Prior to the 2000 Dot.com collapse, startups were racing with time to go IPO (Initial Public Offerings) to gain huge exits for their investors. During that time as a 23-year-old tech entrepreneur and world traveler, I remember getting my Aussie ex-girlfriend’s mom Bernie all excited about buying Cisco, Microsoft, and Amazon stocks. Bernie ended up buying a ton of tech stocks in the frenzy, but she like many other amateur investors ended up selling it in the “tech bloodbath” that was to follow.
I lived in Geelong, Australia for two years while working diligently on my first software startup. If the tech market kept it’s franactic pace, I never would have jumped ship into real estate. After 9-11 and the tech bubble collapse, the herd of investors looked for safer places to park their money… namely real estate.
During the Dot.com era, companies raised massive amounts of capital from their IPOs and used it to try to buy traffic to jumpstart a network effect. Today, I see the same exact phenomenon occuring with two notable exceptions. The first difference is that the source capital is not coming from IPOs but rather from institutional investors and sovereign wealth funds. The source of the capital is 20:1 leverage with low interest rates. In fact, corporate leverage alone now exceeds $8.8 trillion usd. The second difference is a valuable lesson that VCs learned during the Dot.com debacle… the importance of getting to product-market fit quickly.
Silicon Valley has also formulated it’s “winner-take-all” strategy. Dot.com startup Amazon exemplified the “winner-take-all” approach of that era. Jeff Bezos believed that losing money could be the ultimate competitive advantage if you can raise enough capital to sustain it, as it prevents others from entering the space or gaining market share. When competitors are wiped out, then you can raise prices back up to profitability.
Examples of no-revenue companies are Uber valued at $120 billion usd and Lyft valued at $15 billion usd. It doesn’t matter to Uber that it lost $4 billion usd in 2018 and $4.5 billion usd in 2017. First, Uber raised over $22 billion usd. Uber has made a ton of money for it’s early stage investors in it’s recent IPO. Second, Uber’s traction is such that it will be “bailed out” by an acquisition. It’s possible that Uber will survive the market collapse that I forecast will be coming soon.
But here is the problem with a company like Uber… it lacks sustainable differentiation.
Network effects have no value if they don’t create monopolies. Uber will never make a profit in the rideshare business because it has no sustainable differentiation over competitors like Lyft. Raise rideshare prices and customers migrate over to Lyft. To win, Uber must beat Lyft and this doesn’t seem feasible or realistic. Alternatively, Uber needs to use it’s capital to create secondary models in markets such as supply-side logistics (aka Uber trucking). As a side note, I think Uber is trying to scare riders with “sexual assault” stories with the goal of allowing Uber to record driver / passenger conversations (obviously valuable data and a major violation of consumer privacy rights). If I were Uber, I would use Uber’s higher market valuation to buy Lyft. All the drivers who drive for both Lyft and Uber will then be working for the same company!
Uber is an example of a unicorn… defined by venture capitalist Aileen Lee as a startup who exceeds a $1 billion market cap. The number of unicorns has been on the decline since 2014. So here are the numbers… 42 unicorns in 2014, 43 in 2015, 16 in 2016, 33 in 2017, and 35 in 2018. In addition, a recent study by the National Bureau of Economic Research argues that the average unicorn is 50 percent overvalued.
Silicon Valley’s “winner-takes-all” approach works great in bull markets. However, I believe that the “winner-takes-all” fails miserably in bear markets. In a bear market, startups with free cash flow will survive. Ironically, free cash flow during bear markets may win the “winner-take-all” as no-revenue companies fight for their survival.
I think the groupthink in the Bay Area is missing another major blind spot. Prior to the Dot.com bubble, IPOs for tech companies took an average of 4 years. Today in our current “app bubble,” it’s taking 11 years for tech startups to IPO. Ladies and gentleman, this is a math problem. If you visit the history of American financial markets, bull markets tend to last either 5-7 years or 11-14 years. If IPOs for tech companies take an average of 11 years, this is like playing Russian Roulette. Better to look for 5-7 exits and being mindful of the economic credit boom and bust cycles.
So I am sharing my insights as to why VC tech investing is super risky in 2019. However, I don’t see the makings of a real estate collapse. Keep in mind that after the Dot.com Recession, tech workers lost their jobs and it temporarily effected the real estate market. But from my perspective, real estate “megacrashes” like 2007 have economic indicators such as subprime lending, mortgage fraud and over-construction. In a nutshell… I am expecting a 2000 Dot.com crash and not a 2007 real estate crash (well unless the currency collapses).
In 2001 with my first software startup on the ropes and hanging on for dear life, I shifted my focus to real estate investing. After the “app bubble collapse,” I’d bet that people go back to speculating on “hard assets” such as homes. In others words, I am expecting a two year bear market proceeded by a 5-6 year record breaking bull market.
From this discussion, it’s pretty clear how risky venture capital investing can be. Even if you pick the right founders in the right market, you’re still rolling the dice on market timing and competitor risks.
If you’re tech investing in 2019, find experienced founders who can quickly get to product-market fit, change your paradigm from “winner-take-all” to free cash flow as a near term survival strategy, and do your best to time the markets (which can be nearly impossible to do). Beware!