Happy New Year — Unless You’re A Startup

Editor’s note: Bob Ackerman is managing director and founder of Allegis Capital and a leading expert in cybersecurity and data analytics. He sits on the boards of Apprion, DriverSide, Purewave and Shape Security.

As we enter a new year, innovation is advancing across a broad front — mobile, data analytics, virtualization, security, the sharing economy, payment systems and more. That’s the good news.

Here’s the not-so-good news. As in the period leading up to the dot-com bust in the late ’90s, enthusiasm for technology startups is running ahead of their reasonable prospects. We are, as Alan Greenspan said in 1996, in a time of irrational exuberance. The rapidly increasing valuations placed on a wide variety of private companies show that future expectations have once again come untethered from present performance.

Your broker may tell you that prior performance is not indicative of future results but historians know different. The past does indeed repeat itself and the specter of the collapse of the year 2000 is in the air. Or, as Yogi Berra said, it’s déjà vu all over again. The correction will probably not be as significant as 2000 given the qualitative differences in many of today’s startups, but gravity is immutable and omnipresent – and the startup community is on a path to re-learning some of the past lessons.

Where is the shadow longest? As far as revenue growth being unlikely to meet expectations, the weakest sector is probably the sharing economy. It’s hard to argue with the momentum of sharing companies but, overall, performance in the area is uneven. And the performance of the most highly valued sharing companies would have to reach almost unimaginable heights for their valuations to make sense.

Yes, Uber and Airbnb are game-changers. But does Uber deserve the $40 billion valuation at which it raised its $1.2 billion December 2014 funding round? Back in June 2014, when Uber’s valuation reached a paltry (in retrospect) valuation of $18 billion, Britain’s Guardian intoned that the “Uber valuation should mark a nadir in tech insanity: not only has the last sane person in the Valley left and switched out the lights but someone probably paid him at least a billion dollars to do it.”

There are also legitimate questions about the Snapchats, WhatsApps and Pinterests of the world. All are real companies delivering value to their customers, but serious questions surround their valuations, which are based on expectation, not achievement.

With the recalibration of the markets, some of the entrepreneurial hubris rampant today will disappear.

And what are valuations worth anyway? Just because a startup has a mega-valuation doesn’t mean investors will reap mega-returns. It’s important to remember that interim valuations are interesting data points, but it’s money in the bank that’s the ultimate measure of value and return for investors.

This preamble leads to me to my primary prediction for 2015. At some time in 2015 there will be a reckoning, driven by investors’ second thoughts along with events in the public market. A lot of today’s hot startups will undergo a drastic reassessment, and this reevaluation will launch a domino effect across the venture ecosystem, toppling valuations across the board.

This should surprise no one. It’s the sort of cooling event that is repeated every 10 or 15 years, the last time being the dot-com crash, of course.

When will it happen? As I said, I’m guessing this year. When hedge funds, mutual funds and corporate investors start jumping into the venture market, it means we’re closer to the top than the bottom. When common shares in high-flying private companies are being bought and sold at the same prices as preferred shares with hundreds of millions of dollars in liquidation preferences, you may be confident that a period of reassessment is on the near horizon.

But here’s the good news. When the correction does come, it will create very attractive buying opportunities for investors who are astute and well prepared. Where? I believe that companies addressing immediate high-value problems or those delivering significantly enhanced value or savings will bounce back fastest and highest. They will not feel near the impact as those startups that are delivering little value today, no matter how much promise they hold for tomorrow.

In my estimation, areas that are likely to feel less pain in 2015 include:

  • Cybersecurity: security challenges will not go away, but “me too” players will.
  • Internet of things: the world, with all of its complexity, sincerely wants to be instrumented and automated.
  • Data analytics: the quest for insights and efficiencies will never go out of style.
  • Virtualization: the economics and cost savings are simply too strong to ignore.

Here’s a little more good news. With the recalibration of the markets, some of the entrepreneurial hubris rampant today will disappear.

All this is not to suggest that innovation will come to a crashing end in 2015. It won’t. Innovation will continue apace, but the valuation and returns expectations will be tempered. The coming refocus will, as it always has, provide the market with the period of creative destruction that it needs if it is to continue prospering in years ahead.