This post originally appears on the WSJ Accelerators blog here.
On Feb.2, The New York Times published a story suggesting venture capitalists were worried of a looming tech bubble. A day later, The Wall Street Journal published an article with a decidedly different headline: “Silicon Valley Is Not a Bubble About to Burst, Report Says.” After the think tank Joint Venture Silicon Valley released an optimistic report about the region’s economy, its president Russell Hancock told the reporter, “I don’t see any kind of bubble. This is not 2000.”
So which is right? Is the technology industry replicating behaviors that caused the dot.com bubble to burst a decade and a half ago, such as soaring valuations for early-stage companies that aren’t yet profitable and startups burning through venture capital to pay high salaries and rent expensive real estate? Or have we smartened up and figured out how to sustain prosperity, and learned what it takes to be exuberant without being irrational?
In an interesting coincidence, we’re nearing the 20th anniversary of the historic Netscape IPO – on Aug. 9, 1995 – that launched the dot.com boom. I worked at Netscape from the company’s first year through the IPO, joining Menlo Ventures in 1996. So I’m one of those Silicon Valley veterans who has been in the game through a couple of booms and busts, including the crash driven by the 2008 Great Recession. That experience doesn’t give me a special crystal ball into where the current tech boom is headed, but it has sharpened my pattern recognition skills. I’m seeing many compelling reasons to believe that this time is indeed different, albeit I’ve also recognized a few familiar signs of past mistakes, and thus reasons for caution.
First, the encouraging trends.
1. The companies that are dazzling venture-capital firms and leading to strong valuations in the IPO market today are fundamentally better companies than the likes of Pets.com, Webvan.com, eToys.com and other famous flops of the late ’90s bubble. Oh, we still have our darlings, but even highly valued consumer startups like Snapchat and Pinterest attract the kind of heavy visitor traffic that has proven monetizable for high-flyers such as Facebook and Twitter. They also tend to be in “winner take all” markets, where the leading company can gain dominant market share. If you back the leader, the potential value is enormous.
2. Instead of most of the money rushing into one sector — say, consumer dot-coms — now the action is spread across a wider range of B2C and B2B companies, from e-commerce to gaming to data center software, cyber security, mobile applications and more. This limits the exposure that can come when one sector shows weakness and then causes a loss of confidence in the overall market.
3. A new word has entered the venture capital lexicon in recent years: caution. We’ve become more aware of the perils as well as the rewards of chasing unicorns and are less likely to shower billion-dollar valuations on flavors of the month. Well, at least if the flavor can’t demonstrate a sound business model and a believable leadership strategy.
4. “50 Shades of Infrastructure” is a hit in Silicon Valley. Mega-trends you know about, such as big data and the rise of mobile computing, are stimulating innovation in behind-the-scenes areas you don’t. You might not have heard of software defined storage yet, for example, but it’s become a hotbed of interesting startups that have figured out new and better ways to store the insane volumes of data the world produces. While it is not something the average person sees, these infrastructure companies impact our lives every day by improving the way we order coffee, purchase products online and even file our taxes.
5. Enterprise-focused startups can be more repeatable bets because their founders usually have track records of success at similar businesses. It’s easier than with new consumer technologies to assess the size of the market, the merits of the technology and the skill of the team. The leadership team at PernixData, for instance, previously built the core storage software for VMWare and Oracle. Experience does matter.
Now, a few trends that give me pause.
1. We are seeing speculative investing that looks a lot like a bubble, especially when it occurs in unproven business models or in “me too” companies that are not clear market leaders. It may just be the nature of the game. But the Valley still falls prey, more often than is optimal, to the frenzy of over-inflating startups’ valuations in hopes of a big future payoff. Where there is speculation, danger always lurks.
2. A startup that raises $50 million or $100 million before its business model is proven almost always does the same thing with that money: spend it. It’s easy to burn through cash, and it is much harder to slow down the burn than to ramp it up. As Marc Andreessen warned on Twitter a few months ago, “When the market turns, and it will turn, we will find out who has been swimming without trunks on. Many high burn rate companies will VAPORIZE.”
We are strongly advising our portfolio companies to practice discipline – don’t raise and spend money just because you can – and keep a keen eye on the path to profitability.
3. The increasing appeal of enterprise-focused startups is a good thing, as I’ve mentioned, but some of those sectors or niches are getting crowded with would-be disrupters. Fragmentation of a market dominated by a couple of incumbent vendors is a good thing, for startups and for their end customers, but more entrants also means more losers. For a VC, this makes it even more essential to pick winners with the technology and visionary leadership to show quick, impactful value in the market that stands the test of time.
All in all, I believe the foundation is in place to keep the good times rolling in tech for a while to come, even if there is a cooling off in valuations. There is exciting innovation and disruption going on right now in so many industry sectors, and that is what inherently leads to good investment opportunities. Look, nothing lasts forever, but I am hoping that as an industry, venture capitalists have learned to better manage the aspects of the boom-and-bust cycle that we have the power to control.
Mark Siegel is Managing Director at Menlo Ventures, one of Silicon Valley’s oldest venture capital partnerships.