Has The Bubble Popped?

Yesterday, Jason Calcanis wrote that the “bubble” has deflated.  He was on CNBC yesterday and talked about it.  If you don’t know Jason, you should.  He is a very good investor and very astute participant in the seed stage startup world.

Despite platforms like Angel List, seed stage investing is very dependent on locale.  For example, the Midwest didn’t see the run up in early stage like Silicon Valley did.  Where a $6M starting point was the new normal on the coast, a $6M priced round was pretty rare in Chicago.  The coast did a lot of uncapped convertible notes which were rare in the Midwest.

That being said, seed stage valuations crept a bit higher from the depths of the last financial crisis in 2008 to 2015.  The $2M-$4M pre-money became a $4-$5M pre-money.  There were some statistical outliers that I saw where firms raised at greater than $6M.  I even saw some $10M notes, or even uncapped convertible debt notes.

While seed valuations were up, it was really later stage valuations that exploded.  Recently, I received a phone call giving me the opportunity to invest in Uber at $62.5 Billion.  I don’t know Uber’s numbers at all, but my gut tells me that valuation is ahead of itself.  Other headline valuations are probably too high as well.  Snapchat, AirBnB and plenty of other companies were priced for perfection.

At the same time, I disagree with Jason.  I don’t think this deflation in valuation is any where near done.  We won’t know for a few months because the companies that raised money in the last part of the frothy cycle are still working through their capital.  It’s when they raise again that we will see.

It’s not just the headline unicorn companies that will feel the pinch, but companies in the middle are going to be hit as well.

When they go out to raise again, they will have grown to their valuation, and will raise at higher valuations or we will see down/flat rounds.  That’s when it hits the employees of those companies and how they react will be the tell.   It’s easier to hang on to employees when the funding curve consistently moves up and to the right.

Investors that got burned in the frothy time might not be so anxious to invest now.  I was fortunate that I had the experience of trading through 1998-2001.  If you kept your discipline, you didn’t get hurt.  The same principle works today.  It’s very hard to keep your emotions in check when you see everyone around you hopping in.  But, the after effects of popping bubbles and the regrets that come with them will hurt even more.

Another little mentioned facet of venture finance is the limited partners that put money into the funds.  How do they react?  When valuations were frothy, VC returns looked really good.  Now that things are changing, VCs might have to restate, or refigure their returns and that could change the fundraising environment.

Some of those limited partners manage money for government pensions.  They are going to be under extreme pressure to squeeze out returns.  Many state and local governments in the US are actually broke.  Look at states like New Jersey, California, New York, Kentucky and especially Illinois for examples.  They cannot fund their liabilities with the amount of revenue coming in.   They also are having trouble in the muni market.  City of Chicago bonds are junk.

 

The stock market is not close to its bottom.  It might have a pop here and there, but the Bears have a strong grip on the market.  Bears have been singing their tune for the last number of years.  They sounded like Chicken Little.  But, the reality is the chickens have come finely home to roost.  The problem is not necessarily in the US.  It’s China, Europe, Japan and Brazil.  There just isn’t a high enough rate of economic growth to sustain the lofty valuations cheap money has given to the markets.

Lack of economic growth world wide isn’t good for startups; or their valuations.