More bubble 2.0 (or lack thereof) dissertations

A new day, a new article or post about the frothy environment that is developing around us. This time it is Chris “Long Tail” Anderson who publishes a piece in Wired about “the New Boom” in which he suggests that we are not yet seeing the signs of a bubble, just a lot of activity, using essentially the same metrics we have been using for some time now (cheap startup costs, broadband everywhere, etc.) :

So there you have the recipe for a healthy boom, not a fragile bubble: a more receptive marketplace, lower costs, and lighter pressure from investors. Today, the typical exit strategy is to sell your startup to Yahoo! for a few million, not to maneuver for a rowdy IPO and an appearance on CNBC. Highway 101 is jammed with Prius-driving engineers, not biz-dev guys in Beemers. And most New York cab drivers are happily ignorant of what's hot in the Valley, just as they should be.

Nicholas Carr makes a thoughtful comment on the topic, which I happen to agree with:

But there's a flaw, or at least a missing element, in the analysis. Bubbles are simply a matter of supply and demand - too much demand (investor cash) chasing too little supply (investment opportunities). Anderson's article focuses entirely on the supply side. The lower costs required to launch an internet business today means lower barriers to entry and thus a robust supply of startups. At this point, there's relatively little interest (compared to six or seven years ago) in these startups among the broader investor community - ie, the individual investors who ultimately control the bulk of investment capital. But that could change at any moment. An investor stampede would render Anderson's analysis moot. And all those seemingly disciplined entrepreneurs who today pronounce their allegiance to “steady, organic growth” would turn into frothing-at-the-mouth IPO hounds faster than you can say “sock puppet.” Bubbles are born on the demand side, not the supply side.

Anderson, in other words, is making a rational analysis of an irrational phenomenon. The people that turn healthy booms into fragile bubbles are investors, not entrepreneurs. And so far, the exuberance about Web 2.0, or whatever you want to call it, remains much more pronounced on the supply side than on the demand side. As long as that remains true, there won't be a bubble.

Despite all the sensation around startups that are being funded, and the total fantasy that GEMAYANI are acquiring two-year old companies by the dozen (actually take a pause and count how many less than 2-year old startups have actually been acquired by that select group over the last twelve months - less than 20 total), it is still hard work to convince institutional investors to open up their checkbook, and this is how it should be. Especially given that the prospective of great exits is *very* limited since the IPO route is virtually shut off.

The two graph below (Source: Wired Magazine) show the trends in total VC investment dollars and valuations, and both remain reasonably “under control” - for now.

 

Paul Kedrosky (as usual) points out that because it takes less to build companies in the current market, it also involves less invested dollars to screw things up. The counter argument is that the impact of the whole Web 2.0 market “going tits-up” would be fairly limited.

The final point, and I will elaborate on it in a forthcoming post, is that there is so much talk of a bubble, and the risk of it exploding in 6/12/18/24 months (pick up your favorite horizon), that we are narrowing the perspective of entrepreneurs, especially the first timers, who will therefore tend to favorably consider a $10M exit now than the potential of a $50M check in five years.

Comments

[Otis Gospodnetic]

I'm glad things are not crazy. If they do go crazy and people start foaming at the thought of getting rich quickly, some will get lucky and will get rich, but 95% of others will fail. Darwin in action, and the cycle will repeat.