About a year ago I started seeing early signs of a tech bubble. We weren’t exactly partying like it was 1999, but valuations of private startups and multiples of certain public sectors were definitely on the frothy side. Nevertheless, we weren’t in bubble territory. Not yet.
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By March of 2014, that ship had sailed.
Facebook (FB) took a trip to Crazytown and acquired WhatsApp for a staggering $19 billion, albeit a drop in the bucket of the social network’s $180 billion market cap. Meanwhile public multiples and private valuations of Internet, cloud, social media and clean-tech companies were sky-high. And the Nasdaq was within spitting distance of its all-time peak.
It was official: We were in a tech bubble.
Warren Buffett had a different view, saying, “I don’t see it. We do not have a big bubble market now.” What does he know? Hedge-fund manager David Einhorn was emphatic, saying, “Now there is a clear consensus that we are witnessing our second tech bubble in 15 years. What is uncertain is how much further the bubble can expand, and what might pop it."
Besides all the obvious signs that the market looked like a duck and quacked like a duck, what sealed the deal for me was how creative everyone was getting in order to justify the unjustifiable. Mostly they described a perfectly elastic market with infinite growth potential, the same sort of loony assumption we used to hear back in 1999.
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"While some VCs might be young enough to be subject to the muscle memory analogy, most were around to get burned during the first bubble. And therein lies the rub."
The flaw in the ointment is that all these hundreds of companies would somehow magically manage to monetize their ridiculously high valuations at some point in the future. There was no comprehension that they were actually competing for the same sets of eyeballs and limited disposal income.
The other thing I kept hearing was how there’s no precedent for this sort of thing. How, this time, it’s different; how fundamentals like revenues and profits don’t apply here. And as I said back then, most of that crazy talk came “from people who were still in college when the dot-com bubble burst.”
Six months later, Benchmark Capital’s Bill Gurley -- one of the smartest VCs around -- sounded the alarm that the tech industry had indeed gotten way ahead of itself. In a Wall Street Journal interview, he said, "I think that Silicon Valley as a whole … is taking on an excessive amount of risk right now -- unprecedented since '99."
He talked about how more people are working for money-losing companies and average burn rates at venture-backed firms are at an all-time high since the dot-com era -- maybe even higher. And he said, “No one's fearful, everyone's greedy, and it will eventually end.” And so on.
He also said more than half of today’s entrepreneurs weren’t around for the first bubble, “so they have no muscle memory whatsoever.” As I always say, great minds think alike.
Still, you can’t lay this entirely at the founder’s feet. While some VCs might be young enough to be subject to the muscle memory analogy, most were around to get burned during the first bubble.
And therein lies the rub. Most of those VCs, as well as the bankers that underwrite all the IPOs and secondary offerings, have already made their millions, if not billions. While they may remember the pain they know that anticipating a bubble and pulling out too soon can be just as risky as waiting until after the fact.
Let’s not forget that the dot-com bubble didn’t burst all at once. The market dropped, came back, dropped some more, came back even stronger, and bounced around for quite a few months before settling down to several years of sustained decline. There was plenty of time for investors to pull out of the public markets -- that is if they weren’t too greedy and didn’t fall victim to those insidious dead-count bounces.
Of course it’s quite a bit different for VCs. Their deals are long term. And while they are typically the first and often the only creditors to get anything back before their companies go south, that’s usually pennies on the dollar. On the other hand, at least for them, there always does seem to be a silver lining.
It’s easy to overlook that what followed the Millennial bust was the mother of all creative destruction as the Internet reinvented itself as Web 2.0. That’s when Google (GOOGL) launched AdWords, Steve Jobs reinvented Apple (AAPL), and LinkedIn (LNKD), Facebook, Twitter (TWTR) and dozens of other outstanding companies came into being. Once again, the Sequoias, Greylocks and Benchmarks of Sand Hill Road made out like bandits.
As long as those with the purse strings -- the venture capitalists and investment bankers -- stick with their “get while the getting’s good and risk be damned” philosophy, we will always be subject to the tech industry’s boom and bust cycles. But to be fair, that’s the main reason why we’re here going through this all over again. And hopefully a little richer for our trouble.
The good news is no matter which part of the cycle we’re in, the entrepreneurs keep right on innovating and the VCs have got to put their limited partners’ money somewhere. Then it’s just up to us -- ordinary investors -- to notice that it’s déjà vu all over again. That we’ve been here before. And to quit being so greedy and hedge our bets, simple as that. God speed.