When a Bubble Isn’t…?

TechCrunch Chart

Many are arguing that startups, and more specifically hi-tech startups are in a bubble. I’ve argued it myself herein and with colleagues over the past several months. Accelerators and Angel groups are popping up everywhere, from Akron to Auckland and everywhere in between. Money is flowing like champagne on an oligarchs yacht!

To the casual observer, and even to some of the VC world’s most prominent insiders the exuberance is creating some concern. On September 25th Marc Andreessen tweeted this (amongst 17 additional posts on the same subject):

When market turns, M&A mostly stops. Nobody will want to buy your cash-incinerating startup. There will be no Plan B. VAPORIZE.

Andreessen is of course referring to the majority of early-stage tech companies that raise a bucket of money, burn it up quickly while developing their product, hiring and ramping up, desperately trying to time that burn with the inevitable need for additional funding. All the while hoping to add enough value so as to be able to raise the next round higher than the last… get the (market) timing or the execution wrong and:

Raising new money becomes harder & harder. You have bigger bulldog to feed, need more and more $ at higher and higher valuations.

Therefore you take on escalating risk of a catastrophic down round. High-cash-burn startups almost never survive down rounds. VAPORIZE.

Even if you CAN raise an up round, you are increasingly likely to incur terrible structural terms like ratchets to chin the bar.

That nice hedge fund investor willing to hit your valuation bar? Imagine him owning 80% of co after down round. How nice will he be then?

You can read the full Twitter rant and more here.

We had this happen to us recently with a hi-tech company we invested into a couple of years ago. Management went after a specific market that didn’t pan out. They had to pivot, re-shuffle management and address another market. The unexpected additional burn ate up the cash, and when it came time to raise more money the company had to try a down round. Unfortunately even that was unsuccessful… VAPORIZED!

The chart below represents the amount of money raised by startups per TechCrunch headlines. In the spring of 2014, investment into startups totalled more than $5 billion over a 3 month period. By the fall of 2014, new investment has declined approximately 40%, to just over $3 billion.

TechCrunch Chart

Could we be seeing the early stages of a bubble bursting?

Maybe the top is clearly being signaled by the likes of Google, Facebook and Apple using their high-flying stock (Apple’s market cap topped $700 billion today!) as currency to pay what seems like ridiculous amounts for tech businesses run by groups of twenty-somethings. A billion is the new million. It’s not “real” money anyway, right?

It’s cheaper for these behemoths to use paper to potentially grab the next “big” thing and keep the competition at bay, or give them the slight edge that will keep those massive market caps growing.

Nowadays I regularly find myself in debates with kids who barely remember the dot bomb days. The topic is always why it’s different this time. Yes, I know it’s different now than it was then, it always (sarcasm) is.

But… here comes the punchline… As much as I don’t want to admit it, there may actually be some truth in that last statement. Andreessen also recently said that, “Software is eating the world.” There is a massive, paradigm shift occurring in the way business is done and wealth is created.

Instead of toiling in the fields and the factories, technology IS making things cheaper, faster and better in almost every industry that currently exists, and the new ones being created by this shift.

Nathan Heller wrote an excellent article for The New Yorker: Bay Watched: How San Francisco’s new entrepreneurial culture is changing the country. In the article Heller quotes Naval Ravikant, the founder of Angel List:

Once, an entrepreneur would go to a venture capitalist for an initial five-million-dollar funding round—money that was necessary for hardware costs, software costs, marketing, distribution, customer service, sales, and so on. Now there are online alternatives. ‘In 2005, the whole thing exploded,’ Ravikant told me. ‘Hardware? No, now you just put it on Amazon or Rackspace. Software? It’s all open-source. Distribution? It’s the App Store, it’s Facebook. Customer service? It’s Twitter—just respond to your best customers on Twitter and Get Satisfaction. Sales and marketing? It’s Google AdWords, AdSense. So the cost to build and launch a product went from five million…. and it’s now to fifty thousand.’ As a result, the number of companies skyrocketed, and so did the number of angels: suddenly, you didn’t need to be a venture-capital firm to afford early equity.

The cost to start a company, try an idea and secure a market is getting close to zero. With Kickstarter you can literally slap together a video, show some 3D drawings of your product “idea”, and raise money from people willing to purchase it before it’s even created! This is unprecedented.

This paradigm shift led The Economist to publish an extended article on startups titled A Cambrian Moment.

What’s a Cambrian moment? 540 million years ago there was an explosion of life forms on the planet. Prior to the “explosion” the planet was populated by simple organisms. No one is sure what triggered it, maybe it was an alien picnic basket left behind, a rise in global temperatures, a freak event, or… The end result was that within a few million years the plant and animal kingdoms became much more varied.

Over what amounted to millions and millions of years nature has purged most of the life forms that resulted from the Cambrian Moment. That left us with what we have today, which is also constantly evolving. Remember, something like 98% of all the life forms that ever lived are now extinct!

The Cambrian moment occurring in technology today is being created by new materials, more efficient manufacturing, inexpensive and powerful devices and platforms… the Internet! Like the original “Moment”, most of what is created now will evolve or become extinct at some point. Before that happens we’ll see thousands, perhaps millions of startups come and go.

Going back to the comment that it’s “different this time,” Joe Horowitz, a 30-year veteran of the VC world wrote a short but concise piece that Alex Konrad featured on Forbes recently:

During times of recession the economy is stimulated with low interest rates and once they get low enough, the yield on bonds and other fixed investments becomes so unattractive that money starts to flow into equities. Stocks begin to be described as bargains as CEOs of public companies scramble to trim costs and improve profitability.

Once the momentum of this flow of money gets into full speed, public fund managers search for ways to produce returns that are better than their peers, so the window begins to open for IPOs. The quality of these offerings are often very high because there is a pent-up inventory of successful venture backed companies ready for these moments. This leads to some great IPOs (i.e. ServiceNow, Workday, Palo Alto Networks, Twitter, FireEye, etc.) and the light of Silicon Valley begins to shine more brightly. But as these stories become more pervasive venture capital attracts more capital. Limited partners invariably over invest in the asset-class; public market investors chase high priced private deals and newly hatched seed funds sprout up from every espresso bar in San Francisco. Everyone is now a venture capitalist. All you need is access to capital and to be buzz-word compliant.

So are we entering the bubble part of this cycle? The answer is pretty clear from all the signs we are seeing; signs we have seen before. To [Benchmark partner] Bill Gurley’s credit he was the first to sound the alarm. There is little doubt that his recent comments about the pending risk of a bubble resonate with most experienced venture investors. The vast number of start-ups receiving capital today from inexperienced investors combined with excessive levels of funding at over-optimized valuations sets the stage for significant investor disappointment which puts us all at risk.

I’m not going to argue with economic cycles, or with Joe Horowitz. This has all happened before and it will happen again. I too think that the market is frothy. Valuations are high, but guess what, deals ARE getting funded and they are getting follow-ons and getting bought! Until they aren’t.

Right now this is the reality. Don’t fight the tape as they say on the floor. There will be winners and there will be losers.

My advice to investors is diversification, not just amongst their startup portfolio (obvious), but also in asset classes. Maybe it’s time to pare down what’s expensive and start buying what’s cheap..?

My advice to company founders is to take the money while it’s there. We could be one Black Swan event away from another 2007-2008 scenario, and even if we are not, the economic cycle will prevail, and when it turns you want to be as flush with cash as you can be to ride out the bottom.

Have a happy Thanksgiving to our US readers, and we’ll be back with you next week!

– Mark

“Many entrepreneurs today are very young and were not around in the late ’90s [during the dot-com boom], so there’s no institutional memory.” – Navin Chaddha, Mayfield Fund

Stability vs Opportunity


Bernie Madoff promised investors above average, consistent year after year mathematically impossible returns. Investors fell for the high returns but what they REALLY fell for was the apparent consistency. The stability or returns, the certainty.

Bond funds appeal to investors because they offer stable returns each year. Quantifiable and certain. Mutual funds tend to stuff portfolios full of bonds which themselves offer a set return allowing mutual fund managers the ability to promise more consistent returns. That most of them are terrible is not the point.

The corporate job offered stability of returns. I say offered because like the horse and buggy they’re destined for the scrap heap of history as mentioned in “Cubicle Jobs are Over” and the “March of Technology”.

Marriage offers stability of affection and love. Looking around me I feel like the odd one out. I’ve only got one wife, no ex.

Humans love stability and certainty. It’s why Volkswagen sold 9.7 million units last year and AVTOVAS, owner of the iconic Lada brand, sold 533,634 vehicles globally. The Lada, people have figured out, is both ugly as well as unreliable.

Millions of people get divorced each year, bond funds blow up, currencies move against investors. Corporate jobs disappear and about the only thing I’m willing to rely on is that Volkswagens won’t break down. Stability is a myth yet it’s what we humans strive for.

Stability is also NOT where the home runs lie. Jack Ma never became a billionaire through a corporate position, and Kyle Bass and Mark Hart never bought into the “stable” housing market. Instead, they shorted it. Definitely not considered a sure thing at the time. Nope, the payoffs exist outside of the norm.

I recently found myself speaking with a group of gents. One an insurance salesman, another an accountant and the third a partner in a law firm. I know, sounds like the start to a joke.

When they found out that what do for a living is invest in private companies including a healthy smattering of very early stage start-ups the response was overwhelming, “You’re mad, how can you do that? That’s so risky. Who do you sell your shares to? What happens if you need to sell?”.

They really lost it when I suggested it is completely normal and in fact expected to have a good number of these investments go to zero. They wanted stability.

To them what I do was more reprehensible than launching a drone attack on a wedding party or clubbing a seal pup to death in front of a kindergarten class. Clearly they would sooner see their children taken away for medical experiments than invest their capital into private equity.

The flaw in this thinking is that stability and consistency in mainstream investments are stable and consistent. Stability in markets all too often predates violent counter moves. Everything is fine, until it isn’t.

Take the yen which I’ve written so much about my fingers bled. We’ve also prepared a complimentary special report detailing how to trade it and Brad has outlined an asymmetric way to play it to the subscribers.

When we first began badgering you dear readers with the story it was 2012. The yen was in the 70s and we were building short positions. It had been stable for so long. Well, my gut is things are getting a little out of control. Certainly there are some folks unwinding their carry trade.


Feel free to read the free report here. We don’t think this trade is over by a long shot and everything we wrote about in that report is valid to this day.

This brings me back to private equity.

If you’re curious as to where the biggest returns have been in history let me give you a sampling.

  • We all know about Peter Thiel’s $500,000 investment into what eventually became Facebook. Thiel sold 80% of his shares 7 years later they netted him in excess of $400 Million.
  • Henry Flagler invested $100,000 into Standard oil in 1867 and by 1913 this investment was worth $75 Million, over 75,000% ROI.
  • Benchmark Capital invested US$6.7 million into what became known as eBay. In just 4 years this investment was worth $5 billion.

What you’ll find is that the big profits have been made by investing when these companies were PRIVATE.

The first lesson here is that investing for stability without a solid understanding of whether that stability is justified is as foolish as expecting your Lada to perform like a Volkswagen.

And secondly one is that balancing a portfolio with “opportunity” driven from understanding asymmetry such as the yen trade, and/or investing some portion of capital into well researched private equity deals actually makes a ton of sense. I can’t promise that you’ll not be viewed as insane by the average investor buying mutual funds, and CDs but who cares what others think?

Speaking of opportunity…

One of our investments is in a company which is looking for an entrepreneurial online marketing manager. If you’re a self starter seeking an exciting opportunity contact us here.

Have a great weekend.

– Chris

“Never think that lack of variability is stability. Don’t confuse lack of volatility with stability, ever.” – Nassim Nicholas Taleb

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