Are we in a bubble?
It’s the question on everyone’s lips in the tech world. Startups are closing ever-larger rounds of funding at ever-higher valuations, often with no real revenue to speak off. It’s prompted some to speculate that the current state of affairs is unsustainable, and a crunch point or correction is imminent.
Many tech companies are playing a “high-stakes game,” Fred Destin, a European-based investor at the top-tier venture capital firm Accel Partners, tells Business Insider. “A number of companies are taking a chance on the fact the capital markets will remain open.” They can take VC money and remain wildly unprofitable — promising to solve the money question later down the line.
But if the access to funding dries up — pop!
So, are the capital markets going to stay open?
Destin is cautious: He doesn’t believe the end of the world is imminent, nor will there be a Dotcom-style crash. But he predicts a tightening of belts — and there will be casualties.
Right now, there are two things to take into account, Destin says. First: “The fact it is an unprecedented era of opportunity, because of ads, mobile, the ability to scale internationally … [It’s] a perfect storm that allows companies to scale very fast that we’ve never seen in history.
“So the rate of adoption of the services is phenomenal.” But second: “You’ve got to balance that age of unprecedented opportunity with the fact that the markets can be exuberant or irrational … we’re seeing the growth stage of the market. Later stage round are looking overly butchy, and we are sometimes scratching our heads over the valuation levels being achieved.”
It’s a “capital frenzy” — and startups need to try to avoid being drawn in and spending unsustainably.
2015: “We’re a little bit in overdrive”
Bill Gurley — a respected venture capitalist at Benchmark Ventures — is one of the loudest bubble advocates. He says there’s a “complete absence of fear” in Silicon Valley, and that we should expect to see some dead “unicorns” soon — a term for startups valued at more than $1 billion.
“Bill Gurley and others have been trying to call the peak and been wrong” for eighteen months now, Destin says. But he thinks we’re finally there. “I don’t see the markets going higher than they are today, in terms of speed and valuations. So in that sense I think we’re a little bit in overdrive, and [have] certainly reached some sort of plateau in terms of how fast capital gets deployed and at what valuations.”
In Europe, we’ve seen a number of high-profile startups postpone IPOs planned for 2015 — notably Deezer and HelloFresh. Destin argues that public markets have been “very jittery and nervous. And whenever markets are nervous people stop making decisions, and investments don’t go through.”
There’s worry in the public markets, and exuberance in the public ones — plus a rising tide of bubble chatter. “You bring together a sense of overheating in the public markets, [and] a relative jitteriness in the public markets, together with the sentiment changing … If enough people talk about a downturn, it ends up being a downturn.”
Destin says: “I think we might see at the very least, a softening — and possibly a real correction.”
2016: “I think we’re going to see some high profile companies go bust”
How does Destin imagine this “cooling off” will look?
“In 2016, I’m certainly expecting that the rubber will meet the road for a number of companies,” the VC argues. “They will have to demonstrate that the amount of money they raised and the valuation they raised it at is justified. Whether that’s through profitability, or sustainable user acquisition is a secondary problem.”
“But I definitely think there will be a lot of businesses that are in question today that will have to prove what they can do.”
Such as? “So for example, Bill Gurley at Benchmark I think has been quite public in attacking [delivery service] Postmates. I think it’s gonna have to real questions to answer in ’16. There are a number of people that are waiting to see whether these business models are going to work.
“So yeah, I think we’re going to see some high-profile companies go bust, but I think it’s as it should be.”
Here’s how it will work in practice, Destin says. “What will happen first is the rounds will take longer to close, so the pace at which capital is invested will be slower. There’ll be more of a bifurction between the best founders, who basically do what they want, and the rest of the market [in] which will probably get tough to get these companies financed.
“Like we’ve seen in every cycle, for sure there’s going to be layoffs, and there’s going to be some people needing to tone down their ambitions.” It will be fine for the companies at the very top, the Belgian investor says — like Deliveroo, and BlaBlaCar. But “it’s going to be tougher for the companies that are not exceptional … I think if you’re not in the position of being a market leader it’s going to be tougher.”