This Tech Bubble Is Bursting
This Tech Bubble Is Bursting
Despite record amount of money flowing into venture
capital, funding for startups is drying up
By CHRISTOPHER MIMS May 2, 2016 12:01 a.m. ET
When the dot-com bubble burst in early 2000, the fallout
for publicly traded stocks was quick and severe. The Nasdaq Composite Index
fell 37% in the 10 weeks following its peak on March 10, 2000.
For startups, the immediate impact was less dramatic. In
the second quarter of 2000, venture capitalists invested $25 billion in
startups, down only 5% from the first-quarter peak.
“There was a lot of suspended disbelief between March and
June,” says Keith Rabois, then a vice president at PayPal Inc. and now a
partner at Khosla Ventures.
Mr. Rabois and others think we’re now in a similar period
of suspension of disbelief. Startup investment has cooled. Valuations are
falling. But Mr. Rabois says many investors and entrepreneurs haven’t yet
grasped the new reality. “If that suspended disbelief ends, all hell breaks
loose,” he says.
The parallels between the two eras aren’t perfect. After
a seven-month decline, the Nasdaq index has gained 12% since early February.
As of April 18, it was within 5% of its post-2000 high.
Initial public offerings have all but disappeared, but venture-capital funds
raised a record amount of capital in the first quarter.
Mr. Rabois says the record fundraising actually is a
bearish sign. Winter is coming, he says, and venture capitalists know it.
“One of the reasons people are raising all these funds
isn’t because they want the money, but because they believe their own metrics
are inflated at the moment, and they want to get that money before companies in
their portfolios start crashing and burning,” he said. Some startups also are
employing a similar strategy.
Suhail Doshi, chief executive of app-analytics company
Mixpanel Inc., says his company has trimmed spending, including shedding some
employees, to weather any downturn. About 90% of the $77 million that Mixpanel
has raised is still in the bank, says Mr. Doshi, who says that at its current
spending rate, the company wouldn’t need additional funds for more than a
decade.
Companies such as Mixpanel may prove to be the exception.
Many startups are at risk of being stranded as funding dries up.
At least 145 private companies have won valuations
exceeding $1 billion. As venture investments flowed freely in recent years,
executives at many of those companies spent wildly, to outgrow rivals, bolster
recruiting or for other reasons. Now, they are left with a difficult choice:
cut costs drastically to become self-sustaining, or seek additional capital on
ever-more-onerous terms.
Venture capitalist Bill Gurley of Benchmark described
this phenomenon at length in a recent blog post, in which he alleged that
“dirty term sheets” allow some companies to continue raising money at higher
valuations by promising bigger payoffs to new investors at the expense of older
investors. That ultimately could render worthless shares held by employees and
even some founders.
As some of these companies with high burn rates run into
trouble, Mr. Rabois predicts a “catastrophic shift downward,” not just for
one-time highfliers but across startup investing. That is because
venture-capital firms are more interdependent than many people realize.
Investors who have been burned at one company will be
more reluctant to support high valuations elsewhere. As word spreads through
the venture community, other investors will turn cautious as well. Venture
investing is like any other market, torn between greed and fear.
“Without a doubt, the fear cycle is what we’re living
through right now,” says Yatin Mundkur, a venture capitalist at Artiman
Ventures, in Palo Alto, Calif.
“Empirically, there are so many unicorns that many of
them have to pop,” said Jason Lemkin, a venture capitalist formerly with Storm
Ventures. “Two hundred and some-odd unicorns won't yield that many
billion-dollar companies.”
Cracks are emerging at some companies. Messaging app
TangoMe Inc., mobile-gaming company Kabam Inc. and the parent company of
wearable-device maker Jawbone, all valued at $1 billion or more, have laid off
employees in the past few months. Another sign of increasing pressure: Nine of
the 88 U.S. companies valued at $1 billion or more, according to Dow Jones
VentureSource, have changed CEOs in the past several months.
The list includes health-benefits broker Zenefits Inc.,
last valued at $4.5 billion, where founder and CEO Parker Conrad resigned in
February after coming under fire for inadequate compliance procedures.
Capital-intensive startups that benefited from easy venture-capital financing
are arguably the most vulnerable to the new funding climate.
The biggest elephant in the room is Uber Technologies
Inc., valued at $62.5 billion. The company claims it is profitable by some
measures in North America, but it is spending huge amounts of money to capture
markets in China and elsewhere.
If the world’s most valuable startup must curtail its
ambitions, it would send shock waves through the whole system.
Precisely when current weakness in the system forces a
correction even sharper than what we’ve already seen is impossible to predict,
because it is about mass psychology as much as it is the financial system.
At that point, companies may fail the way Ernest
Hemingway’s character Mike Campbell in “The Sun Also Rises” said he went
bankrupt: “gradually, then suddenly.”
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