Friday, April 22, 2011

It's a Heady Time for Start-Ups

Are we returning to the frothy, heady times of 1995 and 1999 in the tech. start-up world? Are we in another, as the Wall Street Journal put it, gold rush? In other words, are we just seeing froth from the exuberance that money is finally loosening up and coming off the sidelines? Or are we forming another dangerous bubble that will burst just as the dot-com bubble burst in 2000?

For answers, I read and reread "In Silicon Valley, Investors Are Jockeying Like It's 1999" in The Wall Street Journal (front page, Tuesday, April 19, 2011). Valuations of certain early stage companies are really skyrocketing. Deals are getting done faster, with multiple venture capitalist competing to invest in certain start-ups. One example the Journal used is Uber, which raised nearly $12 million in funding, pegging its valuation at $60 million. Uber lets people order car service from their cell phones. That's right, not just smart phones, plain old cell phones, too.

The article (and many others like it) went on to say that Silicon Valley investments are hot. For the past three years, venture funding has been in the doldrums. But in 2010 venture capital investments rose to $21.8 billion  from $18.3 billion in 2009, which had marked a 12-year low. Some say the resulting mood is like 1995 when Netscape's IPO set off the dot-com boom. The new possible boom is being fueled by interest in social media, mobile applications and the game layer. 

To me, a sudden rise from a 12-year low does not a bubble make. There is simply too much ground to be made up from the recession and the dot-com meltdown. Do I believe that too much money is being thrown at some early and growth-stage companies? Yes. I still do not understand Twitter's business model. No one knows how many of its 200 million users are active. And given the company's recent management turmoil, I don't think even they can agree on the direction Twitter should take. Is it a service? What value is there in advertising on it? eMarketer estimates that the company had $45 million in advertising revenue in 2010 and could grow it to $150 million this year. Someone thinks Twitter has great potential, as its shares trade actively in secondary markets, and a financing at the end of 2010 put its valuation at $4 billion.

While I'm not worried about a bubble, I am seriously concerned about the private trading of stocks like Twitter in the secondary exchanges. Instead of heading to an IPO stage, private companies' stock stays private, with Wall Street investment bankers loading up on the shares. The Goldman Sachs Group funding deal with Facebook is a prime example. That deal set Facebook's valuation at $60 billion and only a chosen few could invest. It really bothers me that shares in a company like Facebook can't be owned by the general public, spreading the wealth as true capitalism should.

On the other hand, maybe I should be happy that there is this private secondary market because it is bringing more capital out of the woodwork. Funds have been started simply to trade shares of these privately held companies. This frees up capital by allowing for angels and VCs to believe that they can get a better return on their investments faster. Private equity money is flooding the market. And private equity used to stay away from start-ups. All this activity is lending to the excitement. More entrepreneurs are willing to take the risk of starting businesses, and more private investors are willing to invest in start-ups. This may be the catalyst that will reignite the economy.

The private trading of non-public shares also imposes fewer accounting restrictions on the firms. Sarbanes-Oxley has made IPOs almost cost-prohibitive for many growing companies. I've heard it costs a least $1 million a year for a small company to comply with the accounting requirements.  

If you want to get a feel for the excitement in the venture world, read the Journal article. Look up the companies it highlights: Twitter, Uber, Zaarly, weatherbill, Square and greengoose. Ask yourself if you would invest in these companies. What value do they have? What value did the dot-com companies have that made it vs the ones that didn't. Why did Netscape fail? What do Google, Amazon, Ebay, and Facebook do that have made them so successful? Are you an entrepreneur with the next big idea and great management team to pull it off?

What will be the disruptive technology and the brilliantly run companies which will make a difference in our lives? These will be the ventures worth investing in. And that is why the renewed excitement about investing in start-ups is most welcome.
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