Something weird happened in Silicon Valley during the tail end of 2015. People came to grips with reality.
In the prior 18 months or so, unproven young technology companies sold unprecedented amounts of stock at will. The money has become a bit harder to come by. Venture capital firms -- those seeking to find and fund the next Google or Facebook -- made $27.3 billion worth of investments in startups during the fourth quarter, a decline of about 30 percent from the three months ended in September, according to preliminary data from research firm CB Insights.
That broke what has been a relentless tide of money pouring into startups. The gusher help propel young companies like Uber, Dropbox and Spotify to rich headline valuations years before it could be justified by the companies’ actual financial performance.
To give just one example, on-demand ride startup Lyft recently sold a batch of stock that increased the company's implied value to $5.5 billion. The amount is eye-popping for a not quite 4-year-old company that is spending far more money that it generates, and reported a relatively slim $47 million in revenue for the first six months of 2015, my colleagues Eric Newcomer and Alex Barinka have reported. To show how outlandish Lyft’s valuation is, consider that on a roughly similar basis Apple would have a stock market value of more than $12 trillion, about two-thirds of the annual gross domestic product of the U.S.
The fresh CB Insights data show it was the biggest -- and therefore riskiest -- startup bets that are seeing the biggest pullbacks. In the third quarter of 2015, there were 72 investments in startups at $100 million or more. That was once an unheard of sum to put into a company getting off the ground. In the fourth quarter there were only 39 such deals.
The figures support anecdotal evidence that this is the beginning of the end for the era of “unicorns,” or startups valued at $1 billion or more. And thank goodness. The gusher of easy money made many people in Silicon Valley believe they were geniuses who could do no wrong. The big sums also spurred risk-taking that has fueled the ambitions of some remarkable startups like Uber and SpaceX but also over inflated many mediocre companies that may not last.
Now startups are doing shocking things that wouldn’t have happened six months ago, like turning down money they don’t need. That doesn’t seem so wacky, you say? Consider that it has been quite normal for startups to take whatever money they could get -- at the highest valuation they could get. What was the harm?
But seemingly free money does come at a cost. It turns the screws on a young company to take more and more risks to expand as fast as possible to make sure it can give investors their money back -- times three or four, or 100.
One battle-scarred investor said that in the pre-2013 days in Silicon Valley most startups making their first forays into international markets would have started with one country and a few people and see how business went before they considered further expansion. But more recently, startups have had the money and the push from their investors to blitz into a half-dozen new markets at once.
Risk-taking and ambition are essential character components of Silicon Valley, of course. But the easy money also may have let some struggling startups hang around for far longer than they should have -- with more painful falls to earth when they crash.
E-commerce company Gilt Groupe sold itself to the parent company of Saks Fifth Avenue for $250 million, or one-quarter of the valuation to which Gilt’s private investors had agreed. Mobile security startup Good Technology's fire sale to Blackberry left employees with overvalued stock that cratered. It has been a near regular occurrence for richly valued startups to debut on the public markets at decreased valuations, too, because stock market investors aren’t willing to give the benefit of the doubt to young companies.
In the fall of 2008, startup investment firm Sequoia Capital published a dire slide presentation titled "RIP Good Times." The firm warned young technology companies to slash costs, reconsider risky projects and otherwise batten down the hatches for a dark period of financial crisis. In short, Sequoia told startups they were not immune from global reality.
A slowdown of startup financing and a few distressed sales hardly means Sequoia needs to break out its slide deck again. If anything, this is simply RIP, Silly Times. Startups have have been divorced for a while from unpleasant realities like valuations that need to conform to the rest of the market or panic about growth in China. A return to rational behavior makes it more likely that Silicon Valley will cool down rather than crash.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
It’s not clear whether Lyft's “revenue” is a conventional measurement or counts the bigger pool of money Lyft takes in before paying its drivers. Lyft and Uber typically keep something in the the neighborhood of 20 to 25 cents from each dollar paid by their customers.
This calculation is based on Apple's revenue for the six months ended June 2015, and using the trailing revenue multiple implied in Lyft's valuation. No, it's not accurate to value a young, very fast growing taxi company on the same basis as a massive computer hardware company. This is for purposes of illustration.
And investors could argue they were acting rationally, too, in part because of the growing prevalence of stock sale terms that insulated them from downsides of risky startups.
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