Tag Archives: VC

Air Is Coming Out Of The Silicon Valley Startup Bubble

ZeroHedge published an article I found interesting called “For Silicon Valley’s Startups, The Bill Is Finally Coming Due“:

Silicon Valley startups like Hustle, an ad-messaging company that spent lavishly on things like on-tap kombucha and arcade games for employees, are learning the hard way that party is coming to an end and the bill is finally due. Earlier this month, the company announced mass layoffs according to the WSJ . This depressing scene is now playing out across countless Silicon Valley startups, which sprung up like mushrooms when the money was easy and which are now starting to fold as the decade-long credit cycle tests the limits of the current bubble. 

Startup investors and company founders warn that the unchecked growth of the past several years—which by some metrics exceeded heights from the dot-com boom—is hitting a limit. A rout of publicly traded technology companies is fostering newfound restraint for investors in Silicon Valley, especially for younger, cash-strapped startups like Hustle.

Startup investor Sunny Dhillon told the WSJ: “The unbridled optimism that inhabits our world is getting a shot of realism.”

To be sure, the warning signs were easy to spot, starting with the shrinking number of seed deals, which fell to just 882 in Q4 versus more than 1500 that took place three years ago.

Because VCs have a tendency to follow technology stocks, the NASDAQ’s recent 12% pullback from its Sept 2018 highs put pressure on many startups: scooter companies Bird Rides and Lime both had to lower their valuation targets in order to raise capital during their last funding round. Other startups are failing outright, like Munchery, a meal kit service that had raised more than $100 million from VCs.

The latest events in the Silicon Valley startup world confirm the warnings I made a few months ago in a piece called “The Startup Bubble Is A Derivative Of The Stock Market Bubble“:

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts.

The chart below shows the Nasdaq Composite Index and the two bubbles that formed in it in the past two decades. Lofty tech stock prices and valuations encourage the tech startup bubble because publicly traded tech companies have more buying power with which to acquire tech startups and because they allow startups to IPO at very high valuations.

In the chart below, I compared TechCrunch’s monthly global VC deals chart to the Nasdaq Composite Index and they line up perfectly. Surges in the Nasdaq lead to surges in VC deals, while lulls or declines in the Nasdaq lead to lulls or declines in VC deals (yes, I’m aware that correlation is not necessarily causation, but there is a causal relationship in this case).

Unsurprisingly, the decline of the Nasdaq over the past few months is putting a damper on the tech startup bubble. I believe that much more extensive declines are ahead as the stock market bubble unravels, which will lead to even more pain for the tech startup bubble.

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The Startup Bubble Is A Derivative Of The Stock Market Bubble

TechCrunch recently posted a fascinating chart of the monthly count of global VC deals that raised $100 million or more since 2007. According to this chart, a new “unicorn” startup was born every four days in 2018. Unfortunately, this is even more evidence of the tech startup bubble that I have been warning about.

Big Funding Rounds

Here’s the list of “unicorn” companies worth more than $1 billion as of the third quarter of 2018:

unicorn-q1-3-2018

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts.

The chart below shows the Nasdaq Composite Index and the two bubbles that formed in it in the past two decades. Lofty tech stock prices and valuations encourage the tech startup bubble because publicly traded tech companies have more buying power with which to acquire tech startups and because they allow startups to IPO at very high valuations.

Nasdaq Composite Index

In the chart below, I compared TechCrunch’s monthly global VC deals chart to the Nasdaq Composite Index and they line up perfectly. Surges in the Nasdaq lead to surges in VC deals, while lulls or declines in the Nasdaq lead to lulls or declines in VC deals (yes, I’m aware that correlation is not necessarily causation, but there is a causal relationship in this case).

VC Deals vs. Nasdaq

Please watch my recent presentation about the U.S. stock market bubble to learn more:

I believe that a very high percentage of today’s startups are actually malinvestments that only exist due to the false signal created when the Fed and other central banks distorted the financial markets and economy with their aggressive monetary stimulus programs after the global financial crisis. See this definition of malinvestment from the Mises Wiki:

Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.

Rising interest rates and the overall tightening monetary environment will lead to the popping of today’s stock market bubble, which will then spill over into the tech startup bubble.

If you have any questions about anything I wrote in this piece or would like to learn how Clarity Financial can help you preserve and grow your wealth in the dangerous financial environment ahead, please contact me here.

These Are The Headlines You See In A Bubble

The world has gone completely startup crazy over the last several years. Spurred by soaring tech stock prices (a byproduct of the U.S. stock market bubble) and the frothy Fed-driven economic environment, countless entrepreneurs and VCs are looking to launch the next Facebook or Google. Following in the footsteps of the dot-com companies in the late-1990s, startups that actually turn a profit are the rare exceptions. Unfortunately, today’s tech startup bubble is going to end just like the dot-com bubble did: scores of startups are going to fold and founders, VCs, and investors are going to lose their shirts. In this piece, I wanted to show a collection of recent news headlines (all from Business Insider) that capture the zeitgeist of the tech startup bubble – please remember these when the bubble bursts and everyone says “what were we thinking?!”

These Silicon Valley venture capitalist trading cards should tell you where we are in the cycle (close to the end) (link):

VC Cards

When trillions of dollars worth of central bank “Bubble Money” is sloshing all over the globe looking for a home, startups are a popular holding container (link):

5 startups

Since when did throwing “insane” amounts of cash into a hot industry ever end well? It never does and this time will be no exception. Masayoshi Son is definitely “Bubble Drunk.” (link):

Masayoshi Son

So, she started as a VC at age 17?! And the companies she invested in are worth billions? That’s what happens when central banks hold interest rates at record low levels for a record length of time and flood the economy and financial markets with trillions of dollars worth of liquidity. As the old saying goes, “a rising tide lifts all boats.” Also, “never mistake a bull market for brains.” (link)

24 Year Old VC

During a bubble, it is common to see fantastical stories about young wunderkinds getting hired for grown-up jobs, starting companies, making fortunes, etc. in the industry that is experiencing a bubble. (Undoubtedly, the parents play a very large role in opening doors for these kids and getting them media coverage – “it’ll look great when applying to Harvard!” ). Another example of this is the story of the 11 year-old “cryptocurrency guru” that was circulating during the crypto bubble earlier this year before the crypto price implosion. (link)

Coder

Pretty soon, you will see many more headlines like this (link):

25 Most Valuable

I believe that a very high percentage of today’s startups are actually malinvestments that only exist due to the false signal created when the Fed and other central banks distorted the financial markets and economy with their aggressive monetary stimulus programs after the global financial crisis. See this definition of malinvestment from the Mises Wiki:

Malinvestment is a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses. “Wrong” in this sense means incorrect or mistaken from the point of view of the real long-term needs and demands of the economy, if those needs and demands were expressed with the correct price signals in the free market. Random, isolated entrepreneurial miscalculations and mistaken investments occur in any market (resulting in standard bankruptcies and business failures) but systematic, simultaneous and widespread investment mistakes can only occur through systematically distorted price signals, and these result in depressions or recessions. Austrians believe systemic malinvestments occur because of unnecessary and counterproductive intervention in the free market, distorting price signals and misleading investors and entrepreneurs. For Austrians, prices are an essential information channel through which market participants communicate their demands and cause resources to be allocated to satisfy those demands appropriately. If the government or banks distort, confuse or mislead investors and market participants by not permitting the price mechanism to work appropriately, unsustainable malinvestment will be the inevitable result.

As I’ve explained in a recent Forbes piece:

When central banks set interest rates and hold them at low levels in order to create an economic boom after a recession (as our Federal Reserve does), they interfere with the organic functioning of the economy and financial markets, which has serious consequences including the creation of distortions and imbalances. By holding interest rates at artificially low levels, the Fed creates “false signals” that encourage the undertaking of businesses and other endeavors that would not be profitable or viable in a normal interest rate environment.

The businesses or other investments that are made due to artificial credit conditions are known as “malinvestments” and typically fail once interest rates rise to normal levels again. Some examples of malinvestments are dot-com companies in the late-1990s tech bubble, failed housing developments during the mid-2000s U.S. housing bubble, and unfinished skyscrapers in Dubai and other emerging markets after the global financial crisis.

The chart below shows how recessions, financial crises, and bubble bursts have occurred after historic interest rate hike cycles:

Fed Funds Rate

I believe that rising interest rates and the overall tightening monetary environment will lead to the popping of today’s stock market bubble, which will then spill over into the tech startup bubble.

Please watch my recent presentation about the U.S. stock market bubble to learn more:

If you have any questions about anything I wrote in this piece or would like to learn how Clarity Financial can help you preserve and grow your wealth, please contact me here.