Bursting the Bubble Talk: The Difference between More Tech Funding and Overfunding
Editor’s note: This article was originally published on Medium.
Over the last few years, there’s been a lot of speculation surrounding the looming tech bubble, most of which has drawn generally misguided comparisons to the dot-com bubble of 1999. Fearful skeptics commonly cite the overfunded venture industry, profitless public tech companies trading at inflated multiples, and an increasingly large number of tech exits.
Here’s a tip: Always take what a die-hard skeptic or hard-core believer says with a grain of salt. And consider this — in most cases, people with overly strong opinions on whether or not we’re in a tech bubble fail to consider the bigger picture.
For instance, imagine that an equities analyst on Wall Street declares there’s a bubble due to nothing more than an increased percentage of money-losing companies going public. Sure, that’s important, but there are many separate factors that the analyst isn’t taking into account, perhaps because they don’t lie within his area of expertise.
A central argument to the bubble debate (and one that has been widely discussed) surrounds overfunding in venture capital. Many have noticed and documented the increase in extra-large funds and the mass emergence of seed funds (@msuster explains this well here). It isn’t hard to form a hypothesis on venture capital being over overfunded, but keep in mind that increased funding doesn’t necessarily mean overfunding.
More Money, More Problems?
The majority of money in venture capital comes from institutional investors, and institutional investors are constantly re-envisioning different desired asset-class weightings for their portfolios. Over the past several years, those investors have significantly increased their portfolios’ exposure in venture capital.
This has been a predictable consequence of low interest rates and mediocre returns in other various asset classes (such as hedge funds), coupled with one of the most innovative periods of the last few generations. That’s an incredibly simplified answer and one that has already been covered — if you’re interested, you can read more on the effects of low interest rates and recent suboptimal hedge-fund returns. So, if we accept those factors as the culprits behind more funds and larger fund sizes, then we have to then pose questions around the uses of all this money. Specifically, where’s it all going?
There are only so many great companies out there with true, long-term value behind their product or service. Are VCs increasingly backing frivolous products that offer nothing more than shelfware? Or are firms perhaps dumping cash on their favorite ideas regardless of valuation due to increased competition or new metrics (or maybe a combination of the two)? There’s evidence of both scenarios being played out — there is in fact a growing amount of shelfware securing funding, and there certainly are particular sectors with nonsensical valuations. Nonetheless, there are a few additional discussions around qualifying outputs of this larger capital pool that should be noted. Two important ones include the implications of mobile dominance and the fading line between private and public markets.
Mobile Has Taken Over the World
Mobile is expanding the market. This has already been realized on the consumer side and is starting to take effect in the enterprise. Increases in mobile usage have been exponential and global smartphone sales have more than tripled those of both consumer and corporate PCs. Now more than ever people have the constant ability to complete transactions, interact with products, use services, and communicate with friends.
With increased access and connectivity comes the need for new products, facilitating services, and an expanded ecosystem. Believe it or not, there isn’t a cap on innovation. Thus, VCs continue to find new products with true value that are adapting with our changing time. This is exemplified though the proliferation of mobile-first platforms. The amplified count of people that are always connected to the web is a major difference between 2014 and 1999. Other disruptive factors like the collaborative economy (think Airbnb and Lending Club) have also opened capacity, but that’s a little off topic.
Private Markets Are Capturing All the Growth
The evolution of the venture industry and startup financing has also influenced the need for capital. IPOs occur much later in the lifecycle a company, leaving the majority of value creation to accumulate in the private market. Consequently, public market investors are forced to enter the private market to maintain performance standards and venture investors are pushed to later rounds of funding while accepting lower multiples with quicker turnarounds.
But investing at a later stage isn’t cheap. Founders need loads of capital, yet aren’t willing to sacrifice as much equity as they were when their companies had five employees. VCs are left with two choices: forgo the investment opportunity / get diluted or raise more money. Most have chosen the latter.
So No Bubble?
The explanation and uses of increased funding alone shouldn’t persuade anyone to deny the fact that we’ve been in a tenacious bull market for over 5 years. Remember my first piece of advice: there are many pieces to the puzzle, and the fundraising pattern is just one of them.