Pressure on startups is building with IPOs and sales stalled in a funk
bloomberg.com
bloomberg.com
The more riders there are, the more drivers you induce via price demand. With a large amount of drivers, you have quicker pickup times due to more drivers. With a large enough amount of demand, you make things like uberpool economically possible since the probability of another rider wanting a ride along your route is higher. With probability, you make it a near certainty over large numbers. It's kind of like insurance.
By having a large money stream available, you can create a tech advantage for things like uberpool to be better executed, where a city app competitor could not pool the income streams of many cities to make better tech.
I'm located in the Netherlands far away from it all, and to me this article cofirms exactly what it looks like from the outside. Things I'd be interested in knowng are:
- Employees and founders, are you afraid you might end up empty-handed? Do you manage to save some of those big SV paychecks in case it does go to shit?
- People on the investment side, do you see any real worries yet, or is everybody still in full on happy mode?
- Any remarks in general on what the mood in SV is on this? Do people talk about it, or are they mostly just going on like they have for the past years?
I'd love to get some insights!
As far as I can tell there haven't been murmurings of panic. It seems like a lot of these companies are doing ok enough. There's potential & they are "taking time to get it right" before going public. And they haven't had trouble finding large enough investment money to keep them going.
It's kind of painful to have been an employee at these places though because the wait is long. You were under compensated salary-wise relative to market while you worked there and the equity might be worth nothing or you might have to wait 8 years to see.
That's part of the reason why I next want to work at a public company where the stock actually has value when it vests.
Hard to say really. I'm just beginning to raise seed funding myself, so I'll have more perspective on that side soon. So far so good though.
On the VC side... I went to a VC panel in SF a couple weeks ago, and they all were gushing how this is the best time ever to raise money. They are all looking to invest.
There does seem to be a consensus though that investors are preferring to invest in "quality" businesses now vs chasing the Ubers and Uber for this. So potentially in line with the article talking about the levels of "uninvested cash".
This was at the nadir of the .com crash...
I'd mention though that the risk was well known. About 1 year ago most people started to realize that startup options are basically worthless, and similar to buying a lotto ticket.
You might think things are changing but it sounds like you and your friends are simply growing up and being more realistic.
- Rent seems to be holding steady or even dropping slightly over the last year, as opposed to the huge run up over the previous 3-4 years.
- There doesn't seem to be much poaching going on from my BigCo to startups -- less of a "gold rush" mentality among employees than at other times.
Want to start a new small business as an electrician or plumber? A manufacturing startup? A boutique hardware studio? Those kinds of businesses cannot promise returns orders of magnitudes higher than the investment with a straight face like software companies somehow can, and it seems like they are ignored because of the comparative risk/reward ratio.
But jeez, this is one fairly specific industry hoovering up all of this cheap money in our economy. While vast swaths of our economy remain gated behind enormous barriers of regulatory capture and capital investment.
What's going on?
Dividends, or excess capital returned to investors, generally require the business to have a stable profits/revenue streams.
Capital gains, or selling your equity for more than your purchase price, generally require nothing more than functional equity markets and investors with excess capital speculating on growth industries. Software is a growth industry where products can take hold and explode almost overnight, given software's scalability and the current availability of compute and networking infrastructure.
This move from investing based on present fundamentals (dividend) vs. theoretical future potential (capital gains) is puzzling some "value investors" that have relied on P/E (price to earnings) ratios to inform decisions in the past: https://www.bloomberg.com/news/articles/2017-06-08/goldman-s...
There's plenty of capital to go around, but everyone is trying to beat the very low returns you can get on safe, theoretically "risk-free", assets, and they want to do it as quick as possible. You do that by investing early in software, and waiting for the IPO or acquisition from entrenched players.
The real question is - who is left holding the bag when banks start to write the value of their equity holdings down? A lot of pension/retirement/index funds might have a lot less to return to their clients once central banks start to tighten monetary policy and reverse QE by selling bonds back on the market and raising short term interest rates.
As far as I can see, the issue is this: the Fed is trying to apply a macroeconomic loosening of the money supply to fight the deflation from the financial crisis. For political reasons, the old school Keynesian method of borrowing for more government spending can't be used. So, they are maintaining low rates to try to jumpstart the economy. Unfortunately, this money has to enter the economy through a financial system which is geographically imbalanced. So, we get inflation in SF, and NY, less inflation in cities with less finance industry, and deflation in much of the rest of the country. This seems to be the big economic issue of our time in the developed world.
Why we have two economies, and the financial system isn't arbitraging this difference away, I'm not sure. I recall reading an economist (Harold Innis maybe?) who warned about the centralizing effects of a Keynesian inflationary theory. Anyone know more about this?
I have to disagree with your take on Keynesian macroeconomics, however. Republican protests against raising the debt limit are for show & they always capitulate. Plus, concerns about inflation from Republicans are not as pressing a problem now that they control the purse strings. :)
I think you could have removed anything about Keynes and had a perfect comment. Your note about Sand Hill Road is spot-on.
Scales well enough for grameeb bank and the micro lending industry. Scales reasonably well enough for p2p lending. Scales beautifully for kickstarter style platforms. If Wall Street and VCs wanted and their HNI clientele were willing, they'd set aside a portion of investment dollars towards these borrower-lender marketplaces.
A central problem in the demand-side economy is that labor has no pricing power. While this sparked political revolt in the form of Trump's and Sanders's candidacies, little seems to actually be accomplished on solving this central problem. Consequently, companies living in supply-side world are kidding themselves if they think they can sell anything to actual people who earn a living.
There's a lot of simplification in what I wrote, but the point about labor having no pricing power holds. And to a lesser degree if the supply-side economy actually gives a damn about having a reliable floor of demand, they could find it in customers who have jobs that pay enough to drive demand.
I'm seeing this happen to a great degree in Southern California's apartment market. Rents keep increasing, but the incomes in the area don't justify the increases.
That's not actually happening. VC capital for tech / Internet / software start-ups is a hilariously trivial fraction of capital invested into the US economy and an even smaller fraction of the cheap money sloshing around.
Most of the cheap money in the US economy has gone back into the stock market and real-estate. Raise interest rates to historical norms if you want to know just how much cheap money is in real-estate right now ($10+ trillion?).
The over-valuation just on Google and Amazon right now amounts to a minimum of several hundred billion dollars. Apple's earnings and sales have fallen, rather than climbed, and their market cap expanded by hundreds of billions of dollars for absolutely no good reason other than money is desperately chasing returns due to the Fed's hyper low rates for the better part of a decade.
By itself that over-valuation amount, on just Amazon and Google, is more than all the capital invested by VCs into tech start-ups over the span of years.
But it goes far beyond tech companies in the stock market, it's every company. McDonald's hasn't grown for years - they're sporting a 27 PE ratio with zero growth for five years. Their overvaluation alone matches the total VC put into tech companies in a given year. Why did their stock go up 50% in the last two years, while their business contracted? Cheap money.
1) Money is still super cheap in the private equities, meaning companies that likely could IPO opt instead to stay private and take on more private cash to avoid public market scrutiny as they grow.
2) Because money is so cheap, it's easy for competition to pop up in any industry piquing venture interest. This is requiring companies to take losses to acquire customers. These fickle customers then have plenty of options to move to a competitor once the company tries to increase prices to hit positive margin. As an anecdote, I have absolutely no loyalty to most services I use these days.
3) This seems to create kind of a vicious cycle of VC-subsidized business operations, never allowing a large portion of these businesses to hit metrics that would appease the public, keeping most of them private, in friendly ecosystems in the short term.
Remember when everyone was talking about a bubble in '14? It wasn't a bubble in the end-point of these startups, it was a bubble in their initial creation and funding, and this is the consequence of that bubble: decreased returns, illiquid assets, the end of the 3-year cycle time without the values that were expected.
The biggest threat is your third point, as it makes the inevitable bust far more painful if you're able to paper over the long-term issues with short-term money. And the secondary threat is that there is no bust but this just continues on as a slow death, which slowly drains VCs of investment funds from other funds (pensions, etc.), which makes their money more expensive, which sucks out more money, repeat.
they have been saying this for years.
With Silicon Valley under pressure to make cash back from prior startup investments, more young tech companies will run out of money and die. Already this year, more than a billion dollars of investor money has been wiped out in the closing of tech startups like fitness hardware company Jawbone, food-delivery startup Sprig and messaging app Yik Yak. Expect to hear the colorful term "unicorpse" -- that's a dead startup unicorn -- much more in 2017.
Never even heard of Sprig and Yik Yak. From what I gather, neither were valued above $1 billion.
Instead of the media constantly trying to front-run the crash, why not just wait for it. If it's as obvious and inevitable as the media says it is, we shouldn't have to wait too long.
On the other hand, I think there are several "unicorns" that are still private that will do well as public companies -- Dropbox, Lyft, Stripe, and Airbnb. The success of these in the public markets will help the startup ecosystem and encourage venture capital funding.
With that said, I find the case of Blue Apron interesting. I have a hunch that it may have thought its best chance to go public and cash in was now -- that the environment for "unicorns" like itself (one that faces substantial competition, a weak product, fickle customer behavior, lack of customer retention and unstable cash flow) will only get worse.
Logic would make you hope this is true but never forget.. someone funded an umbrella sharing startup.
"...most tech startups that survive are sold rather than become public companies. "
The article then explains that "The value of U.S. technology company acquisitions fell by 66 percent in the first six months of 2017 compared with the same stretch a year ago".
All this analysis is interesting but unfortunately there is no mention of the tech startups that don't survive. I believe that might be the key factor for this.
It would also be nice to survey how many silicon valley startups are considering ICO's instead of IPO's and try to reason if that might bring new impact into the scene.
Away from the hype there is also the tax problem (the elephant in the room in most cryptocurrency/ICO articles). The country where the company is based and how it implements rules to tax and control such money might influence this at lot. A company is arguably starting with the wrong foot by thinking that it can get away from taxation with such money.
But besides money isn't a lot of the startup scene also about disruption ?
edited: typo and final question
And for an example of a startup that didn't survive, take Pebble, $15m in VC funding, ended up being sold for $23m. Not sure though how much of that actually went back to the VC. And this was a startup that had a paying customer base, active development community and a product in many big-chain stores.
Money is not created or lost it just changes hands.
If the VC funds don't get their money back it's because it's been spent on developers, offices, parties, bowls of fruit.
The main issue is that perhaps the money could have been better spent, perhaps charitably.