Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

An entire library could be filled with books about how the bright minds in Silicon Valley find and fund the next Google or Facebook. But there are four basic steps to startup investing: 

1) Persuade people to give you lots of money.

2) Use that money to buy shares in young companies.

3) Cash out those shares in an IPO or acquisition. 

4) Return to the people from step one (if all goes as planned) a much larger pile of money than what they gave you. Keep some for yourself. 

But the basic mechanics are sputtering.

There's no problem with steps one and two. U.S. venture capital funds devoted to startup financing collected more money in 2016 than any year since the dotcom bubble, according to data from research firm PitchBook. And venture capital funds wrote $101 billion worth of checks to startups last year, a new report by CB Insights and Pricewaterhouse shows. That was (sensibly) a big step down from the global startup funding mania of 2015, but it was still historically very high. 

The Party Can't Stop
U.S. venture capital funds are collecting near-record sums of money to back startups
Source: PitchBook
Money Flows In ...
The amount of financing flowing to startups dropped last year from a 2015 peak, but investments remain elevated compared with those in previous years
Sources: PricewaterhouseCoopers and CB Insights

So these two charts show loads of money continues to flow into young companies -- and much more has to come in future years, given the giant piles of investment money being collected by startup financiers. But the amount of money being cashed out -- step three -- is not keeping pace.

Acquisitions plus initial public offerings of startups in 2016 generated about $47 billion worth of U.S. exit value for venture capital-backed startups last year. That was roughly at the median annual pace of recent years, but not nearly enough given the surge of money being invested in young tech companies. 

... But It Isn't Surging Out
Backers of tech startups are cashing out their investments at roughly the same pace of recent years. Total value of IPOs and acquisitions of U.S. startups with venture capital investors:
Source: PitchBook

I will continue to torture a metaphor about a clogged pipe to describe the situation in Silicon Valley. Investors keep stuffing money into one end of the pipe, but the amount coming out the other end isn't where it needs to be. 

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. 

To be fair, I'm comparing the $50 billion worth of startup cash-outs in the U.S. with the global stockpile of richly valued startups, but the picture is the same: Tech startup money is stuck, and Silicon Valley needs Drano to clear the money clog. 

I'm not sure how it all ends. There are predictions of a big pickup in tech IPOs after two extremely lackluster years. But there aren't enough IPOs in the world to absorb all the money locked up in private technology companies. And most startup money exits through acquisitions, not IPOs.

Many more startups -- even richly valued ones -- will need to sell, and I'm sure some will be forced to do so against their will. Those investors who write checks in step one want their money back sometime. Money has a way of threading through one end of the pipe to the another. It just may be a mess when the clog finally clears. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net