One thing the article ignores about a bubble popping, saying it's "mostly people who can afford to lose money" and "rich people" is that...rich people, much like everyone don't like to lose money. So in order to preserve capital, they are going to pull their money out of big gainers in the public market to offset any loss from the private market.
Not only that but this private equity bubble has made housing prices in some cities absolutely explode. Those will go down too, and many people will be underwater on their $300K studio condos in mid-size cities, or $1M studio condos in larger cities. Then of course you have massive building projects that projected those prices to remain steady flooding the market with supply...who knows when this will hit the fan, but we can all see it coming. But let's face it, there is dumb money in real estate too. I don't think "smart money" is effected by FOMO.
When this all happens it certainly hurts the retail investors, pension plans etc. The private market can absolutely act as a contagion to the public markets. I don't think private equity will be the first to go, usually there is some sort of contraction in credit (high yield anyone?) that begins to effect the other markets and it dominoes from there.
I dunno, that's a lot of causal links that aren't necessarily backed up by quantitative analysis.
I don't think the scale of VC/PE in the tech sector is anywhere near large enough to have macro effects. (Zenefits and Theranos aren't going to move valuation for GE.) Real estate moves locally in sync with the local economy, and the SF Bay Area does see bubble effects in the local housing market... though the dips aren't anywhere near as deep as you think; post-2008/9 implosion, home values took a minor hit then were back to pre-crisis highs within a couple of years. (Source: I was looking to buy a house during that period.)
It's popular to predict doom and gloom, and you can show connections between different events... but understanding the actual dynamics is far trickier, and usually way less sexy.
There's plenty of analysis available, people have been sounding the alarm for the past 6-8 months. Not a bunch of nobodies and doom and gloom blogs either, big money movers have been saying this.
If you don't think it only takes one sneeze for an entire market to get the cold, you haven't been paying attention. If VCs are illiquid, and credit markets are illiquid...and there are securities above them that has a valuation based on the premise that there's liquidity in the underlying market...when people pull money out of those top level securities and the underlying market doesn't actually have the money (think ETF-like securities), you're gonna have a bad time.
San Francisco is not the only market that's going to be effected in real estate. Austin, Nashville, Seattle, Charlotte; there a lot of mid-level cities that saw explosive growth over the past 6 years because of VC. The rust belt probably won't be effected like it was in 2008, because it hasn't moved as explosively.
It won't be a 2008 style crisis, it will likely not be so severe, it will probably be more like a 2000-lite. It will probably rebound relatively quickly too, that's perfectly normal, it's a sling shot effect due to inventory depletion after a short period. It's just a market correction. Don't fear the correction, it's necessary; and it's how the smart money gets in cheaper with dollar cost averaging.
The article makes the point that valuations are high, not necessarily because of accurate valuations, but because 'dumb money' wants to get in on the deal. It then goes on to describe dumb money excoriatingly, covering a lot of rich people:
Dumb money is a hedge-funder who’s jealous of a V.C. Dumb money is sovereign wealth. Dumb money is an Emirati home office. Dumb money is a Facebook millionaire in a Maserati who wants to look like a player. Dumb money wants to get in on tech because it’s a box to check off. Dumb money isn’t in it for the long run. Dumb money doesn’t actually care about the technology. Dumb money doesn’t create value.
I think it's a good summary of the tone and generalities that the journalist likely heard from the investors he spoke with.
Does it sound ridiculous? Yeah. Professional investors complain about people whose only qualification to invest is their bank account. They do realize they are investors right?
Well a dollar is a dollar, it doesn't have a brand. The scary thing to professional investors isn't dumb money and large valuations per se. It's the competition that gets the best deals just because it offers more money. How ironic.
To take a more nuanced opinion, I don't think the distinct is between dumb and smart money, but between branded and unbranded money. There is in fact somewhat of a "brand" for a dollar. If A16Z invests in you, their dollars have some built-in, unwritten-but-real future bonus in the professional VC circus that will pile onto your next deal. Some nobody can offer the same deal on paper today as A16Z, but it won't guarantee that brand-name pile on in a later investment. The question is, how often does the A16Z actually pay off in that future-bonus way, or how many VC firms actually provide a meaningful bonus in that way?
If the "Emirati home office" just offers more money up front, the branded dollar's future brand bonus is less valuable in comparison. This helps explain a firm like A16Z's increasingly generous (and preposterous) first investments. Increasing competition, not "dumb money," has negated a valuable competitive advantage American VC firms once had.
The weird thing about dumb money, unfortunately, is that it can act with
fiendish intelligence, insisting on stipulations that guarantee returns at
the expense of founders, employees and other investors.
Dumb money inflating valuations is pretty much the definition of a bubble. Another interesting tidbit: over 200 private tech terms are currently considered unicorns.
200 of what is supposed to be a rare phenomenon.
When the NYT starts talking about it you know the structure of the bubble is weak. Stories like this only popped up in the months before the housing crash. Prior to that all the stories were all about what a great investment real estate is.
Bubbles are odd things though, it could keep going until there are 400 unicorns, but I doubt it.
I agree 100%! That's why I said the bubble could continue until there are 400 unicorns (or just 50 more), regargless a continuation would exhaust my solvency. I wouldn't bet against it because I don't know if it will pop tomorrow or a year from now or later, but I am almost certain we are in somewhere in the top 25% of a bubble. The breathless arguments that this will continue indefinitely has slowed.
If we're in the top 25% of a bubble you should be able to calculate an upper limit to when it will pop. If you say you don't know when it will pop that means you don't know how close we are to the end because these things are characterized by measurable growth dynamics and spend very little time at the top.
> When the NYT starts talking about it you know the structure of the bubble is weak.
The NYT (together with all media) has been saying there's a bubble for years. They've written nearly 200 articles about this bubble between 2008 and 2015.
I always say that the crash comes after the last skeptic buys in. I honestly don't have any anecdotes to specifically back that up, but plenty of people at cocktail parties have nodded in agreement.
I largely agreed with this article. The interesting thing about wealth is that it, in itself, is useless. A bank account with a billion dollars in it does no work, garners no fame other than the "Hey, I got a Beeeelllion dollars!" joke that gets old fast with your friends. And since nobody really needs a billion dollars to "live on" its kind of like a pet rock in its utility. Unless you put it to work.
And since nothing has been paying returns like tech startups, well you get a lot of tech startups. But those aren't "real" returns if you can't cash the money out. So that is where it gets weird. The lack of IPOs is unnatural in that sense, as late stage investors always seemed to cash out then.
I'm all in favor of more meaningful bets though. But to pull them off you have to think about very large interconnected systems and that is a hard thing to do in a 3 year horizon.
That kind of money should be investing in cutting edge stuff. Real cutting edge stuff. Computational biology, heteromorphic computer chips of various kinds, automation of the construction industry, post-capitalistic economic experiments, and a million other things I can't even think of.
Instead they have tried to play it "safe" and they all propped up the same kind of investment: "the uber of ___" or the "airbnb of ___".
The gains are illusory, because they've all been bidding up each other's bets, and these companies haven't created any real productivity gain.
Sadly, I suspect the "dumb money" is largely your average Joe's retirement money, and it's not "dumb", there's just a lot of it, so it can't be moved out quickly without collapsing the market. Joe's going to take another big hit, but his fund manager is going to get his bonus either way. And it will keep happening, because IRAs and 401ks artificially limit what can be invested in, and because Joe doesn't have enough savings on his own to bother to manage it himself.
Googling "heteromorphic computer chip" doesn't yield much. What kind of R&D are you referring to here? It sounds like something I'd like to know about.
> The lack of IPOs is unnatural in that sense, as late stage investors always seemed to cash out then.
Late-stage speculators, surely? After all, an investor would be invested in the companies success, and would have bought it in order to reap some dividend over the course of many years, right?
I don't think this is actually the case, but sometimes I wonder if the rise of private equity marks a return to the pre-modern order of things. The many costs of financial regulation on the public markets have made returning to an older, far less open market.
What's sad is that this would imply that regulation has finally killed the golden goose. For millennia it was impossible for the common man to save his pennies and buy a share in the success of some enterprise; for a century or two it was possible; and now — what?
If a billion isn't real utility, how is a tech company real utility?
Are you suggesting they get practical use from the kind of tech produced? Otherwise why would monetary returns have more utility than useless billions? Or is it the bragging rights of owning a unicorn or something?
At those levels it isn't in a depository account, it will be in either a managed account (where the bank is managing the funds in existing equities and bonds) or a self directed account where the account holder is directing it. In my directed IRA account any cash generated is "swept" into a 'double tax free' (aka California bonds that are specifically both California and Federally tax exempt) until I decide where to put it. It isn't something the bankers have any say in where it goes.
If I had a billion I would no doubt be making some bets with it that were speculative (I'm a big fan of fusion and the industrialization of low earth orbit) but that would not put the rest of the portfolio at risk of loss.
I'm thinking to myself I wouldn't have much of an appetite for risk with $1B. At that point a measly 2% a year in interest is $20M. I'd have a comfortable life not working.
And a number of people I've known have stopped working long before a billion dollars was in their portfolio. The consensus these days seems to be $6 million. That much being managed by a decent finance person would give you an income equivalent to being paid $200K/year[1] and you can can vacation somewhere for a couple of weeks a year and spend $6 - $10K on your vacations.
[1] it gets tricky since when you're being "paid 200K/year" you probably pay 40% in income taxes and disability and you get health care paid for so you actually take home less than that.
Kinda OT: Market Capitalization is the total amount that all the shares of stock for a company is worth. Is there a term or measure for how much people have actually paid for the stock?
ie, as a founder I have 20% of the stock, but I never paid for it. As the stock goes up, the highest bids raise the nominal value for the whole body, but for most of that value (for a startup at least), the stock owner has not had to pay anything.
Paid in capital would be only with regards to what the company received when issuing the stock. For transactions thereafter in the secondary market, paid in capital remains the same regardless the market price. You can calculate what you ask for by using market data (i.e. volume of transactions at each price point in the life of the instrument, taking into account splits etc.)
The Bubble talk is getting old. There's far, far more real money in the Bay Area than "dumb money." Amazon will double WalMart's valuation this year. WalMart is desperately pumping money into their new Sunnyvale tech office to catch up.
Consumers aren't going to wake up one day, realize the Internet is a stupid fad, and throw their iPhones in the trashcan.
I enjoy that your example (Amazon) is not actually a Bay Area example. Your point is still valid though: Apple, Google, etc. are awash in revenue. The article though is about private companies that aren't so clearly generating cash flow.
However, consumers may wake up one day and realize the surveillance web is indeed a stupid fad. And that covers the business models (explicit or implied) for most contemporary "startups".
I think you find these incompatible simply due to the Valley's own particular brand of "audacity." What #2 predicts the end of are build-fast-and-break-things concept-startups that throw tons of energy, developer-wages, and hype into their product, for indefinite periods of time and with umpteen pivots, with no notion of what their eventual business model will be. "We'll figure out money later" has become a startup trope, and while its worked out for several big names (Facebook, Twitter, etc.) its not exactly a good idea.
There are other kinds of audacity, though! Elon Musk has his picture in the dictionary next to "audacious," but likely could have told you on day one how he hoped Tesla would wind up making money, and how he thought he could get there. And by all accounts he's running a tight ship- employees aren't treated lavishly, money isn't being spent where its not needed- all very standard, non-audacious stuff on the business side.
Much of this is of course that Tesla is making cars, not webpages or apps, and the latter categories are much more forgiving in terms of things like unit economics[1]. I think the point is, though, that investors are no longer going to be so happy about founders taking such flagrant advantage of that forgivingness.
[1] What even is a "unit of sale" for something like Facebook? An ad display? Does anyone calculate exactly what operating Facebook costs on a per-ad basis?
Don't have the same expectations for each company, depending on its unique opportunities.
Obviously exceptionally few companies will end up the size of Amazon, Google, Facebook, etc. There is no scenario under which most companies need to bleed red ink to the tune of hundreds of millions in capital. Most companies also will never need to make audacious bets with hundreds of millions in capital, there's no outcome scenario for them in which that makes sense. If you happen to find a potential monster company, you don't worry so much about whether they're burning $40m+ per quarter - they get a larger reprieve than everyone else (Tesla is being given that exception in the public markets today for example; much like in the Amazon / Bezos case, investors want Musk to bet big and they buy into the long-term story).
The best time to hire the very best is when the industry craters. Google and Facebook both rose from the ashes of 2 separate crashes and were able to hire unbelievable talent at a discount in part because the demand was so low.
The best time to create or join a startup is when the industry is broken. The best to invest is then too.
Question for the field: what's the connection (if any) between late stage private valuations (Zenefits, Theranos, etc) and early-stage startup investing? Seems most popular discussions conflate the two, but it seems like they're wildly different markets.
Yes, some large VC firms blur the line a bit, with seed funds and large, late-stage checks that are nearly private equity-esque. But by and large, the companies and backers involved in the seed stage are not competing with Emirati funds and PE arms to make investments.
I ask because I'm raising a seed round, and occasionally investors cite the macro landscape as a check on valuation, but I can't see the direct connection. Negotiating tactic, misconception, or real phenomenon? Deeply curious....
> Negotiating tactic, misconception, or real phenomenon?
I think a combination of all 3 depending on the situation.
If you have a solid business with real traction, $6-7m cap is seen as very reasonable. Investors probably wouldn't cite a market downturn for deals like this, and if they do it's most likely a negotiating tactic.
If you're raising money for "the next big app" with no traction and asking for a $10-12m cap, there will probably be a lot more skepticism than there would have been a year or 2 ago.
Note: This is based on my anecdotal experience in the bay area market. Numbers are probably lower across the board in other cities.
Not only that but this private equity bubble has made housing prices in some cities absolutely explode. Those will go down too, and many people will be underwater on their $300K studio condos in mid-size cities, or $1M studio condos in larger cities. Then of course you have massive building projects that projected those prices to remain steady flooding the market with supply...who knows when this will hit the fan, but we can all see it coming. But let's face it, there is dumb money in real estate too. I don't think "smart money" is effected by FOMO.
When this all happens it certainly hurts the retail investors, pension plans etc. The private market can absolutely act as a contagion to the public markets. I don't think private equity will be the first to go, usually there is some sort of contraction in credit (high yield anyone?) that begins to effect the other markets and it dominoes from there.