some companies that used to be "golden" to start dismantling. And that too is entirely expected.
And some people, perhaps a quite a few, who thought they were "set for life" and perhaps even thought their kids were set for life, will find that maybe they aren't really yet. That certainly happend to me during the dot com crash and it was a sobering experience.
But like the 1,000 sea turtles that crawl out of the sand and into the surf, the 100 that survive may do so for over a hundred years. Sadly there isn't any easy way to figure out which are the survivors until they are the last ones left standing.
Coming off the tails of the financial crisis and great recession rather than an era of relative peace and prosperity in the 90's, this latest round of tech investing has been surrounded by a lot more vitriol and fear than the accounts I've heard of the dot-com bubble, where almost everyone was benefitting from a booming stock market and strong economy, optimistic about the future of the internet, the country, and the world.
A prime example that really struck me the other day was PGs article on inequality. [0] In it he expressed that he felt like he was a wild animal being hunted - one of the most successful, famous, and well-respected VCs in the world feels threatened by macroeconomic rumblings? And he's expressing it publicly? Did this ever happen during the dot-com bubble? [1]
Perhaps this fear is a good thing, a tempering agent. It seems large, late-round pension funds and institutional investors (who probably manage a great deal of this country's retirement/savings accounts) are being cautious and performing due diligence on these tech investments, rather than simply going along with the crazy valuations and riding the bubble for higher management fees and bonuses.
[0] http://www.paulgraham.com/ineq.html
[1] "I feel rather like a wild animal overhearing a conversation between hunters. But the thing that strikes me most about the conversations I overhear is how confused they are. They don't even seem clear whether they want to kill me or not."
The only problem was that it was all fictional. Having your portfolio worth a million dollars now is useless when it's only worth $2000 when you go to sell. Getting six-figure salaries at a dot-com when you just have six months HTML experience is kinda ridiculous (okay, we have a variant of this today as well).
In many ways, this boom is a lot more honest, and a lot more real. It has winners and losers, many (but not all) of the winners put in years of hard work to get there, and people generally have a sense of where they stand. The problem is that there are far more losers than winners. That doesn't make for a positive mood, or a stable society.
This is exactly what you said was happening in the dotcom era: middle class people put in high paying positions.
The point about the stock market stands though. It is the strongest difference the current era has with the 90s.
The variant I'd have in mind is web designers masquerading as backend system developers. That's something Node has made possible. CSS and HTML experts usually know just enough JavaScript to be dangerous--JS is table stakes these days for UI work. Node creates the illusion that they can write backend middleware, APIs and services, too. Some of them surely can, but for every one of those, I've seen ten JS "rock stars" copy-and-pasting Angular and Express code from Stack Overflow, cargo cult style, at six figures.
I don't actually think that web developers of today moving down the stack is all that problematic. For one, a number of them can - modern web development is a lot more intricate than it was in 1997, and if you get beyond the Bootstrap stage, it usually requires that you actually understand fundamentals of how your browser works instead of just cargo-culting some code. People who can do that usually do well in any programming language. Beyond that, Node won't really let them - it will break pretty quickly if you don't understand callbacks, async patterns, modularity, etc.
The contemporary JS world has a lot of problems, but IMHO incompetent devs isn't actually one of them. (Going out on a limb, I'd argue that all its problems actually stem from devs that are too competent in one specific area not understanding what's important and what's not in the larger context of the software industry.)
The entry level bar is so much higher in 2015 that it's difficult to even compare. This feels more like the solo game programming boom of the late 80s and early 90s. Yes there's a ton of opportunity that's open to anyone with the skills. But it's nothing like the bubble was.
http://cdn.betakit.com/wp-content/uploads/2015/06/slide087-7...
The dot com crash was a bit different, people were using money raised by the sale of stock as working capital (the day to day money to fund operations) and when a few companies went "poof" those companies found not only could they not sell shares to the public, they couldn't sell them to private investors either. And without being actually cash flow positive they had to cease to exist, and after a couple of those well everyone was running for the door at that point, regardless of quality. A lot of companies simply ran out of cash to fund operations, and while they shrank to try to intercept their burn at a point where they were profitable, many didn't make it, and many were bought by other companies taking advantage of the overly depressed prices. Very much like the foreclosure market on homes.
So I think what this means is that you aren't going to be able to get some hedge fund or mutual fund to lead your funding round with a huge valuation. Instead everyone will want to "participate but not lead." That is the phrase that every CEO hates, it means "we don't believe your valuation, and you have to convince someone, other than you, that you're worth this or we won't invest any more." So it means that source of funding is now "much harder".
And because of that companies that are running short on cash have only three choices, debt, cut costs, or ask the public markets for money.
The debt financing market is full of sharks, they may already believe you are dead and still loan you money because the terms gets them paid first. And if they have a big enough piece, they wield way more power than the rest of the board of directors because they can put you out of business by calling your loan. That is why it is the last "all in" kind of bet you ever make as an entrepreneur.
Cutting costs is the only thing you are really 100% in control of, you can layoff half the staff, sublease your space, and eliminate any sorts of "perks" like meals or bus passes. You probably cut all travel for anyone except the CEO and the CFO (trying to raise more money) and get out of any trade shows or other venues where you have to pay to play (say SXSW for example). You can come out the other side of this stronger as a company but if you've previously had a pretty costly "culture" its going hurt morale big time.
And finally you can throw together your IPO, you can take it on the road, and try to get the public to buy it. Often times you'll do a big reverse split to get the share values up to a reasonable road show price, depending on how dead like you are your investment banker may structure it so that they make their money regardless (rachets, special additional stock dispensation, etc) and you are of course taking on a crap ton of additional filing and paperwork and regulation oversight.
And a number of companies will die. We don't really need three companies disrupting the taxi business, we only need one. We don't need three or four companies in the casual hospitality space, you really only need one, maybe two. Shopping delivery? A half of one perhaps. Things that are companies and look more like a feature? Well the become features of the company that acquires them. Did you add real value? Did you make something someone really wants? Is it really a market and not a fad? Great you survive. Was it just a gimmick? Or a cute idea that everyone tried once? Well you die. Well all learn something and the world turns around. And if you thought something should have survived and yet it died, then you can look at its life and what it tried and see where the world thought differently than you did. Was it market reach? Operational efficiency? Too many people trying to grab a piece? All great things we learn by trying to build companies that succeed and ones that die.
(love the sea turtle analogy)
The stupidity, of course, is the media and the rest of the Valley using VCs' own valuation as some sort of data, instead of the self-interested BS that it is. VCs are the greater-fool theory in action, and the greatest fool are the retail investors. Look at Groupon that somehow IPOed, and the only ones that lost money were the mutual funds and retail suckers that bought in.
VCs are considered great if they are right 1 out of 10 times. The only reason why they don't go belly up is because they stack the deck in their favor through liquidation preferences, onerous funding terms, etc. So why on earth would we believe them when they say companies like Lyft are worth 5B or Snapchat is worth 20B?
When the Revaluation of 2016 hits, it will be harsh and immediate. VCs act like a flock of birds and it's binary. Either they are in feeding frenzy mode, or they are cowards on the sidelines. When a couple of VCs start getting cold feet, they all get cold feet, and when that happens, unicorns start dying. Companies like Dropbox that have a real business model but whose maximum prospect of profits have been critically injured by Box's IPO, will probably get destroyed by either horrible funding terms or a Square-like IPO. Lyft will probably be dead by the end of 2016, and people will be wondering how they burned through 1.5B in funding.
My bet is that 2/3 of the unicorns are acquihired for terrible terms, dead or on life-support by the end of 2016. If only I could short them, I would, but since I'm living in the Valley, I'm probably going to be negatively affected by this unfortunately.
I make this same prediction, and the consequences will affect me as well.
Hey it's not all bad. The last time this happened, traffic on 101 got really great for a few years and you could get a reservation at any restaurant you wanted to (assuming you could afford it).
There is plenty of artistic license in that film so I don't know how true that really is but its quite exciting for small counter-intuitive "surprises" like this to be the early indicators for massive global events.
That's where we disagree. It's hard for a private market to have a quick correction, especially since (a) VCs can't completely shut down, they'll just be much more aggressive on valuation and (b) many/most unicorns have huge war chests. If they see the market has turned against them, they'll slow down growth and extend their runway to prevent having to raise another round.
> If only I could short them
This is one of the biggest factors which prevents a collapse. Only bulls get to set prices: bears don't have a market mechanism to express their opinion. When investors become more bearish, we'll see a slowdown in funding—but not a "harsh and immediate" crash.
In other words, it is hard to quantify the extent to which coverage about how the IPO market is going to stink, and how valuations are going to hit the toilet actually cause IPO markets to suck and valuations to hit the toilet.
Here's where and why I think the disconnect happens. Most of our possessions in day to day life tend to have a relatively stable value. Your iPhone 6 is worth $600 dollars, oranges are $2/lbs, a t-shirt is $20. Markets for non-capital goods (i.e. goods that are consumed with 1 yr or so) are very efficient most of the time. However, the claim that 'markets are efficient' (and the kinda-corollary that there's some stable intrinsic price) gets applied to all markets all the time. But markets for capital goods are not efficient all the time (by capital goods I mean something where the lifetime is greater than 1 year ... e.g. houses, airplanes, financial investments like stocks & bonds). Because most things in our everyday life have some 'true' value its seems wrong that there are assets that don't have an 'intrinsic' value or whose value is determined by perception.
However value is determined by perception. A great example of this is GE. A little history ... up until the early 90's GE used to fund itself almost entirely with short term debt. GE was able to do this because everyone considered GE a AAA credit risk. This 'AAA' expectation from the market actually meant huge additional profits for GE because GE could continually borrow short term debt at short term rates (say 1%) and turn around and lend their customers money at longer term rates (say 5%) picking up spread. In the early 1990's Bill Gross came out and basically said 'this is crazy ... there's no way a company that is financed almost entirely with short term debt is a AAA credit'. Subsequently, GE was forced to term out their debt and this coincided with GE no longer outperforming the market (I haven't followed that closely but I think that GE has slowly been winding down GE Finance). The point here is that expectations (specifically that GE was a AAA credit) had a huge impact on the 'intrinsic' value of the company.
[0]: The Jay & Farhad Show: The Tech Industry: Tech Bubble or Tech Bust? https://overcast.fm/+DcD5EhUGs
In part because each of those overvalued and overfunded startup were buying Sun servers, Cisco switches, EMC storage, etc. Now they're renting some EC2 instances or whatever. As a result, when the bubble deflates at least a bit, the impact is hopefully largely limited to some VC portfolios, premium developer salaries in some geos, and maybe the income flow for some northern California landlords (or those who paid $2M for a fixer-upper in that area). Not especially pleasant for those involved to be sure, but hopefully not a huge deal for everyone else.
You're right though, "the cloud" is siphoning up a lot of money that would be going to others.
I do wonder how much damage a cloud-everything approach does in start-ups when it goes wrong.
For one thing, I've seen a few early stage stories where businesses seemed to be spending more per month on the fees for the 20+ online services they use than they were spending on hiring good people. They get locked in and dependent, and then their costs are ongoing and scale up with things like head count. A few years ago you might have bought a handful of servers and hired an IT guy to do the same kind of things, and maybe you'd also build-or-buy a small number of software tools for admin purposes.
The usual arguments against that old school approach seem to be that going to the cloud outsources most of the admin work leading to better security/reliability and that it allows better scalability, but I don't really buy either of those as a blanket statement.
In terms of admin, you still have to both identify the cloud services you want to use, in possibly the most hype-driven market I have ever seen, and spend the time to set them up. Those are not small overheads.
In terms of reliability, as we've seen with things like Amazon outages, even relatively well-established businesses who you'd think would know better still don't actually get their resources set up to be properly resilient under pressure, so the idea that you no longer need smart in-house people to run IT just doesn't hold water.
And in terms of scalability, while you certainly can scale almost in real time with some of these services, how many start-ups really need to scale faster than they could rack up some new servers and networking gear of their own with a standard image installed? The downside of paying much higher long-term costs for basic computing and storage resources seems to kick in relatively low with a lot of cloud pricing today.
Obviously there have been some very successful online startups in recent years, both in B2C and B2B spaces, but I do wonder sometimes whether a lot of these XaaS cloud providers are really providing the clear advantages that so many people keep talking about.
Instead, I went into the telecom sector. With a specialty in Sun Microsystems work. Evidently I am awful at being prescient.
The majority of companies funded back then were e-commerce plays focused around selling the same items you buy offline for less money and making up the difference with VC money. As a consumer, it was pretty awesome. I remember signing up for AllAdvantage.com in high school (that was a startup that would pay you to view ads, and pay you for referring friends to view ads), installing the toolbar, pocketing about $50, and then uninstalling the toolbar once they crashed & burned and were no longer paying out money. My sister (newly arrived at college) fell in love with Kozmo.com, which would deliver groceries to your door at about 20% under supermarket prices.
The whole thing was a pyramid scheme designed to prop up valuations by incentivizing early adopters with discount prices, subsidized by VC dollars, who would unload the shares on the gullible public markets for higher valuations. The early adopters got some nifty conveniences at bargain basement prices; a few lucky founders & VCs got massively wealthy; most of the unlucky founders & employees wasted about 5 years of their life; and the gullible public lost their life savings.
There's some of that now, but it's much more muted. My wife and I ate very well this summer off delivery startups that were offering FaceBook deals with VC money for prices under supermarkets. However, most of the giant companies this time around actually have solid business models that operate more efficiently than existing incumbents. AirBnB takes advantage of surplus housing capacity. Uber breaks local laws that enforce inefficiency. WhatsApp ran a really lean organization so they could offer text-messaging services at a fraction of the cost of a telecom giant. Instacart charges more than the supermarket, and people pay it. Slack has made office messaging fun. SnapChat at least realizes that its lack of revenue is a major problem, and they're heads-down trying to fix it.
The public markets are not as gullible now as they were then, and so the "unload on the unsuspecting public" strategy doesn't work as well. Companies that are based on nothing but hype & investors dollars often flame out around the C round now; we saw some of that with Secret and Homejoy.
http://www.fastcompany.com/3055033/instacart-raises-fees-and...
It isn't 1999 again, but I wouldn't go so far to assume that "most" of the giant companies are solid businesses just yet. As Buffett said, you don't know who is wearing swim trunks until the tide goes out. Even if companies aren't obviously subsidizing their customers' purchases (as in the first boom), there's a lot of bubble money sloshing around, making everyone's revenue numbers look better.
They have a business model. It just takes capital to spin up new markets. (They run a market at a loss initially, until its mature enough to take profit from.)
What we know from observable evidence is that they're raising tons of money, and funneling it into growth. We also know that there are lots of subsidies, on both sides of the market -- even in San Francisco, the most mature of Uber's markets, I regularly see and hear of driver referral bonuses.
It could well be that without the easy money, the Uber story becomes a lot less compelling. Time will tell.
http://www.businessinsider.com/uber-revenue-rides-drivers-an...
One of the ironic things about Uber is that after they overcome regulatory hurdles in new markets, they make business dramatically easier for their competitors. Taxi service without regulatory capture is a commodity product.
Just chiming in with an example of the ridiculousness of ecommerce plays in 1999.
Shit. This is exactly the Indian startup scene at the moment.
He mentions box.net but ignores dropbox. No mention of Air BNB, Uber, Snapchat, Slack. Although these aren't public, there is an investor bias against hardware, but such a bias is warranted given the storied history of once high-flying hardware companies eventually soaking investors due to profit margin compression, competition, or becoming fads or obsoleted, examples being Sony, Atari, Garmin, Nintendo, Sega, Fitbit, Nokia, Motorola, Gopro, Jawbone, Skull Candy, Research in Motion, and many more.
Yeah, there is valuation pressure, but for companies that aren't very good. This is evidence investors are becoming smarter and more selective, whereas in the 90's a company like Fitbit would have had a PE ratio of 500 instead of 50, which is what it is right now.
Personally, I think Snapchat has the most to prove.
Snapchat, on the other hand, at least provides a communication channel for a very active demographics. Yes, it has to compete with a lot of big guys in the space, but the utility is there in the product.
I think someone said it elsewhere in the thread, they're replacing all those magazines suburban housewives used to read, and they can advertise more efficiently than those magazines because they have better data about you and can get between you and the transaction.
Tweet from 2012. If the graph Levie is referring to is indeed accurate, then fast forwarding 3 years later means growth for Pinterest has effectively halted.
They did have extremely explosive growth though (perhaps the fastest ever?)
I'm very bullish in Pinterest (see my other comments), but that may indicate a challenge to them.
OTOH, in comparison to an older site like ebay, they do have pretty significant traffic[2].
[1] https://www.google.com.au/trends/explore#q=pinterest%2C%20sn...
[2] https://www.google.com.au/trends/explore#q=pinterest%2C%20sn...
Yes, I understand they aren't monetizing it. Yet.
At least Snapchat has gotten much more serious about experimenting with ads. Pinterest is still in this early Facebook stage of "we don't really care about making money right now," which I don't think really flies anymore for a company of that stage.
Could be worse. [1] That impressive building complex on the San Francisco bay was built to be the new headquarters of Excite@Home, which went bust in the first dot-com crash. Those buildings were empty for most of a decade.
Not every overvalued public offering was such initially. This isn't the case now, nor was it the case during the first bubble.