If you’re an early stage venture capitalist or angel investor there is no time like the present to declare a bubble, say valuations are out of control and predict the demise of the tech industry in the very near future. Since they’re in the business of buying low and selling high, any angle that suggests that the buy price should be even lower sounds great to them.
If there’s any evidence of said bubble all the press will eat it up. Mostly because they were out buying Internet stocks in 2000 instead of doing their jobs and reporting on the fairly obvious signals that the Nasdaq was about to implode. They won’t get caught with their pants down and their hand out again. Declare a bubble early and declare it often.
And there is some evidence laying around. Valuations on a few select private tech startups are pretty darn high right now. And valuations on early stage “Series A” startups have surpassed the all important $4 million line and are now averaging in the $6 million – $8 million range.
That’s bad for seed fund economics. Which leads to paragraph 1 above, followed by paragraph 2 in the press.
There are a lot of arguments that whatever is happening today in tech is absolutely nothing like what happened in 1999-2000. If you weren’t in the industry then, it’s understandable that you’d be concerned when you see Facebook being valued at up to $70 billion in private transactions. Heck, even I’m concerned when I see companies like SecondMarket holding public auctions for Facebook stock, driving the price ever higher, and private equity firms like Felix Investments out there pitching Twitter stock as a must have to any retiree with a million dollars.
But this isn’t a bubble. It’s more like a Blubble.
A Blubble? Yes, a Blubble. Because there is a lot of whining going on.
The biggest problem in 2000 wasn’t that companies were being formed in triplicate to address the burgeoning pet food home delivery needs of consumers. Or even that billions of dollars was being invested in new ideas, most of which didn’t work.
No, the biggest problem was that no one had any idea how to value these companies. It was clear by the late 90s that this Internet thing had legs. And everyone wanted to be at the party. People flocked to Silicon Valley to take jobs like “Business Development Manager.” Anyone can be a biz dev executive because it’s not a real job. It’s kind of like sales but you usually don’t have any kind of quota. You just work on “deals.”
Business development, marketing and sales jobs exploded. If you had experience selling anything, or were willing to give it a try, there was a hot new well funded Internet startup that would hire you, pay you at least $100k, give you a bunch of stock options and then actually loan you the money to pay for those stock options immediately, getting your long term capital gains period started.
When I left the law firm I was working at I became VP of Business Development the startup I joined, a former client. I was running the sales group too within a few months. I was 29 and had never sold anything in my life. But there I was, doing deals and in the thick of things. My stock options, Morgan Stanley told me, were worth over $40 million.
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That story has a sad ending. I’ll tell you all about it later. Short version is that by 2001 I was basically broke and moved to London where I learned to appreciate drinking heavily at lunch every day because that’s what you did in London.
But back to the Bubble and the Blubble.
The problem in 2000 is that all anyone cared about was revenue. Users and page views were an afterthought. Profit was a pipe dream. But revenue. Now that was something that Wall Street understood and could put a value on. Everything was valued at a multiple of revenue. It didn’t really matter how unprofitable you were. Which is why WebVan, for example, could blow though a billion dollars and be nowhere near profitability and still go public. And then go bankrupt right after investors cashed out big. Everyone lost money on every transaction and nobody cared. Because your stock price was tied to revenue, and when you ran out of money raising another hundred million dollars was nothing more than a fancy powerpoint presentation and a month’s work.
As a lawyer I sat in board meetings for my clients. And in those meetings I saw very well known venture capitalists tell these companies to spend as much money as they could as fast as they could, and then raise a bunch more and spend that as fast as they could. Hire anyone remotely competent who comes in the office, they say, and figure out a way to create revenue. Even, they said, if you have to spend $10 to get $1 in revenue.
A perfectly reasonable 2000 tech startup business decision – spend $10 million on a massive advertising campaign that may bring in $500k in revenue. The “branding” value makes up the difference, and those few new customers will continue to spend money and tell their friends! Grab territory while it’s there to be grabbed, the thinking went. We’ll figure out the business later. Money was so easy to come by, it made sense to some.
Take the startup I worked at, for example, called RealNames. When I was put in charge of sales I was told to get us from zero revenue to $1 million/quarter in revenue. We achieved that goal through hard work and creative accounting. And boom! Morgan Stanley was brought in to take us public. At the first internal meeting for the IPO they told us that we could expect to debut on Nasdaq at a $1 billion valuation, and should trade up quickly to a $9 billion valuation, which was the market price for Ask Jeeves at the time. I had about half a percent of the company in stock. Thus, my $40 million net worth.
That IPO never happened because in March 2001 the Nasdaq crashed. And then all those creative revenue deals fell apart.
In the most innocent cases Company A would buy a bunch of ads or whatever from Company B. Maybe a $5 million deal over 24 months. Company B would then buy a bunch of stuff from Company A. Say $4 million over 18 months. As long as the deals weren’t mirrors and they were separate and binding contracts the accountants were high fiving everyone.
Everyone was doing those deals, particularly the public companies that absolutely had to keep those revenue numbers up to support their valuations. Note that I haven’t said a word about profits.
Some people, many of whom were subsequently convicted of felonies, were forward thinking enough to begin to hide the fact that these were reciprocal revenue deals. They invented “triangle deals” involving at least three companies so that there were no mirror deals between any two companies. AOL was particularly fond of these deals:
The prosecution alleged that Homestore was engaged in “triangular” deals. That meant it would buy goods from a third-party vendor, the vendor would make a purchase from a counterparty, and the counterparty would then place other companies’ advertising on Homestore’s websites and pay Homestore the remaining revenues.
The indictment said Homestore should not have recognized revenue on any of the transactions but listed the money as revenue on its financial statements. AOL, the decision said, served as the counterparty in 17 transactions included in the indictment.
I once sat in a meeting where a Homestore executive pitched me on participating in one of these deals. Even in the craziness of the 90s, it smelled awful.
So to sum up.
2000 Bubble: Raise at least $100 million in venture capital. Spend! Hire everyone (particularly sales people)! Get revenue by any means necessary! Go Public! Sell Your Stock! Run!
2011 Blubble: Drag blubbering angel investors into Series A rounds valuing your company at $6 million instead of $4 million. Hire engineers, lots of them, as many as you can. Don’t hire non-engineers or other overhead people unless you absolutely have to (thus the dearth of VP Biz Devs around). Your APIs are your sales team! Balance fast growth with low burn (through cost controls or profitability). If you happen to have started Facebook, Groupon or Zynga, capitalize on your massive profitability by doing big late stage rounds that value you at something like 30x forward profits (which isn’t that crazy). If you’ve founded Twitter and have no revenue, capitalize on the massive worldwide cultural impact you’ve created instead.
But no one. Absolutely no one, is telling startups to raise and spend money as fast as they can. With the possible exception of Color. I have no idea what those guys are up to over there in crazy picture sharing land.
