Tech Bubble 2.0

Are we really doing this again?

Matt Olivo
In the Trenches with C2V
7 min readFeb 12, 2021

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As the 2020 numbers start to roll in, I thought I’d add my two (somewhat curmudgeonly) cents to the various “State of Venture” commentaries out there.

Where to Begin…

Let’s work backwards from an IPO market that’s starting to give off a whiff of that unpleasant 1999/2000 odor.

Crunchbase recently shared the following chart, which was troubling for more than just the fact that only 2 of these companies are profitable despite valuations that would qualify every one of them for the S&P 500 (and put several in the top 100).

Source: Crunchbase

There’s a fair bit to unpack here, but in the interest of brevity, let’s just focus on one comparison that neatly sums up the absurdity of these valuations.

Intuit

(A fintech company that’s been successful longer than the term “fintech” has been in use)

vs.

Snowflake

(A recently IPO’d SaaS darling from the table above)

Source: Yahoo Finance & C2V Internal Research

There’s a lot to unpack here as well, but the short version is that a mere 24% premium currently buys you 15x the revenue and an additional $2.3 billion of P&L (and that’s with Snowflake off 20% from its peak).

Try modelling a scenario where Snowflake’s revenue and profit catch up fast enough for your IRR to exceed the yield on a muni bond. It would be easier to mathematically prove that lottery tickets are a good investment.

Am I Alone Here on Incredulous Island?

No! Although there might only be two of us.

Here’s what David Trainer, the CEO and founder of equities research firm New Constructs, told Business Insider ahead of DoorDash’s IPO, which he called “the most ridiculous IPO of 2020”:

“We think this proposed public equity offering holds no value, $0, beyond bailing out private investors before unsuspecting public investors realize the business is not viable in its current form,”

And DoorDash is the third most profitable company on this list!

So What’s Happening Here?

Supply and demand gone horribly wrong, that’s what.

Simply put, there is way too much money chasing too small a pool of recent IPOs and late-stage venture companies. Mr. Trainer alludes to the excesses in late-stage venture when he suggests the DoorDash IPO’s sole value lies in “bailing out private investors.”

Whether valuations or return targets of late-stage venture backers directly influence IPO pricing is a topic for the tinfoil hat crowd, but it’s worth taking a step back to look at how so many companies with no current ability to — or foreseeable hope of — generating sustainable cashflows continue to see their values skyrocket pre- and post-IPO.

If it Looks Like a Duck…

Could one describe many of these late-stage/IPO high-fliers as companies that “with little or no legitimate earnings, require a constant flow of new money to survive”?

And would it be fair to suggest that, ”when it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse”?

Would it surprise you to learn that the quoted text is taken from the definition of a 100-year old investment scam that, sadly, we’re all quite familiar with? (Hint: it rhymes with “Fonzie Meme”).

Now, I admit this might be a little harsh, as these types of schemes are also, by definition, intentionally deceitful and I certainly don’t believe that’s what’s going on here.

While the way in which these markets are being artificially propped up is eerily similar and equally dangerous, the data suggests this is more a case of the venture funding mix having drastically skewed toward the late stage in recent years, and there’s further reason to believe it may get worse before it gets better.

Late-Stage Funding Run Amok

In 2020, the share of startup funding going to late-stage rounds (>$50 million capital raises) hit its highest point since at least 2006 (as far back as the data goes in the most recent Pitchbook-NVCA Venture Monitor), having tripled over the past decade.

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

Mega-VC Funding Run Amok

As one might expect, this skew towards mega-deals follows a similar skew towards mega-funds, as $1 billion-plus funds’ share of total VC fund raising is also hitting new peaks. On a rolling 3-year basis, mega-funds’ share of total VC funding has doubled over the past 12 years.

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

Are SPACS the Answer?

No, they most certainly are not!

As little more than late-stage VC money in different packaging, the SPAC craze is actually more likely to make things worse.

The pro-SPAC crowd has pitched these vehicles as a way to let mature startups access public markets earlier, reversing the trend of longer and longer private funding cycles. The only problem is, they are way (way) too big for that.

The average SPAC raised in 2020 was north of $300 million. That’s more than double the size of the average late-stage mega round in 2020.

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

Furthermore, there are already way too many of them. The number of SPACs raised in 2020 was more than 4 times that of the prior year and total SPAC capital raised in 2020 was 6.8 times 2019’s total. To put this in further (and somewhat horrifying) perspective, total SPAC capital raised in 2020 was greater than the amount raised by mega-VC funds in the past 3 years combined.

But wait, it gets worse! According to CNBC, a further 128 SPACS have raised an additional $38 billion so far in 2021. That’s already more than half of last year’s total in 6 weeks!

Bottom line: this is all part of the same massively over-crowded trade.

Well, These Things Are Cyclical, Right?

Yes, and these types of massively overcrowded trades always unwind eventually (usually making a big mess in the process), but as the famous economist John Maynard Keynes once said:

“The market can remain irrational longer than you can remain solvent.”

Despite the recent profligate spending, VCs are still sitting on record-shattering stores of dry powder (double the levels of a decade ago).

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

While it’s hard to rule anything out after these last 12 months, I doubt that VCs will suddenly start worshipping at the altar of Buffett and returning unspent capital rather than continuing to chase overvalued companies, so this is likely to get worse before it gets better.

Where is an Intrepid Value Investor to Turn?

The early-stage, of course! Finally, some good news to share!

All that money pouring into the late stage has seen the share of VC funding going to Seed and Pre-Seed rounds (sub-$5 million capital raises) hit its lowest point since at least 2006, a full 40% below that previous low point.

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

Furthermore, the runaway valuations in the late stage have not had any impact at all on Seed and Pre-Seed prices. In fact, the median pre-money valuation for both rounds went down in 2020! By quite a bit in fact!

Source: Q4 2020 Pitchbook-NVCA Venture Monitor

So Where Does This Leave Us?

I personally think the late-stage venture and tech IPO markets are headed for an ugly reckoning. That said, I wouldn’t step directly in front of that train either, because it’s too hard to predict what will cause it to derail or when (see Keynes quote above), but you can certainly avoid the track altogether.

As an early-stage investor, we get to buy into the overlooked and underfunded market and sell into the the overheated and oversaturated one. Value propositions don’t get much better than that, and as you can see from the data above, there’s plenty of room in our pool for those ready to jump in.

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In the Trenches with C2V
In the Trenches with C2V

Published in In the Trenches with C2V

Startup and funding commentary and advice from the perspective of founders, CEOs, and VCs on the frontlines.

Matt Olivo
Matt Olivo

Written by Matt Olivo

General Partner at C2 Ventures (early-stage venture fund), with 20+ years in finance as a banker, hedge fund manager and CFO.

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