Ben Lee, Business Analyst
With the funding landscape at its most buoyant level since the 2000 bubble is history about to repeat itself?
Let’s take a trip back 15 years, when everybody wanted a slice of ‘the next big thing’ and funding for the tech industry was flowing faster than Niagra Falls. The nucleus of the boom was located in the notorious Silicon Valley where the ‘American Dream’ was more evident than ever, with ‘Siliconaires’ being created overnight. Companies with fundamentally flawed business models were receiving multi-million dollar valuations and IPOs were becoming a daily event for the tech sector, with conventional valuation methods being completely disregarded amidst the hype. In 1999 there were 457 IPOs, of which 117 doubled in price on their first day of trading. The majority of these were technology companies. In March 2000, the NASDAQ peaked at over 5000 points, driven by the frenzy of successful tech IPOs. The speed of the decline however was just as monumental. In 2001 there were only 76 IPOs, none of which doubled on their first day of trading and the NASDAQ had plunged by almost 4000 points by October 2002. Tumbleweed blew through Silicon Valley in the aftermath, with huge numbers of tech companies forced to liquidate as the capital dried up.
Now let’s fast forward again, back to 2015 and Silicon Valley is buzzing once more. Fledgling startups have been effortlessly raising millions of dollars from Venture Capitalists within months of launch and the NASDAQ recently climbed past the 5000 point mark for the first time since 2000. The US Venture Capital association has also reported that the market for IPOs in 2014 was the best since 2000, with 115 VC backed companies filing for IPO. This has in turn attracted plentiful late stage capital which has driven up company valuations to stratospheric levels. According to Bloomberg, the number of late stage companies worth more than $1 billion increased 160% from 2013 to 2014. Apple, Microsoft and Google are now worth more, individually, than the entire Russian stock market. We are in the midst of another tech boom and the question remains: is history repeating itself?
Many prominent names in Venture capital are convinced that another crash is imminent. Bill Gurley of Benchmark Capital stated that “Silicon Valley knows no fear, which isn’t necessarily a good thing… I think you’ll see some dead Unicorns this year,” referring to venture backed startups valued at over $1 billion. It is certainly true that burn rates are incredibly high, encouraged by the availability of capital. Late stage investors are driving up valuations with vast investments at lofty valuations, such as Uber’s $1.2bn raise in Dec 2014 at a $40bn valuation. Investors want a piece of the success stories pre-IPO, reasoning that they will make a hefty return when the company successfully floats (as demonstrated by ETSY’s recent IPO, with the share price jumping 86% on the day it floated). The fear is however that if any of these high profile ‘unicorn’ companies go bust, the late stage funding will flee as tech companies are no longer regarded as such savvy investments. With a lack of funding, and an unproven revenue model, the high burn rates will suddenly become more of an issue and will ultimately lead to the demise of a number of tech startups, potentially blowing tumbleweed back to the Valley.
Whilst there are stark similarities between the funding landscapes now and at the height of the last bubble, interestingly there are major differences in the fundamental business models of the companies receiving late stage funding. Research from CB Insights shows that top tech companies in the last bubble boasted dizzying PE ratios in the 80-90x range, with 70% of IPO candidates being unprofitable. In comparison the average NASDAQ listed company today trades at 21x PE and have proven and sustainable business models, with the median tech IPO having 400% more revenue and more than 2 times the maturity of the median 15 years ago.
The major difference between the technology industries now and then is that high tech is no longer a distinct phenomenon, completely separate from other industries and therefore somehow justifying ridiculous valuations and business models. Today technology spans all industries, innovating and disrupting age old sectors, both in terms of consumer behaviour and enterprise workflow. As stated by the founder and CEO of salesforce.com, “It’s not a tech bubble. It’s the biggest wave of innovation in the history of the world.” This is something I am inclined to agree with. I think there is likely to be a correction of sorts and valuations may take a hit, particularly for early stage ventures. Venture capital firms are at risk of taking some major losses on some companies within their portfolios and funding may slow down as a result. It may even be the case that we experience the demise of some unicorns as capital is harder to source and their high burn rates cannot be sustained. For the true innovation however, I am confident there is longevity. Technology has now become engrained in our personal lives, our business processes and even global leadership and governance. When considered within this context, the hype is perhaps justified. A correction is likely, however in my eyes there is no bubble to burst.
By Ben Lee