One of the smartest VCs of all time says Silicon Valley is in a risk bubble

Benchmark Capital partner Bill Gurley is sounding the alarm about startup investments again.

In a blog post, Gurley said that of the 80 privately held tech companies currently worth $US1 billion or more, very few should consider going public right now.

“Lost in this conversation are the dramatic differences between a high priced private round and an IPO,” he says. “Understanding these differences is crucial to understanding the true risks in this large private-round phenomenon.”

Companies that IPO go through a rigorous auditing process — everyone from the SEC to lawyers and bankers toil over the company’s numbers, making sure everything is accurate.

But with heavily funded private companies that raise large rounds, Gurley says investors don’t have anything to go off of besides the numbers on the slide deck that these companies present. Here’s Gurley:

Many of these private companies will wait up to twelve months after the end of a fiscal year to complete their audit. And even then, the auditors do not roll up their sleeves in nearly the same way they do during an IPO process, where they know the SEC will review their work in excruciating detail.

As a simple example, many investors and entrepreneurs do not realise that coupon or discount use is a contra-revenue event when it comes to revenue recognition. You must subtract it from your top-line revenue. Yet, for many “promising” private consumer companies this marketing tactic is widespread, and many improperly account for this in their financial presentations.

The Benchmark Capital partner also warned investors that Silicon Valley isn’t in a valuation bubble — it’s in a risk bubble. Analysts and investors are forgoing the traditional risk analysis they use to assess late-stage companies and are rushing into late-stage investing:

Companies are taking on huge burn rates to justify spending the capital they are raising in these enormous financings, putting their long-term viability in jeopardy. Late-stage investors, desperately afraid of missing out on acquiring shareholding positions in possible “unicorn” companies, have essentially abandoned their traditional risk analysis. Traditional early-stage investors, institutional public investors, and anyone with extra millions are rushing in to the high-stakes, late-stage game.

Gurley has previously warned about burn rate. In an interview with the Wall Street Journal last fall, Gurley said burn rates are the highest he’s seen since 1999, and that startups are taking on an “unprecedented” level of risk because it’s easy for startups to raise money. He repeated this warning at Goldman Sachs Technology and Internet conference earlier this month.

Warning of a tech bubble mirroring that of the late 90s, Gurley also says people are happily working at startups that may be losing millions of dollars a year because the industry is very optimistic.

You can read Gurley’s entire blog post here.

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