Bubble?

The blog post dejour for those in the startup community (including several VCs) is to discuss an upcoming bubble.  These folks who are mentioning the bubble are those in the software sector, which includes consumer, enterprise and infrastructure.  The cleantech, hardware, and life science sectors are not part of this conversation.

There have been two bubbles in past 10 years, both which I was a witness of.  I’m not going to go into great length describing the two bubbles as there have been plenty of articles written on the topic, but here is a quick summary.

2000-2001 : many VC backed companies did not have the proper financial basis to go IPO, research Pets.com and Webvan for details.  Essentially too much speculation.  This bubble was mainly driven by the valley, VCs, startups and I-bankers.  Rightly or wrongly, a lot of money was invested into enterprise/infrastructure for the potential Y2K bug.  This downturn was exacerbated by 9/11.  Over $100B was invested by VCs in 2000.  NASDAQ dropped from ~5,000 in March 2000 to ~1,500 in September 2001.

2007-2008:  a lot of VC backed companies were raising large Series A rounds of $6M, with not much to show in terms of customer/revenue traction.  Follow on rounds were being done at inflated valuations, $50M+. The stock market tanked, primarily driven by inflated residential real estate prices, which was enabled by loose underwriting guidelines and poorly collateralized investment vehicles.  The difference is that the 2007 market crash was not the fault of tech companies, as it was in 2000-2001.  $32B was invested by VCs in 2007 (compare that to $100B in 2000).  NASDAQ dropped from ~2,800 in October 2007 to ~1,300 in November 2008.

2011?: Folks are saying there will be crash, the problem is that they are not providing specific data points as to why they believe this is going to happen.  What I hear from VCs is “it feels like a bubble is going to happen”.  I also hear, “valuations are too high for Series A deals”.  In 2010, we are on pace for $22B to be invested by VCs (compare that to $32B in 2007 and $100B in 2000).

We are not in a bubble, here is why:

  • Stock market is already depressed, so it will not pop as it did in 2000/2001 and 2007/2008
  • Overall economy continues to be very poor (except for tech) and unemployment is very high (except for tech)
  • There is a lot less supply of VC money.  In 2000 and 2007, there was too much supply of VC dollars.  In 2007, there was roughly $35B invested and 2010 it will likely be $22B.  Many VC firms are going out of business and follow on funds are typically much smaller (ie DFJ $650M to $350M, Menlo $1.2B to $400M, and many more)
  • Angels/Micro-VCs/Super Angels in aggregate equal ~$600M, that is roughly the size of one VC fund
  • Series A/Seed rounds or initial rounds of financing are much smaller.  In 2007, there were ~$6M, now they are ~$1.5M
  • Valuation of Series A/Seed rounds are much lower, In 2007, they were $6M Pre on a $6M raise, so $12M Post.  Now they are $4M Pre on a $1.5M raise, so a $5.5M Post
  • There is a lot of money sitting on the sidelines by startup acquires such as: Apple, Google, Oracle, Amazon, Cisco, Microsoft, HP, etc.  This cash will continue to be used to acquire startup companies 2011 as these large public companies need revenue/product growth, which is what acquired startups provide.

A point of emphasis, some VCs are saying there is going to be Angel/MicroVC/Super Angel bubble.  As I mentioned previously, if you add all these dollars, it is likely to be $600M, which is less than one VC fund.  Lets do that math Floodgate ($75M), SV Angel ($20M), 500 Hats ($30M), OATV ($51M), Lowercase ($8.5M), K9 Ventures ($6M), SofttechVC ($12M), Felicis Ventures ($40M), Harrison Metal (?), Baseline (?),Y Combinator ($8.25M), TechStars ($2.5M), Founder Collective ($40M), IA Ventures ($25M), etc.  The majority of the firms I mentioned have funds, of which many were raised in the past 12 months, so they still have another 12 to 24 months of runway, as most funds are deployed within three years.  In addition to the $500M, lets add another $100M for individual angels, some of who are active on AngelList, so in total $500M + $100M = $600M in the seed/angel category.  The seed rounds also include traditional VCs (funds larger that $100M) such as Sequoia, CRV, Trinity, Redpoint, Polaris, True, Greylock, First Round, Union Square,  etc.   It is difficult to know how much money from these funds are allocated for seed rounds, but it total, I would guess it it close to an additional $500M.  In total we there is $1.1B available for seed rounds ($500M + $100M + $500M).  In the big scheme of things these seed rounds make up a very small part of total VC dollars invested, which will likely be $22B this year. 

There is certainly an argument to be made about the challenges of finding great engineering talent, but that will not result in a bubble occurring.  Yes, there are a lot of incubators that are popping up, if those fail, that will not create bubble, they would be collateral damage.

There are a lot of companies that received seed funding this year who will not be successful, but that is not a definition of a bubble.  These companies are raising much smaller rounds ($1M compared to $6M) and they are lot more capital efficient.  Only a small percentage of startups become successful, this is true now and was true 10, 20 and 30 years ago.  Yes, many of the seed funded startups will not raise a follow on round of financing.  Seed rounds are meant to allow the startup to make a go of their business and if they fail to execute, they will not get additional funding, the next round of funding is never promised in this business.  In addition, there is a great emphasis for startups to get to cash flow positive and that a revenue model must be proven.

In summary, 2011 will be a good year for startups who are raising seed rounds, there is sufficient cash available, so go get it!

Sites that provided some of the data I used for this post:

http://www.chubbybrain.com/blog/a-guide-to-super-angel-investors-who-are-they-what-do-they-invest-in/

https://www.pwcmoneytree.com

http://www.businessinsider.com/who-are-the-super-angels-a-comprehensive-guide-2010-10?slop=1

2 thoughts on “Bubble?

  1. Pingback: Pre-Marketing 12/17 – gpkendall.com

  2. Pingback: 2010 in review « Shai's Blog

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