Talk of the bubble bursting eventually surfaces with every successful market. When valuations are increasing exponentially, excitement is building to a fever pitch, and companies are sprouting seemingly overnight — it’s almost like everyone becomes afraid that success won’t last.
Here Comes Chicken Little
The headlines are beginning to appear already, like the July 23rd article in TechCrunch, heralding the imminent doom and gloom that would come from the tech bubble burst: “Should it burst, the tech bubble will have ramifications that ripple around the tech world like the shockwave from an apocalyptic asteroid. Most tech hubs are not self-sufficient at all; the fact that they are always referred to as the ‘Silicon Valley of [insert country]’ should be a tipoff that they are merely branches off the trunk that is Silicon Valley. Even prolific hubs like Israel, China and India depend on Silicon Valley to pump capital through their arteries.”
Additionally, the media points to the emergence of unicorns — those companies valued at more than $1 billion, like Slack — and now the “decacorns,” which are those valued at more than $10 billion, like Uber (which has been given the illustrious valuation of $50 billion).
CB Insights notes that there are currently 107 of these unicorns whose fanciful rainbows may begin to blind investors, and the Valley, to the overall reality that companies cannot all reach those levels of value.
Lessons have been learned from the past, and today’s investors and entrepreneurs do not plan on repeating history.
At the same time that these self-proclaimed soothsayers are issuing warnings, there is the other side of the coin, where the apocalypse may actually have to wait a bit longer.
Unlike the housing market and the previous Silicon Valley burst that started the 21st century, the sky is not falling here and Chicken Little should be put on mute at this stage in the tech startup game. Lessons have been learned from the past, and today’s investors and entrepreneurs do not plan on repeating history.
It’s that thought process, and the now in-depth analysis of the data that can be done, that makes what is happening now different from a bubble. The New York Times recently reminded us about what a bubble means: “A bubble, in the economic sense, is basically a period of excessive speculation in something, whether it is tulips, tech companies or houses.”
That doesn’t stop people from talking and some VCs to back off a bit.
The Sky Is Still Up There
Despite sources like Silicon Valley News reporting that the second quarter of 2015 was the largest quarter in Silicon Valley since 2000, investors assure everyone that no one is speculating, but rather investing in those high-demand segments and verticals that are showing significant sustainable revenue and viable metrics.
Let’s dig into some numbers to further show why the media can’t burst our bubble here in the Valley, which show positive signs when looking at IPOs and the number of unicorns on the cusp of going public.
A recently released report from Ernst & Young (EY) about the health of the global IPO market has significant numbers to back up this positive forecast that goes beyond just what’s happening in the Valley. Here are the highlights:
- Global IPO activity maintained a steady pace during the second quarter of 2015, with 631 IPOs completed by the first half of 2015. That’s a 6 percent increase over the same period in 2014.
- Although the total capital raised during this first half of 2015 was 13 percent lower than the same period in 2015, EY felt this slight cooling was not about a lack of confidence but was “an ongoing pause for breath while entrepreneurs and company management teams evaluate the broader range of funding options currently available.”
- Expectations and signs indicate an increase in IPOs during the second half of 2015, according to EY.
- An economic backdrop underpins this healthy IPO market, including figures from the International Monetary Fund that show the world economy will expand by 3.5 percent in 2015.
- EY’s 12th Global Capital Confidence Barometer (CCB) indicates that mergers and acquisitions activity is increasing, with 56 percent of companies expecting to pursue acquisitions in the next 12 months (noted to be a five-year high). Recent activity like Samsung’s acquisition of SmartThings and Google’s purchase of Nest show that major companies are interested in what these startups have to offer.
In focusing on the U.S. IPOs specifically, more numbers emerge that show the sky is still there, despite some decrease in IPOs:
- During the first two quarters of 2015, the U.S. had 101 IPOs raise proceeds of $19.7 billion, compared with 158 deals with a value of $35.4 billion in the same period last year.
- U.S. stock exchanges produced two Top 20 global deals in the first half, including Tallgrass Energy GP LP, which raised $1.4 billion in May, and the Columbia Pipeline Partners LP IPO, which raised $1.2 billion in February.
- In 2014, there were 47 tech IPOs, but in 2015 there have only been 15 tech IPOs. In the energy sector, there were 29 IPOs in 2014 and only seven so far in 2015.
However, this is not a bad sign. EY reports that U.S. IPO activity is expected to rise through the rest of 2015 “with a robust pipeline, strong investor confidence and improving economic fundamentals.” The proof is in the fact that EY found that IPO returns continued to outperform the S&P 500 Index during the first half of 2015, while market volatility declined.
Market factors have changed compared to other periods when the bubble burst, making it like comparing apples to oranges.
Also, although the NASDAQ Composite reached levels similar to the dot-com bubble 15 years ago, valuations of leading public technology companies have tended to be more realistic than the same time period. Additionally, the JOBS Act was mentioned as having a positive influence in terms of driving IPOs.
Something else you need to figure is with all these recent companies going public, there are still thousands of employees with stock options that are not fully vested. Some of these employees still have two years until all their millions of dollars worth of stock vests. Most of these people will re-invest in their own startups, houses or in startups in their local areas.
The Changing Look Of IPOs Herald A Different Outlook
While some startups will not go public as quickly as expected, and appear to be lengthening the transaction process, this is not necessarily a bad sign. Instead, more companies are taking a measured approach, planning out their public offerings two years in advance.
This further builds out the global IPO pipeline and puts vesting schedules even further out in the timeline for employees, providing a way for more of these startups to shore up their cash reserves and solidify their positions as a developed business.
Also, the diversion of funds to fuel “unicorns” is draining funds that typically have supported IPOs that have been used to scale their business. In this way, the market factors have changed compared to other periods when the bubble burst, making it like comparing apples to oranges.
As EY reports, this could lead to a new type of IPO that actually creates companies that are “bigger, more stable, and with more established business models that deliver the sequential quarterly growth public market investors expect and reward.”
In this way, the IPO is not about scaling up but about focusing on other benefits, including “greater transparency, stronger reputation and brand profile, and the potential to access new markets via cross-border listings.”
Marc Andreessen, co-founder of Andreessen Horowitz, one of the Valley’s most powerful VCs, put it this way in an interview: “In 2000, you had 50 million people on the Internet, and the number of smartphones was zero. Today, you have three billion Internet users and two billion smartphones. It’s Pong versus Nintendo. It’s Carlota Perez’s argument that technology is adopted on an S curve: the installation phase, the crash — because the technology isn’t ready yet — and then the deployment phase, when technology gets adopted by everyone and the real money gets made.”
While all good things must eventually come to an end, the measured approach that more founders and investors are taking in terms of disrupting and innovation means the end won’t come with a crash, burn, burst or any other destructive event. If anything, it will be a slowdown and recalibration for the next opportunity that comes during a new cycle.
The sky is not falling. Instead, let’s continue to focus on building sustainable companies with well-conceived strategies and high levels of execution.