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The amount of money investors have plowed into startups has reached record
highs. In 2014, investors of all kinds, from angels and VCs to big asset
managers, invested $48.35 billion in startups, “only” the third highest year
on record, but the highest since the crazy bubble years 1999 and 2000 when
investors blew $55 billion and $105 billion respectively, even as the
dot-com bubble was already imploding. Investors at the time were just a
little slow in giving up hope.
But the “valuations” are getting crazy. The price at which new investors
buy into a startup during a round of funding determines the “valuation.” As
investors have become more eager with other people’s money, and as hedge
funds and big asset managers have jumped into the fray in late-stage rounds,
they have sent valuations on vertigo-inducing trajectories.
Slack, one of the innumerable startups that over the years have
claimed to have found the successor to corporate email, just inked a new deal
with investors for $160 million in funding that jacks up its valuation to
$2.76 billion. The round is expected to close over the next few weeks.
“People familiar with the matter” purposefully leaked this to the Wall Street Journal as part of the mega-hype that the
startup scene needs in order to attract ever more money.
Slack launched its app only about a year ago. At the time, it wasn’t even
in the Billion
Dollar Startup Club, that ever growing group of startups with valuations
over $1 billion. But in October, it raised some money at a valuation of $1.12
billion. And five months later, its valuation jumped 146%.
Unlike some other startups in the Billion Dollar Club, Slack has a revenue
model. Of its 500,000 users, 135,000 pay a monthly fee of at least $6.67 per
person, according to the Wall Street Journal. So at least it has some
revenues, if minuscule compared to its valuation.
But on Friday, just after the funding deal was signed, Slack disclosed
that it had been hacked, and that messages between users and some user data
had been compromised, including usernames, email addresses, and encrypted
passwords. Businesses with confidential information love this sort of thing.
“It’s unclear when Slack discovered the breach or if new investors were
told of it before they agreed to the deal,” the Wall Street Journal reported dryly.
Valuations of other startups have increased even faster over the last 12
months. For example:
King of the Hill Uber saw its valuation soar by nearly 1,000% in 12
months, that’s by $37.4 billion, to reach its current valuation of $41.2
billion. Snapchat gained 900% during that time, or $13.5 billion, with a
current valuation of $15 billion. The US Intelligence Community’s darling
Palantir, which counts the CIA among its early investors, didn’t do too badly
either, as its valuation rose by nearly 300%, or $11.2 billion in 12 months,
to $15 billion. Pinterest’s valuation jumped by 190%, or $7.2 billion, to $11
billion. Airbnb booked a 300% increase during that time, or $7.5 billion, and
now sits on a valuation of $10 billion. And so on. Startup valuation fever
has reached the state of delirium.
The combined valuation of the top 30 startups in the Billion Dollar Club
has soared by 130% since March 2014, from $78.8 billion to $181.2 billion.
That’s a gain of $102 billion in 12 months for 30 companies.
During that time, some of the companies fell off the list, like Fab, which
is now struggling to survive. Others exited out the front door via an IPO,
such as GoPro. And companies like Slack moved up into the top 30. So this
startup index, if you will, is in flux.
Each gain was decided by a relatively small number of people behind closed
doors, where each knew what was expected: ratchet up the valuation with the
current round to enrich earlier investors, just like future investors are
counted on to ratchet up the valuations further, to enrich current investors.
So be it if some of the startups haven’t figured out how to get a serious
amount of revenues. But they do know how to burn cash in prodigious
quantities. In fact, all this cash flowing their way, supported by the idea
that they can always get more, encourages them to burn prodigious
amounts of cash.
This process is self-feeding. As long as new investors keep piling in with
other people’s money to drive up valuations, earlier investors see their
investments balloon and are willing to make more investments. And other
potential investors see that, and they get in line to put their money to work
at even higher valuations. Hence the incessant hype about valuations, and the
purposeful “leaks” to the media.
But turning a valuation into cash for investors requires that there are
more investors at the far end with more money to bail them out, either via an
IPO or via a corporation that can use its own shares as currency, of which it
can always print more. That exit is open only in a raging bull market, such
as the current one.
Such an exit will saddle future investors with huge risks in return for
relatively puny gains, at best. Only a few of the companies will thrive. Most
of them will fall on hard times when the money runs out. Many will become
penny stocks and disappear after they burn through their cash, leaving in
their wake a lot of capital destruction. It’s just a question of whose
capital will be destroyed.
Even while the startup bubble roars ahead, Corporate America is
sinking into a very somber reality. Read… Worst
Revenue & Earnings Declines Since Crisis Year 2009
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