Closed Is there a bubble in Silicon Valley?

Uber is fundraising at a $50bn valuation; Airbnb at $20bn. Are private tech companies getting massively higher valuations than would be justified in public markets? A recent slideshow from a partner at venture capital firm Andreessen Horowitz argues that, no, there is a not a bubble – at least not anything like the last bubble. Join the Lex team and other FT writers from 5pm to 6pm London time as we dissect this argument. We’d love to hear your thoughts too – comments welcome.

We’ll be kicking off our live discussion at 5pm London time (which is noon in New York and 9am in San Francisco). While you wait, read our colleague Jonathan Ford on “The Strange Death of the Tech IPO” here.

Also while you wait — check out the slideshow that has made waves in Silicon Valley over the past week. This was put together by Morgan Bender, Benedict Evans and Scott Kuper at the venture capital firm Andreessen Horowitz.

Welcome to Lex Live. Is there a bubble in private tech valuations? Please feel free to share your views in the comments section to the ride.

Our first data point: there is a ridiculous number of companies with valuations of more than $1bn dollars, also known as “unicorns” (although we don’t consider that a proper financial term at the FT).

Pretty wide variety of companies there from software to sharing economy

Big jump from Uber down to Snapchat is very notable

Uber has revenues, Snapchat barely does.

Funny thing about unicorns is that companies seem to be very aware of the term and that status

the previous picture is from a study from the Fenwick and West law firm that just completed a study on unicorns

numbers 3-5 I have never used; hardly know what they are; are worth $45bn together/ Color me suspicious

[gets into horse drawn carriage and rides home]

@Sujeet Yes, it seems like a lot of founders are specifically negotiating in order to achieve unicorn status — and sometimes agreeing to pretty stringent terms in exchange.

@Rob Are you saying you’ve never been to the moon? What century are you living in.

@Leslie What does unicorn status mean for the founders, other than a big valuation and huge expectations?

@Rob That doesn’t surprise me: Palantir is a business to business data software, created at first for the intelligence agencies, SpaceX is a commercial space company and Pinterest is a female-dominated social network.

@chicagolocal No, the problem with private markets is they are very private. So it is hard to get access to the terms. I think you’re right though – it is important to consider the details of the deals.

I thought the previous slide from Mary Meeker’s presentation was a good way to orient ourselves on how technology has evolved

@ChicagoLocal getting rocks solid valuation data on private companies is about as easy as finding, well, unicorns

@Oliver. That’s a good question. There’s a lot of prestige that comes with being a unicorn, even though it’s just an arbitrary number. Having an aura of success can really help with hiring the best engineers — always a challenge in San Francisco.

@ross sure and how they want to expand beyond people to delivering goods. However, would a public market price in all that potential when it is just experiments at the moment?

@ChicagoLocal. If only. The terms of private valuations are not made public because they are, well, private. However some very smart folks over at Fenwick & West have dug through the terms that have been disclosed in regulatory filings. They found that private valuations and public valuations are like apples and oranges.

@chicagolocal- interesting story about Salesforce accounting in the NYT yesterday

Let’s get some definitions out of the way. A lot of times I get asked, what is a private valuation?

The obvious answer is that a private valuation is the valuation at which investors are willing to invest. But the terms of these investments are often much more favourable to investors than investments in the public market would be. Here’s my quick summary of a study by Fenwick & West:

What stands out about their results is how little investors stand to lose if the “valuation” of the company they invested in falls. All the deals reviewed gave investors liquidation preferences, meaning that they would get their money back before common stock in the event of an acquisition. Of these, a fifth had senior liquidation preferences, meaning that investors would get their money back before other preferred stock.

Investors can also be protected if their company fails to IPO at a higher price than its most recent private valuation. This is not uncommon – recent listings such as Box, New Relic and Hortonworks all went public at prices below their previous rounds.

The study found that a third of the deals included clauses that either allow investors to set a minimum IPO price, or give investors additional shares if the IPO prices below a certain level.

The thing with Google is that it doesn’t require the physical infrastructure these others do…

Google is a great scale business. Not clear that Amazon or Uber is.

@Geoffrey Love – good point. But how much do the investors in the private funding rounds know about the businesses and their growth rates?

@sujeet – Google might not have distribution or cars to worry about but it has huge data centres. And perhaps more importantly, its core business scales but it spends the money from that on lots of side projects that cost a lot and have so far produced little revenue.

Again from the Meeker presentation… interesting that Apple is considered an internet company now.

@Sujeet – nice table. What stands out (other than the size of the market caps) is how few companies are on both lists.

@Geoffrey Love. Those are all good points. With private companies, so little is disclosed that it is impossible to get the type of valuation multiples and comps that you can on public markets. But something has definitely been changing. Our next data point: IPOs are getting delayed, because private companies are able to stay private for longer.

The delayed IPO is one of the main points of the Andreessen Horowitz slideshow. (Link here if you haven’t seen it yet.

Along the same lines, here’s a chart showing the sheer volume of IPOs during the turn of the century boom and bust.

“A private IPO” is an attractive term because it makes it look like the same process is going on privately as does on the public markets. But not only are there not the same reporting standards, it also takes ages for many companies to put in place the experienced executive teams they would need to go public. Functions like finance, pr and cyber security can be neglected for longer if the company stays private.

@Geoffrey Love. We may not be far from the point at which dentists are involved. High net worth clients end up with a portion of some fundraisings, and as @Leslie Hook has written, a burgeoning secondary market now exists.

In 1999, the median time to IPO was four years; in 2014 it was 11 years, according to AH. No one wants to deal with the hassle of going public anymore.

Having been a banker during the first boom, the sheer volume of transactions (most of which involved terrible, immature businesses) was mind-blowing.

Meeker with her own chart showing the differences between the two booms (the first she was directly involved in creating as a stock analyst)

@chicagolocal I wouldn’t be so sure on down rounds. I think for the biggest unicorns, we haven’t seen them, but that there have been other down rounds. Companies do their utmost to keep them private as they feel it damages their and their VC’s reputation.

@hannah- wasn’t Box IPO a “down” round and late investors got protections to save their investments?

@Sujeet Really interesting slide from Mary Meeker. There is one point that everyone agrees on: total investment in this cycle (eg 2014) is still lower than it was in 2000.

I think the best results of the current boom is to once and for all show how crazy ’99/’00 was.

The stats around tech IPOs vary widely, depending on how you define “technology”. The charts that Sujeet has posted below, using data from Dealogic, show that tech IPO volume in 2014 was higher than in 2000. But the Andreesen Horowitz slideshow declares that the tech IPO is dead.

Yes @sujeet – it was a down round but it was easier to see because it was going public. I suspect there are more and more round the edges.

@MelloYello. I agree that the slideshow is a bit self-serving. With $4.2bn under management Andreessen Horowitz is one of the largest VCs in the Valley, with a portfolio that includes Airbnb, Pinterest, Lyft and Slack. The huge sums they have invested have helped sustain the bubble.

interesting how late stage investors protect themselves. Previous is from the Fenwick study.

As Fenwick mentions, these protections creates differing incentives about exit between founders/early stage/late stage investors

@LevyForecast It is generally assumed they will go public, as VCs need to take their returns. However, many of the smaller ones could get acquired as few are questioning the stability and deep pockets of major tech companies such as Google, Amazon, Apple and Facebook.

@LevyForecast Important question. The assumption from VCs and new mutual fund investors is that this is a delay to IPOs, not the end of IPOs. We’ll likely see an upsurge next year, clearing current bottleneck.

Also, the public markets get an unfair rap. They can be highly accommodating to speculative ventures and remarkably tolerant of investment for growth – eg Amazon – especially if you can lock in founder control – eg Google.

One thing we have all noticed here is that VCs have become very eager for liquidity over the last few months. Whether it is early investors selling equity during late-stage rounds, or later stage investors encouraging companies to IPO, there is a premium on liquidity right now.

@Max from MVP writes “Tech has outperformed in the 2008-2009 slide and in the low growth and “forced by the Fed” risk asset trade. Context always gets ignored in tech investing. It always plays a role. The next 3 years could not possibly be as favorable to tech as the last 3 years but, may still be gentle enough to allow top firms to keep sprinting ahead. It is the marginal firms and leading valuations, especially when they occur together, that make us nervous.”

@stephenfoley- to your point the problem with delayed ipos is the valuation creation opportunity mostly disappears

@Max sounds like a gloomy forecast

But is it unfair to use the Twitter example here? Twitter’s problems on the public markets may have been caused by going public at too high a valuation, without investors truly understanding the business model and without profits.

I wouldn’t draw conclusions from Twitter’s performance to a potential Uber IPO, for example.

@Sujeet The shift in returns, from public markets to private markets, is a key theme. But I take issue with some of the data in the Andreessen Horowitz slide. They seem to be cherry picking their examples.

If Uber is at $50bn already, is it really going to $200bn or $500bn?

The new money coming into late-stage, eg mutual fund money, HNW networks, family offices etc, have lower return expectations than VC. Many need unicorns only to outperform public market growth stocks. In fact, some are just desperate for any return given concerns over equity and bond markets.

Stephen- good point on investor expectations differing.

amazing who’s a VC investor these days.

The slide on public growth v private growth (three slides back) seems distorted. For starters, LinkedIn, Yelp, Facebook, and Twitter have all had a tough year, why pick on them now? Look at Etsy, or GoPro, or Fitbit — plenty of public value creation there. Also, it’s unclear exactly how these “returns” are calculated because we don’t know which private valuation was used. If you begin with a small enough number for private valuations, private growth goes to infinity.

I wonder if companies are just having rounds so they can publicize valuations.

How low do we think institutional investors could go? Could they move into much earlier stage rounds then they are at the moment? And do they have the expertise to do so? @stephenfoley

@Sujeet Are you saying that Ashton Kutcher is not a qualified investor? Stephen Foley wrote an interesting piece on this here.

great piece, Ashton’s done pretty well for himself it seems.

@Hanah Kuchler Hedge funds have been going earlier stage, starting to get cold feet at the pre-IPO stage, but takes time to build the networks that create access to deals.

Ashton Kutcher served his time, put in a lot of time to build a network. I’m not so sure about Snoop Dogg.

FitBit and Etsy got some pretty good IPO pops not that will inspire some more IPOs.

@stephenfoley Snoop Dog used to hold parties at Twitter HQ. That’s a network, of sorts.

@Max from MVP. You make a good point about how expectations, patience levels and media scrutiny are different for public companies. It’s hard to blame founders who say, why bother with going public at all when they can raise privately.

@Hannah Yo it’s Dogg, not Dog

If only every investor had music videos like this

and the FT refers to him as “Mr. Dogg” in print

@LeslieHook You’ve just blown my cover. I was trying so hard to be cool.

@ Max writes “True but private shares must trade at a discount until and unless there is full disclosure, regulation and liquidity of an entirely different type in private share trading. Thus, there must be some delta between being private and public and that can be easily and temporary removed by changing flows of capital but seems like a trend that must be reverted to?”

@Max I agree, that seems like the crux of the argument. In a rational world, private shares should trade at a discount.

So will the the delta between public and private change? There are still investors eager to pour into this market.

@geoffreylove we are all venture capitalists now

oh, maybe we forgot the “real” bubble we should be studying

@Sujeet good topic for next time?

So in conclusion, what have we learned? This bubble might be slightly less crazy than the last bubble. But that doesn’t mean it’s not a bubble.

Buy San Francisco real estate now!