Why Mark Cuban is dead wrong

Mark cubanChristian Petersen/GettyDallas Mavericks owner Mark Cuban looks on in the first quarter as the Mavericks take on the Oklahoma City Thunder in Game Three of the Western Conference Finals during the 2011 NBA Playoffs at Oklahoma City Arena on May 21, 2011 in Oklahoma City, Oklahoma.

Mark Cuban has never been more wrong than he is when he says we’re in a tech “bubble” worse than 2000.

Let me back up.

First, I have enormous respect for Mark. I don’t know him personally, but I’ve invested in a few of the same technology startups that he’s invested in.

Anyone who’s involved in the startup field can’t help but admire Mark. He’s a trailblazer. He speaks his mind. Which is why his argument that the current investing environment for technology companies is unsustainable is so shocking and hard to swallow.

In his recent op/eds, Mark claims that we’re in a tech “bubble” much worse than the 1999/2000 dot-com bust which erased $US5 trillion in market value. However, his primary criticism is with the private investment market – the “angel” investors, crowd-funders and other early-stage investments.

His argument: there’s no liquidity and no valuations for these companies.

First of all, I disagree on both accounts, but that aside, people don’t invest in startups because they expect a short-term cash out. They know it takes on average three to seven years to exit, if not longer. If they want to be able to cash out early, they can day-trade stocks on the NYSE or Nasdaq. The reason people invest in the private market, whether it’s through an angel investment or a crowdfunding platform, is because they want to make money – real money, big money.

There’s nowhere else a private investor is going to get a 10-50-100X+ rate of return on their initial investment other than through the private market at the early stage. Is it a gamble? Do people lose money? Of course! Just as it’s a gamble in the stock market and people lose money there all the time.

But the essential difference is, a person who invests privately has a shot (not a guarantee, but a shot) at making an exponential return if that startup takes off and either lands an acquisition deal, as many are doing today, or IPOs on its own. Just look at the profits Mark has made on his exits. But IPOs are much harder to come by, I fully agree with Mark, so for the average private investor, you’re pretty much gambling on an acquisition.

Private investors should know the risks and only invest what they feel comfortable losing. They should also do their homework, not jump in blind. But the same is true for stocks as well.

Also, keep in mind …

  • Only accredited investors are currently allowed to participate in crowdfunding platforms, until the JOBS Act passes. Compare that with the equity markets where anyone can invest. That alone brings a higher level of scrutiny to private investments.
  • Venture capital has been the top alternative investment class for the last 20 years at a 30% IRR rate – compare that with the standard 9-13% IRR with energy futures, real estate, equities, etc.
  • Venture capital firms have been making early-stage tech investments for decades. They call it “getting in on the ground floor.” Because of crowdfunding, accredited investors now have access to deal flow they could only have dreamed of in the past.
  • It only takes $US1,000 to invest, such as on equity crowdfunding platform WeFunder.

But to get back to Mark’s points about valuations and liquidity …

When it comes to valuations, we’re living in a post-dot-com bust age.

Investors are asking tough questions of startup founders these days – I know, because I’m one of them. My firm sees hundreds of deals a month, but only invests in less than 1%.

I’ve also mentored startups at incubators and accelerators around the country. Believe me, getting into the top programs like Y Combinator is no cake-walk.

Also, just look at the news. Ever since the Dow and Nasdaq began to set new records, the instant reaction in Wall Street talk was, “are we in a bubble?” Google “tech bubble,” and half a million results pop up.

Compare that with “stock bubble” at 150,000 results. The term “bubble” appeared 250 times on CNBC in last 30 days alone.

In the 1990s, the Internet was still relatively new and no one fully understood the market potential. Also, many of the ideas being pushed were too early to take off.

Take Webvan, Kosmo and Flooz if you want examples. Fast forward to today, and we have a much better grasp as to the market potential of tech, plus the web is more fully integrated into the daily lives of average people, and we know what the actual commodities are: “eyeballs,” personal data and online transactions.

WebvanScreen grab from WebvanWebvan was founded in 1999 and went bankrupt in 2001.

This helps us give a value to the company in question, based on obvious metrics like daily active users (DAU), etc. Sure, it’s not an exact science, and it never will be, but we know what we’re looking for. That’s a big difference from 1999/2000.

Now for liquidity.

While it’s hard for a private investor to “cashout” early on a tech startup, opportunities do exist such as when founders, other investors, employees decide they want to buy back shares. Deals are getting done on the secondary market all the time. It’s also not unheard of for startups to offer dividends – this is rare, but it does happen.

Acquisitions are also picking up thanks to growing competition between Yahoo, Facebook, Google, Amazon, Apple, Microsoft … pick a name. The M&A activity is huge right now and acqui-hires are happening at the early-stage more than ever. Is that a bubble too? It may slow down, but the enormous market potential of the high-tech industry means companies will have to keep innovating – and in many cases they will do so by buying early-stage companies.

But let’s talk about something Mark didn’t mention in either one of his blog posts: INNOVATION.

The democratization of cash, which is essentially what crowdfunding and angel investing really are, is not just levelling the playing field for America’s innovators, its revolutionizing it. In 2000, it used to cost an average of $US5 million to launch a startup. Today, because of private investor-fuelled incubators, accelerator programs and crowdfunding platforms like Kickstarter and Indiegogo, it only costs a fraction of that. This is opening the door for a greater level of experimentation and risk-taking than what could ever have existed during a VC-dominated funding environment.

Cs used to hold all the cards. They could low-ball valuations, dictate terms.

Now, startups have options. They can choose their own destiny, they can take chances. In the next few years, we’ll see a slew of Internet of Things, healthcare IT, augmented reality, and cybersecurity startups transform the way we interact with technology. We’ve already seen it with the explosion in mobile app companies that Mark likes to poke fun at.

That type of change can’t happen when startups fear taking risks.

Mark Cuban may call the private investment space a bubble, but bubbles tend to occur when no one is looking. Today’s technology companies are more closely watched, and better run, than they have ever been.

Don’t confuse innovation and democratization with hot air.

Amish has been an entrepreneur since the age of 25, when he started his first company in 1998. He has a proven track record in leadership, sales, marketing, strategy and recruiting. Venture Capital firms, C-level executives, and Founders of early and mid-stage startups from around the globe call on him directly for his consultation and advisement before making major decisions that will have an impact on their bottom line.

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