Venturing Startup Nation

The recent turbulence in the public stock market has resurfaced the question of whether we are in a mini tech bubble in startup world.

On the one hand, VC’s like Andreessen Horowitz claim that we are not in a tech bubble arguing that the market size and opportunities today are in a completely different scale than they were at the end of the 90’s: Internet penetration has grown from 40 million to 4 billion, people are spending more time online and mobile has changed the world. Andreessen’s main claim is that the recent funding surge is mainly for late stage startups and is replacing the ‘traditional’ IPO. Therefore we are just seeing a shift in value from public to private investors.

On the other hand, Venture Capitalist such as Fred Wilson from Union Square and Bill Gurley from Benchmark have been sounding an alarm on tech valuations. Their main claim is that low interest rates have caused investors to search for more risk / growth which has increased valuations.

Regardless of which camp you believe, the end result is a massive growth of unicorns (private companies valued at $1B+), Many of which I personally believe are overvalued (and I have taken the risk of betting against a few here). This massive growth of unicorns has created a FOMO effect (Fear of Missing Out) for VCs, which coupled with an environment of relatively easy money and constant increase in multiples (revenue multiple first expand, then get applied on run-rate instead of revenue, and then on end-of-year run-rate), resulted in increasing valuations across the board.

As you can see in the chart below by Cooley, A top Valley-based law firm –  the median Series A pre-money valuation has increased from $8M in 2010 to $18M today. Over the same time median Series B pre-money climbed from $25M to $55M today. This is a growth of over 2x in 5 years!!

Now the math is very simple: Unless you think the median exit value is going to double in the near future, investors are going to get screwed. This is why price matters.

One could argue that seed rounds are larger today than they were 5 years ago and take the company further along. Therefore, what used to be series B is now series A and so forth:

But a look at the NVCA data shows that the number of series A deals nearly doubled from 2010 to 2014. This means that investors are both doing more deals and paying twice as much to get in:

At this point it’s impossible to know whether this is just a correction to a current bull market or whether we are nearing the end of this cycle. The private market typically lags behind the public market by a few months so if this is just a hiccup I suspect we will continue to see a frothy environment. But otherwise, if the music suddenly stops, I believe many startups will realize how difficult it is to sustain a large burn rate and several investors will look back and say “what the hack was I thinking?”