Rihanna Calls The Tech Bubble Like It Is
Venture industry dynamics explained in @badgirlriri’s words
I’ve shelved this post for almost a year now because though I’ve been in venture for five years across both Wildcat Venture Partners and Mohr Davidow Ventures, it’s not lost on me that I’m still too early in my career to be “rocking the boat”. But thanks to Gurley’s recent article, the cat is out the bag and I finally have the cover to share this.
Yes, this started out as a joke between peers, but I’ve found Rihanna’s hit single, “Bitch Better Have My Money”, to be remarkably effective at explaining many elements of the current tech bubble. So for everyone who’s wondering “Is this even a bubble?”, “How did [fill in the blank startup] raise THAT much money?”, or “What happens when the bubble bursts?”, here is the metaphor for all to enjoy:
“Who y’all think y’all frontin’ on?”
Slide decks notwithstanding, we are in a private market bubble
By definition, bubbles occur when asset prices depart from their intrinsic value. Valuation multiples are one way to measure this: specifically, higher multiples can imply greater speculation (and are thus suggestive of a bubble). When one looks at the average multiples in tech (see figure below) across private rounds, IPOs, public market trading, and even our own team’s investments, there is a significant departure (250%+) between the average private rounds other funds are leading (20–25x) and public market trading (5–10x). I pulled this data in mid-2015, so with public multiples trending lower now, the divide is even greater.
Some champion macro trends (more users, more mobile phones, lower hosting costs, etc.) as the rationale for why “this time is different”/startup valuations are merited, but this has always felt dubious to me — hyper-growth companies are still exceedingly rare and startup failure rates haven’t materially changed in the past two decades.
The takeaway? Private investors are investing at significantly higher valuations than their public counterparts; so though this isn’t 1999 (where public investors were too), we are definitely in a private market bubble.
“Louis 13 and it’s all on me… you just bought a shot”
LPs commit dollars while VCs “bank” the paper gains
The recent spate of unicorns is driven by greater late-stage capital, abound downside protections, and overly optimistic entrepreneurs (high valuations also come with high expectations). Each new unicorn or big up-round allows early stage VCs to mark up their paper gains/unrealized returns; so in a frothy environment like we’ve experienced in the past three years, VCs can go back to LPs, show promising (paper) returns, and raise larger funds. In a bubble, the whole asset class performs well — again, on paper — which in turn attracts more LPs and more capital.
On the fund level, larger funds mean more VC management fees and more capital to deploy. As a result, average round sizes (see figure below) and corresponding valuations increase: the average Series B pre-money today is more than double what it was three year ago. Also, larger early stage funds inevitably have to invest downstream in traditionally growth fund territory — though may not have as rigorous investment guidelines as their seasoned growth equity peers — because there simply aren’t enough quality Series A & B deals to deploy $Bs of capital.
The takeaway? This is the downward spiral in a nutshell: Bubbles → paper gains → more LPs & more capital → larger funding rounds & higher valuations → bigger bubbles. Meanwhile, VCs bank the higher management fees, LPs and late stage investors increase their exposure, and startup risks remain the same.
“Pay me what you owe me. B*tch better have my money”
LPs and common shareholders will eventually get liquidity, but it may be a lot less than bargained for
Until recently, there has been plenty of late-stage capital and appetite so companies have resisted going public, but the music stops eventually. When that moment finally arrives, it will force profitable and unprofitable unicorns to access the public markets for capital, but neither public markets nor M&A are likely to sustain both the high valuations and preference waterfalls that many unicorns have accumulated. The unfortunate consequence, then, is that many early stage investors, their LPs, and company employees will walk away with a lot less than they anticipated, and in some cases, nothing at all.
The takeaway? The outcome won’t be as dramatic as Rihanna’s music video, but it won’t be pretty either. The diminished real returns, in contrast to the previously soaring unrealized gains, will mean a lot of capital exiting the asset class, so fewer LPs, fewer funds, and substantially more pressure on late-stage companies to shore up their fundamentals.