I flew into JFK, saw that the taxi line was really long, called a Lyft, and was on my way 2 minutes later. And I paid $10 less than I would have, had I chosen to wait in line for 30 min, ride in a hygienically questionable car driven by an uber aggressive maniac yelling into his phone, with the radio blasting in an unrecognizable language. Instead I was in a quiet, clean Camry driven by a polite person, with a free bottle of water. Unicorns are changing the world, making incumbent business models obsolete by improving the service by 10x while saving people money AND helping people earn a living. There is no doubt these guys are improving the overall wellbeing of Americans and in the long run it will be very hard for anyone to stop them. But Uber should not be valued at $50B valuable when you adjust that potential for regulatory and liquidity risk.
Are we in a bubble?
Yes, I think we are in a bubble. Nothing like the dot com bubble or the financial crisis of 2008, but a modest bubble in a more localized area of our economy; the tech private IPO market. The term private IPO is already an oxymoron (come on, private initial public offer?) which is a strong signal that the end is near. Investors are throwing billions of dollars to companies with audacious business models & goals without properly adjusting valuation for risk.
No Exit in Sight
Some of the unicorns are too big to be bought out, too risky to go public, and too expensive to operate to turn a profit in the short term. Who’s going to pony up $50B to buy Uber? $24B to buy Airbnb? $11B to buy Pinterest? Well, I guess the last one is not completely unrealistic, but the point is, this is not exactly a seller’s market at this price range.
Which brings us to the IPO as an exit option. How do you know you are operating a risky business? How about: When a leader gets arrested for merely doing his job. An IPO is a tradeoff of accessing large amount of capital in exchange for transparency and scrutiny. You can’t really take a company public operating in a regulatory gray area. You would also need a financial plan to justify a high valuation. Kind of hard when you thought you had a million contractors and overnight you may be stuck with a million employees with benefits. Adding to this, it is increasingly hard to get to cashflow positive in Silicon Valley nowadays when an entry level engineer will cost you $150K (with benefits) and you are competing against Google, FB, and Apple for talent.
Another way to return $$ to investors is to pay out dividends. LOL. Sure, that will happen in our life time.
What will trigger the bubble to pop?
Private companies are by definition less transparent and less liquid than public companies. Because valuation of these companies don’t get adjusted in real time like the public market, we see valuation jump up round to round, making it a bumpy uphill graph that looks like stairs. That is, until you exit and join your post IPO buddies, or you run out of cash and have to raise another round at (gasp) a lower valuation.
Is Uber worth $50B? I don’t think it is, not today after you adjust for regulatory and liquidity risk. Two things can happen when Uber runs out of cash and has to raise another round. The existing investors plus additional suckers driven by the fear of missing out doubles down at a higher valuation and extends the bubble period or (I think the more likely scenario is) Uber raises a round at a lower valuation, which triggers the bubble to pop.
What is interesting about this bubble pop is that it will be a series of smaller pops spreading over months or even years. Uber will cause the most significant splash and will affect the public market. Then we will wait a few months until the next unicorn not ready for an IPO has to raise a round at a lower valuation, and then another. Each time this happens, the asset column on an investor’s balance sheet shrinks, investors and entrepreneurs become more risk averse, and startup fueled innovation slows.
So who’s getting screwed?
Investors, investors of investors, founders and employees will feel the most direct hit since they own these less valuable assets. Let’s think about what the ripple effect will be.
Early round startups: lose
There will be less funding to go around to the new new things. The apparent decrease in upside will make entrepreneurs more risk averse and it will be harder to convince early employees to leave a big company to join a small startup. VC’s will also have a tougher time raising funding.
Publicly traded tech companies: lose then win
A lot of focus will be put on righting the unicorns, which would include added financial discipline and perhaps rounds of firings and key employees leaving. I would think stock prices of tech companies will go down with the ripple effect but Google, FB, Apple, etc. are companies generating real profits with less regulatory risks and full liquidity. They had to overpay for engineers because startups were luring them with equity upside but disappointed rockstars will start leaving unicorns and tech giants will pick them up immediately. These are rare game changing talents that could show up in bunches. In the long run the tech giants will get stronger from this.
I think this series of events is just a hiccup on the hype cycle. A lot of unicorns are building businesses that are disrupting dysfunctional industries, creating jobs, and generally improving the world. Uber may not be worth $50B today but they just need to tackle the issues they are facing one by one and in a few years they could get there (or more). The cause of this round of bubble is less about the businesses faking value and more about investors making undisciplined financial decisions; a private company valuation inflation if you will. Unicorns are supposed to be hard to find. A billion dollar valuation represents more than just market size and potential but the ability to execute on and operationalize the opportunity. Some unicorns will lose their status after this is all over but that does not mean they are worthless. Some will figure things out and will make a dent in the universe.