Pando

No shock: Venture capital didn’t crash in 2016. Here’s why many insiders wish it would.

By Sarah Lacy , written on January 11, 2017

From The Venture Capital Desk

Remember early 2016?

Tech stocks had one of the worst starts since the dot com bust.

No one thought Donald Trump would get the nomination, let alone the Presidency.

Everyone still thought (Pando investor) Peter Thiel was a harmless, lovable, eccentric contrarian.

Uber was still claiming it was winning in China.

And nearly every VC -- and outlet quoting them-- was insisting that any moment venture capital was about to correct leaving a generation of founders who’d only known good times and negative gross margins in a redux of the year 2000.

This view was so pervasive that a CB Insights poll wondered whether we’d have more or fewer unicorns in aggregate by the end of 2016. 50% of people predicted in a year the correction would be so great, that not only would no new companies get over $1 billion valuation, but in a year’s time a meaningful amount would go under, have a down round, or get sold for a lesser price. (I argued the opposite.)

This hopeful self-nominated Cassandra trend lasted into the spring. From a piece I wrote in May:

There used to be a popular-- if callous-- bumper sticker in the wake of the dot com crash reading some variant of: "Please, lord, give me just one more bubble." Today's equivalent slapped on Teslas up and down Sand Hill Road might be: "Please, lord, let this crash happen already."

Today in VCs trying to talk us into a market correction, the Wall Street Journal gives us: Keith Rabois from Khosla Ventures!

In a May 2 story, Christopher Mims writes a bold unequivocal story-- or at least a bold unequivocal headline: “This Tech Bubble Is Bursting.” The problem with his argument? It’s more of the same, still with no data showing an actual crash.

It leads with a VC making an impassioned and fearful argument about how it’s all a house of cards that’s going to collapse once everyone wakes up and realizes there’s far less underlying value to these companies than… we thought six months ago under almost identical market conditions….

...Here’s problem one with the argument that a bubble is about to pop, because VCs keep saying it will: They seem to never mean their own over-inflated companies. (Or do they really?)

Here’s another problem with the argument: As of yet, there’s simply no evidence of this crash. Mims says in his story that “startup investment has cooled” and “valuations are falling.” I wish he’d cited his data source, because all the ones I track haven’t shown that at all. 

This morning, PriceWaterhouse Coopers and CB Insights have published their wrap up of venture capital in 2016, and it says just that: There was a decceleration of investing but absolutely nothing like what the press and many prominent VCs were predicting a year or even seven months ago.

It’s been covered widely, but here are a few points:

  • The number of deals continued to fall, and mega rounds and unicorn rounds still happened each quarter but at a lower rate than in 2015. Absolutely nothing new here: Both trends had already started in 2015.
  • In the US, deals fell just 14% in the fourth quarter and dollars fell just 16%. This is not a crash. It wasn’t even a consistent trend line: Dollar amount of aggregate deals popped back up in the second quarter of last year.
  • Despite a lot of talk about India crashing and China being overheated, global deals only fell 16%.
  • The report tries to take a dramatic tone in saying $100m mega rounds fell to a five quarter low. But that assumes anything about this trend was the norm. It would have fallen in any market, because all the talk of a correction caused every late stage or growth stage company to bulk up on capital. Unless your name is Uber, there’s a limit to how fast you can spend $100 million or more.
  • “Only” four new unicorns were minted in the last quarter. Only four! Remember: Companies worth $1 billion were coined as “unicorns,” because they were supposed to be rare. The fact that reliably more companies get that designation each quarter, means we are not in normal times, let alone a crash.

Another trend that has continued: Record amounts of venture capital going into companies, historically speaking with a second dismal year for exits. As Bloomberg wrote this morning looking at the same data, Silicon Valley needs some Drano to unclog its pipes:

At last year's pace of nearly $50 billion worth of startup acquisitions and initial public offerings, it would take bankers about 14 years just to clear out the 184 tech startups valued at $1 billion or more each, which have a collective value of $650 billion, according to CB Insights. And that doesn't count thousands of smaller startups nor the new ones getting their first checks from financiers right now.

Still, with so much of the press predicting a great year for IPOs and M&A and a bullet we’d all occurred was heading straight towards us never appearing, you’d think people would be feeling good about things.

Pitchbook-- for its part-- argued today in its newsletter that the venture ecosystem is healthy. More complex than it’s been before-- but healthy. As we’ve reported at length, the big factors were the unabated crush of capital coming from the rise of corporate venture funds and a flood of international cash. Neither is showing any sign of abating.

Still, signs of unease that this crash never happened are all around us.

There was First Round Capital’s state of startups report last year. On one hand, fewer founders feared we were in a bubble, more founders saw the next year as a good time to sell or go public, and one in five companies had conviction their business was truly worth more than $1 billion. On the other hand, there was unease. 66% of those surveyed believed that VCs, not founders, had the upperhand.

More anecdotal, but telling, was a Facebook thread started by industry analyst Jeremiah Owyang on what could kill Silicon Valley. In the comments are fears about China (natch), Silicon Valley continuing to grow but “losing its soul,” and an over-reliance on STEM education and a love of data and coding to exclusion of any merit placed on arts, literature or the humanities.

There was another clear concern: No correction in the cost of living in the Bay Area, coupled with a related and increasing homogeneity of who lives here. It’s not your imagination: We’ve written before that San Francisco is one of the only places in California that is getting whiter. Meantime, tech founders who are white and male (which is to say: The vast majority) have said they don’t think diversity is a problem or believe it will just solve itself.  

Sure, people have frequently bitched about the cost of living in San Francisco, but this feels different. Not only did we not experience a crash, but things will likely get worse for housing prices and rents if anything close to the banner IPO and M&A year being predicted happens. And unlike previous eras, we have several companies competing to be the first $1 trillion market cap company all still continuing to grow and expand and hire and inflate the cost of living.

Even if we saw a “crash” of every private unicorn, Facebook, Google, Apple, Salesforce and so many other publicly-traded companies built in previous waves are not going anywhere.

Add to that another little noticed trend I wrote about recently: The death of network effects and the return of the VC as kingmaker. Google and Facebook have become so dominant as distribution channels that everyone is buying growth right now. VCs will essentially pick one entrant in a category, fund it heavily, and choke off the competition.

This trend has lead to an astonishing lack of “me too” companies chasing massive market opportunities, and de facto winners before the game is even played. It’s also one reason we’ve seen the number of deals decline but dollars go up for so many quarters. Among other potential problems with this trend, unprecedented levels of private capital in the hands of fewer companies, is not going to help the cost of living in San Francisco or the homogeneity of the type of person who is #winning.

We’re long past the point of worrying about how teachers and other vital members of a community you need when you want to not only work in a place, but live there. The concern on this Facebook thread was whether or not even successful tech companies will be able to afford to have more than, say, the top, most elite 10% of their workforces live in the Bay Area if the trend continues.

If Facebook building more housing is the answer, well, that’s kind of terrifying. Our ecosystem becoming more reliant and more dominated by tech companies worth hundreds of billions of dollars is not healthy, no matter what you think of Facebook. Facebook is already gaining influence in a Donald Trump administration, thanks to its board member Peter Thiel’s influence in the White House. Let’s not too live in a world where Facebook essentially controls Palo Alto and Menlo Park city counsels because it pays for essential city services. (Germany, in case you are wondering, seems to be the only government in the world holding Facebook accountable.)

As a parent, I share every single concern voiced on the thread. On one hand, in a Trump America, I can’t imagine raising my children in other parts of the country where a majority of voters believe it’s ok for the disabled to be mocked, women grabbed by the pussy, children shouldn’t be vaccinated, immigrants are what’s wrong with America, and ethics are to be discarded if “no one cares.”

On the other hand, I am raising my children in a place so white and myopic and elitist that the reaction to that election was we should take our football (ie billions from tech companies) and go home rather than mix with all those red states. A place that has so DISRUPTED! labor in this country that billions in venture capital have been put to work not to solve problems like climate change, but to create a world where people who are less well off bike and drive all over town, acting as servants to those who are more well off.  A place where the concerns about propaganda influencing our election are waved off because statistically only 1% of the content on Facebook everyday was fake. (Nevermind, that because of Facebook’s gargantuan size, that 1% still represents a higher volume than most major newspapers publish on a given day.) A place that doesn’t care if customers are bullied, teenagers commit suicide, or women get raped in cars, as long as that number is under an acceptable percentage. A place where a man caught on camera beating his girlfriend gets a new job at another venture fund.

I can understand why parents-- even those working in tech-- are concerned about a decrease in the aptly-named humanities being taught: Silicon Valley is increasingly becoming a place that doesn’t put a premium on humanity. It’s becoming a place without empathy, because of everything “the data tells us.”

Trump’s evasion around ethics in his first press conference was “The American people don’t care.” Silicon Valley’s is “what the data tells us.”

Venture capital is called “the lifeblood” of Silicon Valley, and that’s an apt moniker. Wherever that blood flows, is where life teems, pools, populates, and grows. Venture capital doesn’t just pay the bills and enable the economy here. It gives permission, it changes norms, it reestablishes what is “OK” culturally.

Breaking laws becomes disruption with enough capital flowing to it. Gender and racial bias become a pipeline problem when the bulk of the money insists that’s the case. A region becoming “whiter” becomes an efficient market economy where the best are getting rewarded. That money exiting is the moral justification for anything it’s done along the way.

So, yeah, “the data” shows us today what we argued back in May, that there wasn’t a correction after all. And it shows what we argued in June, international cash is a major factor and it isn’t going anywhere. It’s what the data doesn’t show us that a lot of people in the Valley are starting to worry about most.