What Will a Market Correction Look Like?

“When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co’s will VAPORIZE.” – Marc Andreessen

We’re in the midst of a second California Gold Rush but this one’s in private equity. Investors are behaving like the 49ers of old, throwing caution to the wind and scrambling for coveted positions in a seemingly ever-expanding field of tech opportunities.

While the Silicon Valley faithful have mostly avoided the dreaded “B” word (bubble) like the plague, a growing list of entrepreneurs and venture capitalists agree that a correction of some sort is not a question of if but when.

At Re/code’s recent Code Conference in Rancho Palos Verdes, Snapchat CEO Evan Spiegel, who raised more than $1 billion for his ephemeral messaging app in just six months, said the bubble is a result of easy money policy, near zero interest rates and governments printing money. “I think that people are making riskier investments and I think there will be a correction,” he said.

Benchmark Capital’s Bill Gurley – whose investments include Zillow, GrubHub and Uber – was the first venture capitalist to sound the alarm. Since early last year he’s cautioned that startup burn rates are alarmingly high among money-losing companies and investors are flooding late-stage startups with enormous amounts of capital at sky-high valuations.

In a September 2014 Wall Street Journal interview, Gurley said, “I think that Silicon Valley as a whole or that the venture-capital community or startup community is taking on an excessive amount of risk right now. Unprecedented since '99. No one's fearful, everyone's greedy, and it will eventually end.”

In a series of tweets less than two weeks later, Marc Andreessen of Andreessen Horowitz said the last decade’s crop of founders have been spoiled by easy money at ever-higher valuations, saying, “THAT WILL NOT LAST. When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co’s will VAPORIZE.”

In March, perhaps the most famous beneficiary of the dot-com bubble, Mark Cuban – who made billions on the sale of Broadcast.com to Yahoo – said this tech bubble is worse than the previous one because, at least then, companies rushed to go public so investors could sell. That’s not the case with private equity. He says, “the only thing worse than a market with collapsing valuations is a market with no valuations and no liquidity.”

Meanwhile, there’s no shortage of entrepreneurs and investors living in denial of what seems a foregone conclusion.

While a number of CEOs of so-called Unicorns – venture-backed companies with $1 billion valuations – have been willing to go on the record on the subject, what’s telling are their overly creative explanations for why it’s different this time. And yet, they all come out sounding like magical thinking about infinitely elastic markets.

As IronSource CEO Tomer Bar-Zeev told Fortune in January, “I don’t think we’re in a tech bubble because I don’t think technology is something that can be separated into one discrete aspect of our lives anymore,” he said. “The growth potential for tech businesses is theoretically limitless.” That’s bubble talk if I’ve ever heard it.

Some folks sound almost superstitiously paranoid about even mentioning it. In a recent New York Times article, Tomasz Tunguz of Redpoint Ventures said, “I guess it is a scary word because in some sense no one wants it to stop. And so if you utter it, do you pop it?”

At the Code event, Zillow CEO Spencer Rascoff said, “The topic of allegedly excessive valuations of private companies is something that people should be talking about more. Nobody wants to talk about the “B” word, bubble, because nobody wants it to pop on their watch.” Translation: someone should talk about it, just not me.

Don’t get me wrong; there are plenty of naysayers out there. But the question is, are they credible?

Former Apple CEO John Sculley told USA Today that the landscape is different this time because Millennials have been “weaned on mobile devices and the share economy,” he said. “Today’s start-ups are valued higher, but they are ‘real businesses’ with proven financial models.”

Some are real businesses, but far too many startups are valued not on solid fundamentals but on monthly active users (MOUs), the assumption being they can monetize that customer-base at some future date to-be-determined. The problem is they’re all chasing the same finite sets of eyeballs, disposable income and ad dollars.

And former AOL chairman Steve Case thinks “There's a lot of capital, maybe a little froth in places like San Francisco or New York City or Boston, sort of the tech hubs, but most of the country is desperately in need of capital … I'm hopeful that there will be more people who are supportive of these young start-ups.”

Consider the source. Case led the most famous M&A disaster of the dot-com era – perhaps of all time – the $156 billion AOL-Time Warner megamerger.

What I think it comes down to is this. Private valuations are unsustainable so there will have to be some sort of correction. As for what that correction might look like, there will almost certainly be lots of layoffs and down funding rounds. Many startups will fail and be acquired for pennies on a dollar.

The result will be a shakeout in private equity, particularly amateur angels and crowdfunders who never should have been investing in early-stage startups to begin with. In addition, many VCs and institutional investors have “abandoned their traditional risk analysis,” writes Gurley on his Above the Crowd blog, and invested in “large, high-priced private financings that are the defining characteristic of this particular technology cycle.”

How this will affect the public markets is anyone’s guess. But considering the long-running bull market with all major indices near all-time highs, it seems a bit unrealistic to assume we won’t see a correction there, as well. Momentum stocks – particularly Internet, cloud computing, social media and clean-tech – that lack solid fundamentals will likely be hardest hit.

There is a silver lining, however. Once the private equity markets cool down, late-stage startups will be more likely to consider IPOs to raise capital. Let’s just hope the pendulum doesn’t swing all the way back to the irrational exuberance of the dot-com era.