When a lot of money flows into a sector yet the supply of investments is too small to meet demand, valuations go up and a bubble forms. That's Economics 101.
We've seen it happen in housing and stock markets. And we know it's what happens in goods markets, especially when there's a shortage of a necessity such as food.
So when large amounts of money flow into venture capital funds, but money managers can't find enough good places to invest, one of three things will happen. They will sit on the money, start buying into terrible startups, or pay too much.
It's sacrilege for VCs to let their funds sit in bank accounts, especially in this zero-rate environment, so doing nothing is a non-starter. As Gadfly's Leila Abboud and Elaine He wrote last week, endowments and foundations that entrust their money to venture capitalists expect them to put that money to work.
At the same time, in the magical world of venture capital there's no such thing as a terrible startup. Failures are far more common than successes, you just don't hear about them unless someone blogs about it, and so buying a loser is really no badge of failure. That means any business can attract funding given the right price. Yes, that's right, you too can start a company and attract venture capital... if you're willing to chase VCs and accept that your cool new dating app isn't the unicorn you thought it was.
Given that money must be deployed, and any startup can be on the table, a surfeit of liquidity inevitably leads to scenario three: paying too much. We've already seen that happen throughout the world, especially in Greater China, and despite a recent bout of rationality it's likely to continue.
According to the National Venture Capital Association, U.S. VC fundraising is on track for its best year since the dot-com boom (and we know how that ended), while a report out last week from KPMG and CB Insights shows that deployment is at the lowest level in two years. Despite this fact -- or, ironically, because of it -- VCs are rushing to raise even more money, Bloomberg News reported last month, which of course will need to be invested over the coming years.
Now that we've painted a picture of the state of global venture capital, consider this little nugget: SoftBank's Masayoshi Son is building a fund to invest as much as $100 billion over the next five years. That's almost three times the amount of money the entire U.S. VC industry raised last year. The fund is being bankrolled by the Saudi Arabian government to the tune of as much as $45 billion with SoftBank and others to make up the rest.
"Masa" has hit a few home runs in the past, Alibaba and Supercell being among them, so I won't be so bold as to say he's clueless. Yet at this level of funding, more money flowing in does not mean more startups will be born. The startup ecosystem is like the economy in general in that a certain level of money is needed to create favorable conditions, but no more.
Just as tax cuts for the rich put extra money in the pockets of billionaires, at some point they don't need any more yachts (or ponies). Likewise, throw more money at startups and they won't produce better algorithms or superior dating apps. Instead, you'll just get silly valuations and ridiculous marketing stunts.
I call it trickle-down venturenomics.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story:
Tim Culpan in Taipei at firstname.lastname@example.org
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Matthew Brooker at email@example.com