Shedding Tears for The Bubble
- Posted by Jeff Carter
- on December 5th, 2012
Is there such a thing as a bubble? It’s talked about all the time. The internet bubble, the home mortgage bubble. Now we are hearing about the start up bubble. If you believe in market efficiency, you know those statements are fallacious. I was at a talk one time and listened to Gene Fama speak. He said pointedly, “There is no such thing as a bubble.”.
A palpable silence cruised through the room as the real depth of that comment sunk in.
Markets work. Market prices provide information about lots of disparate things instantaneously. Market prices tell you to dig deeper for more. Every single activity belies a market. Angel investing has a market, with supply and demand and market prices. When someone tells you that in the midwest they could only raise capital at a $3M pre-money valuation, but on the coasts could do it for $6M-is that a bubble on the coasts? Or is the midwest undervalued? Who’s right and who’s wrong is the answer that everyone wants to know.
The answer is that markets set the price and there isn’t a way to arbitrage between angel markets on coasts. Investments are stuck in probability theory. It’s either x, or 1-x. Once the check is written, there are only two outcomes, success or failure. Since it’s easier to start a business than ever before, it’s no surprise that we are seeing a lot fail.
Each separate market is efficient. Additionally, they each have their own supply and demand curves. More supply in this case means more capital. If demand for that capital stays the same, prices will rise. As prices rise, more demand enters the market and you have what looks like a bubble as long as the supply of capital can keep flowing to meet higher and higher levels of demand. When the capital runs out, prices drop and everyone says, “It’s a bubble.”.
That’s when the Monday Morning Quarterbacks come out and say, “See I told you so.”.
There are various factors driving start up valuations right now. Macro effects that cannot be altered. Some of them are structural, and some are caused by structures that weren’t there a few years ago. What is really interesting is that if you believe in bubbles, this bubble was popped faster than any bubble I have seen. The internet bubble took at least 7 years to pop. The home mortgage bubble took 8 years. The internet valuation bubble popped almost as soon as we heard about it.
Recently, Dan Lyons penned an article that took the entrepreneurial community to task. It is an interesting read. I agree with much of it, but it is served up in such a sarcastic manner it isn’t appetizing when you are trying to build some of the things I am trying to build. Dan is right, there is too much cheerleading. Too much reaching around and patting ourselves on the back.
It’s wannabe journalists writing about wannabe investors giving money to wannabe entrepreneurs and everyone in the circle jerk believing that the whole thing makes perfect sense because, trust us. This. Will. Be. Huge. Oh, and by the way, bloggers aren’t just bloggers anymore —they’re now entrepreneurs too. Because blogs are being funded by venture capitalists. Get it?
It’s Robert Scoble riding on the StartupBus to SXSW, gushing about some kids from Stanford — Stanford! — who take three whole days to build an awesome company called Gourmair that solves a huge world-changing problem: how to find gourmet food and have it shipped across the country to your doorstep. Why? Because “there isn’t a centralized place to discover, discuss, rate or buy these kinds of gourmet meals.” And because, “According to our market research, the top vendor in the space does more than $450 million in annual sales.” Wow.
It’s John Doerr of Kleiner Perkins, age 60, trying to be hip by wearing a hoodie and T-shirt and sneakers, and announcing a fund for social apps. So cool!
It’s Ben Parr of Mashable, whose background includes blogging and … blogging, announcing that he too is now a venture capitalist and is creating a “celebrity fund” that has a super cool name — #DominateFund. What kind of guy is Ben Parr? The kind of guy who makes up a name like #DominateFund. And who announces a fund before he’s actually raised the money. And who launches a fund focused on consumer Internet just when all the smart money is moving away from the consumer Internet and rushing toward the enterprise, and when VCs are closing the door on the deals that angels bring them. Enough said.
There are going to be tons of enterprise companies that fail too.
Entrepreneurship is about a lot of things, and one of those things is failure. Instead of insulating ourselves from failure, we need to learn from failure. The article is just a bit too critical of failure for my taste. Lyons pokes fun at angel investors that invest in kids dreaming up stupid ideas. Maybe Dan wouldn’t have invested in those companies, but someone did. Were they foolish? Maybe. In 1995 if I told you I put money into a website that was going to allow people to sell their junk, you might have laughed at me. But, it became eBay($EBAY). In 1998, if someone said, “I need $100k because I am going to make the world’s information universally accepted and useful.”, would you have written a check? There were already at least seven well funded companies already started trying to do the same thing. But, you would have missed on Google ($GOOG). In 2006, if I said I was raising money for a company that would allow you to use 140 characters to put a message out on the internet, and called that message a “tweet”, would you write a check? If not, you missed on Twitter. At the same time, lots of companies failed. People lost money. In hindsight, maybe they were stupid. But if they learned from their failures and did something great later, it’s okay.
One of America’s greatest presidents was Abraham Lincoln. He was a total failure when it came to running for public office. He only won three elections in his lifetime, once for Congress and twice for the Presidency. Good thing he didn’t quit.
There are a lot of things happening in the entrepreneurial world all at once. It’s almost impossible to process them all. Trends happen. Hot money flows through entrepreneurial markets just like it does in financial ones. Chasing deals, throwing money at seemingly stupid ideas, and failure are guaranteed to happen. It’s just a part of the job description when you sign up to be an investor, or an entrepreneur.
What’s clear is that no one has the market cornered on good ideas. Great businesses are being created every day. On Built In Chicago, I think the stat is a new digital company every other day. 99% of them will fail. Some will attract money, and some won’t. Some won’t get next round capital. That’s the market working. It’s efficient and allocates capital ruthlessly.
Without people willing to take a chance and assume some risk, nothing gets moved forward. Or, if it does, the pace is mind numbingly slow because corporations aren’t necessarily the best innovators. In our society, people that think differently and out of the box are generally not embraced when they tumble. Society only accepts their eccentricity and out of the norm thinking when they achieve success. That’s because most of us think in a “me too” way and don’t want to rock boats. Except there are plenty of boats that need rocking.
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The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.
Jeffrey Carter is an angel investor and independent trader. He specializes in turning concepts into profits. He co-founded Hyde Park Angels one of the most active angel groups in the United States in April of 2007. He previously served on the Chicago Mercantile Exchange Board of Directors. He has done market commentary for (More...)