Global Biz
Start-ups, flush with cash, may be primed for a fall
By Jenna Wortham and Evelyn M. Rusli (China Daily)
Updated: 2010-12-19 08:48
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Less than a decade after the dot-com bust taught Wall Street and Silicon Valley investors that what goes up does not keep going up forever, a growing number of entrepreneurs and a few venture capitalists are beginning to wonder if investments in tech start-ups are headed toward another big bust.
The exuberance has given rise to an elite club of start-ups, all worth billions. Successive investments in Twitter have reportedly increased its value 33 percent, to $4 billion, while Zynga, creator of the popular Facebook game FarmVille, is worth more than $5 billion.
Google was willing to pay $6 billion for Groupon, an online coupon company that was valued at $1.35 billion only eight months ago. And Groupon was willing to reject the bid on December 3, presumably because it could sell for even more later.
The chief evidence of a looming bust, according to industry experts and analysts, is the way venture capitalists and established companies are clamoring to give money to young companies, including those with only a shred of an idea. Companies that involve social networking and mobile apps are especially sought-after.
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"I'm not saying Quora, Foursquare, Square aren't eventually worth a lot of money, but the price to pay to get into those games is kind of amazing - $50 to $80 million?" said Dave McClure, founding partner of 500 Startups, a technology incubator in Silicon Valley.
Fred Wilson, a prominent venture capitalist, said the trend had accelerated. "I am seeing many more unnatural acts from investors happening," he said in a recent blog post. And he notes, "I have never seen phases like this end nicely."
No one really knows if there is a bubble until after one pops. Nevertheless, there are many signs of froth. For example, enthusiasm for closely held Facebook shares has run so high that private investors are trading derivatives of it.
Although the rapid-fire pace of investment feels reminiscent of the investing craze that led to the dot-com bust, there are a few significant differences.
For starters, this is not a stock market bubble.
None of the companies are publicly traded. Instead, entrepreneurs are increasingly looking to large technology companies with mountains of cash.
Microsoft, Apple and Google have about $90 billion in cash on their books. McKinsey & Company, a management consulting firm, calculates that the largest software and hardware companies have enough excess cash on hand to buy nearly all of the tech industry's medium-size companies.
And financiers are much more conservative in their investing. "Back in the '90s, companies got funded for five times the amount that Tumblr raised and didn't have anything close to a business model," said Roger Ehrenberg, founder and manager partner of IA Ventures. "People were getting $50 to $200 million a pop and it brought down an entire industry."
The frenzy is also the result of simple supply and demand.
Thanks to the falling cost of computing power, a start-up needs less money to launch.
Meanwhile, more wealthy people are viewing investing in tech as a hobby, which has increased the competition.
"Angel investing was the province of wealthy men," Mr. Ehrenberg said. "Now it's become the province of everyone."
Most Silicon Valley investors still see no signs of doom.
"All the start-ups today have business models and business cases that make them viable," Ron Conway, a San Francisco financier, said in an e-mail.
Jeff Clavier, managing partner at SoftTech VC and a well-known investor, said the real challenge for start-ups with plenty of venture cash will be proving they are worth the investment or risk having to fold.
"The music is going to stop," he said, referring to the children's game musical chairs, "and people will realize there aren't enough chairs for companies to get the next round of financing."
The New York Times