Whether you want to call it a bubble or not, the tech industry is booming. At last count there were 114 privately-held companies with valuations of $US1 billion or more — often called unicorns. Some, such as Uber and Airbnb, are worth tens of billions of dollars.
For the tech industry, these are heady times. But economies and industries usually move in cycles. At some point the party has to end.
We polled several tech industry insiders and investors to find out the biggest risks that they see out on the horizon.
Here’s what they said:
1. Something happens that “breaks” the sharing economy business model
A ruling from a little-known California labour agency sent shockwaves through the tech sector earlier this month. The agency said a former Uber driver should have been classified as an employee, not an independent contractor and that Uber owes her $US4,000 for expenses.
The ruling applied only to one woman and Uber is appealing, but it underscored a potential vulnerability in the foundation of so-called “sharing economy” startups. Many of these companies are expected to overtake entire industries, premised on a business model that doesn’t involve the costs borne by incumbent players, such as hiring full-time employees and paying for worker’s compensation and social security.
But if they’re forced to treat their wokers as employees, their cost structure could totally change. That could potentially “break the model” for sharing economy startups, the thinking goes.
“If you have to make these people employees, those businesses are less valuable than before,” says one hedge fund manager.
Other richly valued sharing economy companies such as Airbnb, TaskRabbit, and Lyft could also face these kinds of sweeping regulatory or legal risks.
That said, regulatory changes often turn out not to be as severe as expected.
In the early days of e-commerce many people worried that the Internet startups would be toast if they had to make consumers pay a sales tax, as their brick-and-mortar competitors did. But years after Amazon began making consumers pay a sales tax in many US states, people are still buying stuff on the web.
Similarly, the benefits of some of the new sharing economy services are so great, consumer demand will continue to be high even if prices go up as these companies have to pass new costs along to customers.
Of course, if a sharing economy service is banned outright, as French President Francois Hollande recently said Uber should be, that presents a bigger problem.
2. Public market investors get spooked
The proliferation of “unicorn” tech companies has to a large degree been fed by the money pouring in from new types of investors.
These are not the venture capitalists that typically invest in tech startups in early stages. They are hedge funds and mutual funds hunting for big returns in a zero interest rate market.
But those investors could easily get spooked by a major shock in the broader macroeconomic or geopolitical scene — say the eruption of a major conflict, or a sudden downturn in a major economy.
Goodwater Capital co-founder Chi-Hua Chien lays out one possible scenario: “My guess is that some macro shock outside of our ecosystem will be the driver of a change — geopolitical conflict, Greece, China, ISIS, something we can’t even anticipate. When the public markets have a correction, the hedge funds and mutual funds will see their overall portfolios decline causing their illiquid investments in tech companies to instantly become a larger percentage of their overall portfolio than originally targeted. At that point, I expect to see many of them pull back from this market, focus on shoring up their public positions, and perhaps even seek liquidity for their illiquid private company investments.”
The flight of public market investors would not only put an end to the big billion-dollar late stage funding rounds, but could also have a ripple effect on earlier funding rounds that are critical to smaller tech startups, says Jeff Clavier, the managing partner of VC firm SofTech VC. Those at greatest risk would be the “high burn companies that assume that there is a lot of cash available for top line focused high growth.”
3. Unicorns faceplant
When a high-flyer gets into trouble, people notice.
And few companies have a higher profile right now than the tech-industry’s unicorns, particularly the companies with $US10-billion-plus valuations like Uber, Palantir, AirBnb, Snapchat, Pinterest, and Dropbox.
If one or two of these beasts stumble — say, a new competitor enters the market and undercuts them on price or they suffer a big regulatory change — the enthusiasm for similar companies could darken.
A big IPO flop could also cause problems.
Many tech IPOs are priced low to ensure that the stock pops on the first day of trading. But investor sentiment can be a fickle thing. If a high-profile tech company were to actually trade down on its Wall Street debut, whether because of a sudden change in investor sentiment on the company or a shifting IPO market, investors might rethink their other tech bets.
The public markets have proven to be harsher judges of Web companies than private markets. Yelp, Twitter, and LinkedIn have all seen their stocks get punished in recent months as financial results and user growth metrics have not satisfied public market investors.
So many of the current unicorns are thriving in a world where performance and valuations are determined and measured differently than they would be in the public markets.
“Right now it seems like anything related to the sharing economy gets these huge valuations. But then you look at the real world of companies that have actually had to get valued by the market…and it gets rocky,” says the hedge fund manager.