A couple of colliding trends suggests that an unhealthy tech bubble may be inflating — and shows signs it isn’t going away.
Silicon Valley’s moment of sanity is likely to be short-lived.
Two contradictory trends are swirling in the world of tech startups. First, what had been a torrent of money rushing into young tech companies has become a babbling brook in the past six months. This has been a healthy development that has forced Silicon Valley to migrate slowly back to the altar of profits.
The second trend, though, is incompatible with the first. Venture-capital firms — that is, the financiers who write those checks to startups — are collecting more money than they have in years.
We know how basic economics work: When there’s an increase in demand (money that needs to be invested in startups) and a finite amount of supply (startups that seem worthy of investments), a bubble inflates.
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And the phenomenon doesn’t show signs of going away. That means Silicon Valley’s moment of somber reflection and realization — hey, companies can’t burn cash forever — isn’t likely to last long.
First, a bit more about trend No. 1. The amount of money that venture-capital firms are investing in young companies has declined for two consecutive quarters, according to data from CB Insights and KPMG International. That is the first time since 2012 that there has been a six-month stretch of falling dollars flowing from venture-capital firms.
On the other hand, those same venture-capital firms are pulling in money at levels reminiscent of the dot-com bubble. In the first three months of 2016, U.S. venture-capital firms collected nearly $12 billion from pension funds, university endowments and others hoping for a shot at outsized returns.
All over Sand Hill Road — home base for the country’s fleece-and-jeans-wearing venture capitalists — the fundraising dinners are heating up.
It was the biggest quarterly figure since 2006 for the Silicon Valley financiers, according to data from Thomson Reuters and the National Venture Capital Association.
Annualized at the rate of the first quarter, U.S. venture-capital firms could pull in more money in 2016 than in any year since 2000. When the words “Silicon Valley” and “the most since 2000” appear in the same paragraph, everyone should worry.
Venture capitalists must eventually spend their money by writing checks to startups. That is what VC firms do. The spigot, then, will open up again for tech startups, and it could get ugly.
David Hornik — yes, a venture capitalist with August Capital — recently did some that is pretty scary.
If that pace of fresh funds for venture-capital firms is annualized for the year, and if you assume venture firms on average own 10 percent of each company in which they invest this year, those startups will need to be worth a collective $680 billion for investors just to break even.
That is an incredibly high bar. Consider that 65 technology firms have gone public in the U.S. since 2014, and they have a collective current stock-market value of $333 billion, according to an analysis of Bloomberg data.
And it’s not like the IPO market has been wide open to venture firms that want to cash in their tech investments. No tech companies have gone public so far this year.
Let us repeat: Zero. Number of Tech IPOs in 2016. Zero.
To be fair, the money being raised on Sand Hill Road isn’t going to be spent tomorrow. Typically, venture funds are open for 10 years.
A lot is going to happen in a decade, and startup investors say they are being patient rather than overfunding bad tech ideas. It will be hard to hold back, however, if the investment dollars keep piling up.
That’s too bad, because the respite from startup-money mania has been good for Silicon Valley and for investors everywhere. Young companies are no longer maximizing growth at all costs — behavior that has sometimes disastrous outcomes.
Even Uber, a symbol for setting money on fire in the quest for more and more revenue, is starting to change its ways. Let’s hope this change in behavior holds even if the money picks up again.