Mark Cuban Thinks It’s Bubblicious

Yesterday, Mark Cuban blogged about the tech bubble here.  He updated it here.  He also went on CNBC and spoke about it later in the day.  Here is an excerpt from his first blogpost:

All those Angel investments in all those apps and startups.  All that crowdfunded equity. All in search of their unicorn because the only real salvation right now is an exit or cash pay out from operations.  The SEC made sure that there is no market for any of these companies to go public and create liquidity for their Angels.  The market for sub 25mm dollar raises is effectively dead. DOA . Gone. Thanks SEC. And with the new Equity CrowdFunding rules yet to be finalized, there is no reason to believe that the SEC will be smart enough to create some form of liquidity for all those widows and orphans who will put their $5k into the dream only to realize they can’t get any cash back when they need money to fix their car.

and his CNBC appearance.

Albert Wenger, VC at USV blogged about it here.   He said,

So now we have a different phenomenon: demand in the public markets outstrips supply which results in well higher prices. But then in turn it is those high public market multiples that inform private market valuations. And voila you have a case of MC Escher‘s famous picture of hands drawing each other (dear Internet: someone please put “public” and “private” on the hands and have them write 10x each)

His partner Fred Wilson, and people like Marc Andreessen and Bill Gurley have been sounding the alarm on Twitter, on blogs, and in newspapers for months.  VCs have loaded up term sheets in later rounds with so many junk terms, cap tables seemingly are set in cement.

I have blogged about the bubble as well. Valuation is a touchy subject.  Is this a 2000 dot com kind of bubble?  No.  It’s not. The reason is the public markets have a different kind of bubble.  The rise in public markets can be traced to the easy money policies of central banks world wide.  People feel wealthier, but they are not.

Are there some crazy valuations in the startup world?  You bet.  Are companies raising initial rounds of capital at valuations that most people think are high?  Yup. But, on the coasts if a seed stage fund tells companies they won’t write checks at a $6M pre, they won’t get many meetings and they won’t write any checks.  As someone told me, “That’s the market.”

I have also written previously that there is an intense fear of missing out (FOMO) on the next hot deal.  Funds have to deploy cash over five years.  If they miss the hot deal, how are they going to raise their next fund?  If you are a fund based out of Silicon Valley, how do you tell your investors you aren’t in Uber, Snapchat, or any other deal that is hot and raising at big valuations?  In most VC funds, partners are loyal to their management fee first, their LP’s second, and the companies they invest in third.  Without the management fee, they can’t turn the lights on.

There is also a FOMO aspect to missing out on early stage deals.  There are a lot more seed funds.  More money is flowing to early stage.  Crowdfunding has increased that flow.  Simple supply/demand equilibrium would tell you valuations (the price) will go higher.  The truth is at seed stage, the hot deal doesn’t have a better probability of success than the cold deal.   Seed stage investing is very high risk.

When I was on the trading floor, nary a week or month went by when we didn’t hear about some new business to invest in.  I don’t know of anyone ever making any money off of any of them.  It was one of the driving reasons behind starting Hyde Park Angels.  The idea being that a smart network of people could work together on diligence to make smarter investing decisions-creating a defacto market.  Post investment, the group could put their networks together to advantage the company.

I see zero evidence of crowdfunding doing anything like that.  It sort of reminds me of the trading pits.  Everyone is on their own, their own diligence.  Crowdfunding has broken down barriers and friction for raising capital, but early stage companies generally need a lot more than money.  That’s why money is never a commodity.

Who is right?  Is there a bubble or not?  I think that some companies are raising money at high valuations-and they don’t have the numbers to support those valuations.  If they can’t grow fast enough to support those valuations, their investors will get diluted in the next round-or even crushed out of the business.  See Fab for a case and point.

Mark Cuban made a tremendous point on CNBC.  If a company doesn’t have top line revenue, they better figure it out.  Sales are a key indicator that the company has something.   If it’s a social network where sales aren’t the key driver, but growth of the user base (like Cyberdust), then it better be growing big month over month with a high level of engagement.  At least then, there is a possibility of monetizing the network with ads.  It’s rare to see companies bought simply for eyeballs these days.

Sarbanes-Oxley has been a huge detriment to our public markets.  It’s tripled accounting costs for public firms, with no apparent benefit.  It’s caused startups to avoid going to public markets.  Some of the companies I am invested in would be public today if it wasn’t for Sarbox.  The general public would have a shot at those companies.  The IRS and Sarbox eliminate that.  That only increases the wealth disparity in the US because only accredited investors are allowed to play in private markets.

But Cuban is wrong that angel investors won’t make money on an app.  Plenty of evidence to prove him wrong.  He is also wrong that this kind of investing is detrimental to the economy-but he is right to sound the alarm.  Startups are where new innovation happens.  It’s what unseats the big corporations and continues the creative destruction that is essential for a vibrant capitalist society.

He is also wrong about exits.  Most angel backed companies that successfully exit sell to a larger company-they don’t IPO.  He is right if he means that a company should never be backed if it’s going to tailor itself to be bought by a handful of potential acquirers.  Every company that gets going ought to have the goal of being a standalone business.

It is entirely possible to make money angel investing.  But, you have to be focused, disciplined, and have a strategy.  Spraying and praying will guarantee losses.  Following the herd will guarantee losses.  Giving someone money because it sounds like a good idea will guarantee losses.  Making less than 20 investments will guarantee losses.  Not doing post investment work will guarantee losses.  Good angel investors don’t treat it like a hobby, they treat it like a profession.  It’s a main job, or a second job.

Cuban’s point about losing money is right.  There is going to be a lot of money lost.  More than ever, since more money is flowing into angel deals than ever.  There will be a total lack of liquidity. I have seen investors get into financial straits where they want to get their money out-and can’t-or have to sell at a deep deep discount to another investor (50% or more).  But, by law angel investors have to be accredited.  At least they were smart at one time to build up enough assets to meet the criteria to invest.

I think that the US government policies like Sarbox, Dodd-Frank, and policies on dividends and corporate taxes, hurt the United States general public exponentially more than private investors deciding to invest their private money in private companies.


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