US Technology Fund – What’s Going On? – Quick Reaction

Link to the A16z presentation:

The big question in Silicon Valley: are we in a bubble? A16z says no, and produced a 53 page presentation with relevant data to show that 2014 investments are nowhere near the levels of 2000. I believe that we’re in a smaller bubble that can be managed, but we need to vigilant on what kind of money is flowing into the startup market.

There are a few nitpicks I’d like to make about the presentation that stems from my view of the market.

The first one comes from using VC fundraising as a sign of a tech bubble. It would make sense to look at if you assume that only VC funds provide a meaningful funding for “startups.” Shadow capital has played a bigger role in direct investments. For example, in the later rounds, we see Fidelity, GS Merchant Bank, and sovereign funds leading the series, usually raising somewhere in the vicinity of +$50m. Investors that attempt to diversify their funds may find that they’re overallocated in venture capital. In addition, VC funds remained focused on targeting irregular returns and focus on the earlier rounds (despite the inevitable waterfall structure), so VC fundraising is determined more by the number of new startups rather than actual capital in the entire startup space.

The second discusses the “tech returns,” and how tech returns that used to be in public markets have now shifted to private. But the companies used as an example, specifically Twitter, didn’t provide a dividend recap or get acquired. In fact, the only monetizing event for each example comes from an IPO. I understand the idea: value creation came while the company remained private. But investors can’t live off implied valuation based on the new rounds, and at some point will need to see cash come out. There have now been IPOs where the company’s TEV is lower than the implied TEV post-latest round. Now, thankfully, Hortonworks’ valuation has gone up to its original implied private valuation, but investors now see this as a potential risk.

Long story long, we need to realize that startups are remaining private for a number of reasons, but the most important reason is because they can [remain well-capitalized while staying private]. Private companies don’t face the same scrutiny public companies do, whether it’s from SEC regulators or agitated shareholders, and valuations are based off the latest round while not taking into account any of the terms (preferences, priority, etc.). I hope it’ll be a soft landing, but we need to realize that we are in a manageable bubble, and denying it will only lead to a large pop at the end.


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