I have been a seed and early stage deep technology investor for the past 20 years. This means that I am part of the problem, so writing a column on a potential tech bubble is like asking an oil baron how he feels about natural habitats. I love the challenge of adding business perspectives to a research breakthrough, new innovation or patent portfolio. Doing this together with the most qualified people in their respective fields brings me enormous joy, but for some strange reason I have been starting to feel a bit uneasy lately…
As an entrepreneur, I went through the Swedish financial crisis of the early 1990’s, and as an investor I have experienced both the 2000 dot-com crash and the 2008 financial crash. A couple of years ago, I stated that I was 100% convinced that we would see a sharp downward correction in the technology market in the not-so-distant future. I am aware of the fact that the more often I say it, the higher the chance that I will eventually be right. The question is not if, but when it will happen and of course also what to name it. We have had the “railroad crash,” “great depression,” “oil crisis” and “dot-com crash.” Maybe go for something more poetic this time? Why not the “Urban mobility demolition derby” or “The slaughter of the Unicorns?”
It is incredible to see how quick the market forgets about earlier downturns. The excesses are back, and again I hear talk about “the new economy,” ”this time it’s different” and ”we’ll figure out the business model later.” We have a whole generation of investors, entrepreneurs and startup employees with no recollection or experience from the financial crisis of 2008 when there was NO money to be found anywhere.
A quick Google search will give you hundreds of interesting graphs showing the future of any market heading in any direction. There are numerous VC’s, analysts and experts that are better versed than I in the underlying number crunching. To mention a few, check out Mark Suster (@msuster) from Upfront Ventures on, Tom Wehmeier (@twehmeier) from Atomico on the and Anand Sanwal (@asanwal) from CB Insights on everything related. As an early stage deep tech investor (with the lack of a better description) I base my decisions on long term macro perspectives; the excellent work from people like the ones mentioned above, but also on my own subjective observations (or gut feeling if you will) of potential signs that this tech bubble is soon to see a sharp correction, i.e., things that I haven’t seen since before the last downturn:
First, in the market today there is an enormous surplus of available and risk prone money that is looking for returns higher than what you get in the bond market (i.e. anything more than zero). Every other day I hear or see news that later stage investors are turning to earlier stages because of the “amazing opportunities,” and I have heard many fund managers say that they are moving to earlier stages because of this.
You also see examples of private equity investors (by default with focus on “traditional,” “late” and “mature” investments) launching venture capital funds. Yet,(with anything more few and far between), you would be surprised to learn that hesitancy in investment is now a virtue. With the result being what are almost as good (or bad) signs as when your cab driver gives you advice on the stock market. SELL SELL SELL!
That said, it is also a fact that once interest rates go up (and eventually they will) from their historically low current level, investor appetite for low margin, high competition businesses will disappear overnight.
Second, you suddenly see people in traditionally high salary (low risk) professions such as investment banking, management consulting and law jumping ship and founding or joining start-ups. Really happy for them if they see an opportunity to “live the entrepreneurial dream,” but I have seen it before, and in many cases it is unfortunately just a sign of jealousy of all the money that is rumored to be made in the start-up world. Believe me, it is not as easy as it looks.
Also, employees today take big risks when joining companies with large negative cash flows, lured by “impressive” stock option programs that makes the companies hard to evaluate for an external investor, and multi-million acquihires (acquiring companies mainly to secure engineering talent) also point in the same direction.
However this will soon become a thing of the past as the startup boom draws to a close. Advances in hardware have already begun to rob these smaller companies of prototyping possibilities due to hardware’s increasingly expensive and complex nature. In terms of data, startups can never hope to achieve the levels already achieved by the Big Five, further hampering efforts to stand out when developing AI systems. In the self-driving space, startups are offering themselves up for acquisition rather than challenging the status quo – some will undoubtedly be acquired, but it is increasingly unlikely that they will become major players themselves. Instead playing fiddle to the kings court and offering tribute.
This is because incumbents have access to much of what startups would kill for. Not only when it comes to data, but to clients, client relationships, people and, of course, money. For the incumbents who have survived this past decade, we can expect to see them continue to consolidate power in the year’s to come – what doesn’t kill you makes you stronger. The question is if established companies will be able to ramp up innovation before startups ramp up user growth, and this goes for “all” industries.
Third, we see outrageous valuations with no or low profits, at least in relation to the level of funding. Also we have examples of private, venture-funded technology companies with vastly higher valuations than public ones post IPO. The argument for these valuations is that it is different this time (yes, some of us have heard that one before).
How overvalued? One study of 135 U.S. unicorns – private companies with reported valuations above $1 billion – suggests that after adjusting for valuation-inflating terms such as different share classes,(65 out of 135) lose their unicorn status. That’s a lot of donkeys in disguise.
One of the “new” explanations and excuses for these larger-than-life valuations is that priority No. 1 is customer acquisition and data mining of user data. This is even more important than actual revenues and (God forbid) profits. The thinking goes that once the users are in place, we can start working on business and revenue models. This is perfectly OK as long as venture funding is available and investors value a customer base higher than the bottom line, but will not work once the investor chicken race is over.
Again, as in 2000 we see “entrepreneurs” believing that venture funding is a viable business model in itself. An alarming endeavor, the largest number since the peak of the dot-com boom in 2000, when 81% of newly public companies were unprofitable.
Fourth, in an expanding market, money is “easily” available, price competition is often nonexistent, and customers are rarely price conscious, therefore everyone thrives. In an upturn, salaries are increasing and employees also see stock options and perks as important parts of the package. For the companies with less than stellar business models and margins, a downturn will mean that they will face increasing competition. This means lower margins, higher customer acquisition cost and the risk of losing key employees when perks disappear and stock options lose value.
I recently listened to the founder/CEO of a startup that had only raised a small seed round, but was now seeing good growth and being profitable, “we call this smart growth” he said. I double-checked with experts and they call it “standard business practice.”
Fifth, the explosion of networking events, meet-ups, incubators, maker spaces and conferences with vague or no specific focus. I love networking and being inspired by innovators and thinkers, preferably outside of my own comfort zone, but often today many meetings and spaces are nothing but brand building efforts to benefit the organizer. This means that the actual value for an attendant is very hard to measure. Recently I met with one entrepreneur that had come to the conclusion that it is a better idea to attend industry specific conferences with the aim of meeting potential customers than networking with other entrepreneurs looking for the next round of funding. How revolutionizing!
Having visited close to a dozen startup environments in Asia, the Middle East, Europe and the Americas in the last year, I am very impressed by the energy and curiosity on display. At the same time I have come to the realization that all these environments are equally unique, since you see the same fintech, mobile AI and gaming ideas everywhere.
One more thing. It’s natural that markets go up and down, and we can all state the obvious and talk about the emperor’s new clothes from time to time. That said, we live in a very interesting time. Technology will redefine society and the way we do business, and I am convinced that there are lots of long-term opportunities for entrepreneurs and investors in this ongoing techstorm.