When many people hear that the tech bubble is going to burst, they harken back to 2000 or 2008 when the floor fell out of the tech industry.
“Other than the fact that they are cycles of eight, the three sort of periods are very, very different,” warns Hemant Taneja, managing director of General Catalyst Partners.
The first collapse came at the end of the dot-com bubble in 2000 after companies had gone public, only to disintegrate and run out of money completely.
The subsequent bubble burst came in 2008 when there was a financial crisis that rocked the country across all industries.
Now in 2016, venture capitalists are worried that a slowdown is happening again. Faced with some rockiness in the public markets, the tech community has shifted from greed to fear — yet the capital is still there to be invested.
“In 2008, what really happened was the financial crisis. There was good reason why there was a liquidity crisis and capital started to get sparse,” Taneja said. “When I think about 2016, I can’t think of any event that are really that impactful to the venture world.”
That’s good news for some companies
So why all the fear?
In 2016, there are more than 160 “unicorn” companies that are now worth more than $1 billion.
“The venture community has realised that a number of companies were funded at valuations that were far ahead of their fundamental progress as businesses, and that some of those companies are not actually that great fundamental businesses,”said Sequoia Capital partner Alfred Lin.
Not all of the unicorns are unworthy of their rich valuations, of course. But there is a growing acknowledgement that the buzz to reach the billion-dollar valuation got out of control.
“What really happened was we were fixated on this word unicorn,” Taneja said.
Sequoia’s Lin started feeling the tremors of the shift after July 4th, but it didn’t really enter the public’s conscience until after Square’s IPO in November. The payments company, valued at $6 billion, went public below its last private valuation price. And not only was it priced below, it had a “dirty term” of a ratchet, designed to protect its late stage investors.
The IPO intensified two fears already creeping into the venture capital community: that these startups might be valued too high, and some companies might have taken “dirty” terms to get the big-number valuation.
Now in 2016, there’s been a slowdown, and the venture capitalists we spoke to only describe the path ahead as bumpy.
“I wouldn’t say the easy money’s gone, but the price of oxygen has increased,” said Keith Rabois, a partner at Khosla Ventures.
It’s all about the business
Unlike 2008, where the capital crunch affected all parties, there’s still money for startups in the market.
But venture capital investors now need to decide between keeping certain companies on life support or investing in the next big thing. And investors are suddenly much less tolerant towards startup business plans.
A year ago, venture firms didn’t scrutinize companies very closely when it came to the business economics, says Shasta Ventures’ Nikhil Basu Trivedi.
“…Maybe [VCs] felt like the consumer pain point was so huge, and the potential for it to grow explosively high, so we might have overlooked unit economics,” he said. “Where today, we are focused on the unit economics/gross margin question.”
As the pendulum swings from growth at all costs to building a sustainable business, some companies will get caught and die, says General Catalyst’s Taneja. If they can’t show that their business can make money and are burning through too much cash, they won’t survive the industry shift.
You haven’t seen an avalanche of failures, but I think the percentage will be increasing
“You haven’t seen an avalanche of failures, but I think the percentage will be increasing,” Rabois said. “If you say there are 100, 150 companies, private, high valuation, a lot of capital, at least half I would say will end in unhappy outcomes. The other half may be spectacular successes.”
For Sequoia’s startups, Lin is advising founders who have the cash not to raise more money. Those that need money, should start sooner rather than later and understand that there’s an added focus on having a sustainable business model.
Whereas Uber raised a lot of money fast and at an increasing valuation, Lin is backing off that model.
“That’s not the game we’re advising companies to do. We’ve been advising companies not to do that since last June,” Lin said.