Why There Might Never Be Another Tech Bubble
If you have been in the technology business since the mid to late 90’s, the Internet bubble was probably the most memorable bad moment that happened in and around 2000/2001.
Recently, talk about a resurgent “tech bubble” comes back intermittently, with the proverbial question being: “are we in a tech bubble”?
My opinion today is that we don’t need to fear the repercussions of a tech bubble again, at least not in the way of its previous devastating effects.
Let’s first understand the causal factors of the previous bubble. A brief history and post-mortem point to what happened:
- Over exuberance and hype about the Internet’s capabilities – just reading media articles in 2000 would demonstrate that.
- Over abundance of venture capital commitments – close to $100 Billion were poured in 2000 alone.
- Less experienced VCs running funds – some large funds were hiring a lot of new VCs with little experience.
- Valuations were getting higher, and companies were fixing them based on others that preceded them – unfortunately, the minute you start doing that, the system self-inflates itself, and undoing the damage becomes problematic.
- Deals that shouldn’t have been funded were being funded – the gold rush mentality was real, and crazy ideas received funding with big amounts.
- Companies went public prematurely – they did that before proving the business model’s viability, and some of them even before generating significant revenues.
- Lots of consumers were buying stocks in public Internet companies – it was the trendy thing to do, as there was a fear of missing out, and a belief that the sky was the limit. Sadly, while investors could take losses, consumers couldn’t, and many of them suffered subsequently.
So, in 2000, there were plenty of excesses and bad practices to go around, from venture capitalists, entrepreneurs, public markets and consumers alike. Today, the picture is very different, and we are not even close to a bubble.
Why do I think so? It’s a combination of two factors. One, the tech ecosystem is a lot more resilient than in 2000. Two, we’re not seeing the same bad symptoms of 1999.
I’ve previously written about the resiliency of the tech startup ecosystem (or we should say Antifragility), in the context of reviewing the book Antifragile by Nassim Taleb in a 2013 post, Good News, The Tech Startup Ecosystem is Antifragile.
1) We’re more resilient about taking losses. Not only is it cheaper to start a company; but if you fail, you fall from lower heights, so it won’t hurt as much. “Small” failures are not harmful to the system as a whole. They are only harmful to the small teams being affected.
2) We know a lot more about running Internet companies. Today, there are many more lessons from mature and successful Internet companies. We have learned a lot about how to succeed as a startup or Internet company. Failures and successes have made everybody smarter. That body of knowledge is benefiting the whole, and it keeps getting better. We are producing better startups, and better entrepreneurs.
3) Entrepreneurs are better networked. Social networks and social media had their effects on the entire tech community, and this is a good thing. Business accelerates when its network participants are connected without barriers or distance challenges.
4) There is a better quality of accelerators. Techstars, Y Combinator and other top tier accelerators didn’t exist then, at least not at the quality and caliber levels that we have today.
5) Ecosystems around the world are becoming viable and vibrant on their own turf. New York, Boulder-Denver, Austin, Seattle, Berlin, London, Waterloo-Toronto, just to name a few are strong stand-alone ecosystems, with their own full set of actors.
Not like 1999
A lot is different today, when compared to 1999. It is important to understand these differences and their implications.
1) The tech startup ecosystem is more international. Unlike in 1999, today, risks are spread outside of Silicon Valley. The likelihood of a domino effect of failures that is concentrated in one area is unlikely.
2) Investors are wiser and tighter with their funding. Despite the recent flurry in new fund announcements, we still haven’t reached the capital commitments levels of 2000 by any stretch. See the following NVCA historical chart, from their 2014 Annual Yearbook report:
3) Going public isn’t the main goal. Yes, tech IPOs are returning, but they are returning timidly, and with the lessons of 1999 still engraved on everyone’s minds, i.e. these companies are going public with sustainable revenues and/or profits. In parallel, a number of healthy exits are happening to counter-balance the need for an IPO.
4) Crowdfunding is a release valve for demand. A lot more startups can get funded via non-traditional ways, thanks to open marketplaces like AngelList, CircleUp and others. Independent investors and agile angel investors are offering another sifting mechanism for helping startups succeed.
How to spot the next bubble?
If we were to see the following symptoms re-appear, there would be cause for concern:
- Good companies abound, but they can’t get funded
- Companies that shouldn’t get funded start to get easily funded
- “Me too” companies get funded in order to compete based on greed
- Many people with no Internet experience start to get into tech startups or VC
- We start to see big failures from companies that were funded with a lot of money
What about overvaluations? I think that’s OK, because they equalize over the long term, most typically at the subsequent round. If a company got funded at a high price, two things can happen. Either they live up to their expectations, and they earn that valuation over time, or they don’t deliver and they take a haircut at the next round, if there is one. Either way, things end-up by equalizing.
What if the new VC funds end-up producing lower returns? Well, I think that would hurt these VCs (and their LPs) more than entrepreneurs, but as long as the top VCs continue to perform well, LPs will keep returning for them.
In closing, I’m not going to categorically say there will “never ever” be a bubble in the future. But I will say at least, that the signs aren’t apparent, now. If a bubble were to happen, it will likely be from a new set of causes that aren’t that visible or obvious today, or it could be from a black swan type of event.
At least for now, we shouldn’t fear another Tech Bubble, but rather let’s embrace the great times we’re in, with the wisdom of the past, and the optimism of the future.
The main reason a bubble won’t burst, isn’t that many companies are massively overvalued ( they are), it’s just that the knock on effects if/when they collapse won’t be that huge. If Facebook or Twitter or Snapchat plummet in value, it’s likely other media companies with better business models will do better. It’s all just Private Money anyway, so won’t effect the real world.
Exactly. That’s what I was trying to say. The effects of bad stuff are distributed & absorbed by the system, instead of affecting it.
What a perfect intro to tonight’s class for a free thought discussion…Thanks William as your content consistently enhances the classroom.
#7 is interesting, especially if the JOBS act finally comes to true execution and non accredited investors will be able to buy pieces of pre-IPO startups. Do you think a bubble might happen, if that comes to fruition?
Great one. Just wanted to point out that the VC AUM data leaves out all non-VC early stage money. I imagine it could be very meaningful, especially when normalized by revenue (or lack thereof).
yes, it would be interesting to also look at the Angel stage and crowdfunded money. I did see a report a few months ago somewhere.
i think we’ll need to see the effects of that. i believe even non-accredited investors will have limits on what they can invest, no? that way, the downsides are somehow mitigated.
ah! good to be part of your discussions that way.