Venture Capital and Technology: The Movie Sequel You Have to See and Buy
I watch a lot of movies, but I rarely watch the same movie twice.
For me, watching the same movie more than once feels like the strangest and most unusual self-inflicted torture imaginable.
I just have little to no interest in re-watching the outcome of a scenario that I’ve already seen play out.
But when I do have some downtime, sometimes I like to queue up movies that I deem “classics.”
These films may be categorized as “classics,” but I enjoy them because they’re action-packed, hilariously funny, inspiring, and great to watch over a few beverages of my choice.
A few of my favorite movies, in no particular order: Enter the Dragon, because Bruce Lee makes me feel invincible, Harlem Nights, because Eddie Murphy and Richard Pryor are absolutely entertaining, and Willy Wonka and the Chocolate Factory (the original, not Tim Burton’s adaptation), because it’s the children’s equivalent of It’s A Wonderful Life – don’t judge me.
And then there is a movie playing right now that we all may have seen before: The Technology Boom, Part 2.
And I’m eager to watch it unfold all over again.
Open the C Drive and Let’s Take a Trip Down Virtual Memory Lane
The Internet changed the way we live when it was introduced to the public in the 1990s.
From the late 1990s into the early part of 2000, the NASDAQ Composite Index showing no signs of slowing down as the market responded in a huge way to the technology shift made by both traditional businesses and Internet start-ups.
After the introduction of the first web browser during the early 1990s, there was a rush to migrate to the Internet platform, as it was widely believed to be the future of consumer communication and commerce.
As people began to integrate the Internet into their everyday lives during that period, Internet use went from roughly 16 million users in 1995 to almost 250 million by the end of 1999.
And, of course, there were a bevy of venture capital firms offering seemingly unlimited and inexpensive capital in exchange for equity stakes in companies that would take advantage of this magical new medium.
The goal for many companies and venture capital firms during that period was to cash out at nose-bleed stock price levels after going public.
In other words: take the money and run.
If you didn’t cash out early, well, there’s probably a virtual tombstone with your name on it somewhere on the Internet.
But the financial markets can change quickly.
Fast forward to October 9th, 2002, the day the NASDAQ hit 1,114: it had lost 80% of its value, plunging from 5,132 down to barely ~20% of that in 2.5 years.
Two years later, out of all the IPOs issued in 2001, exactly 0 companies doubled on their first day after going public.
Metrics? Are We Talking About Metrics?
During the Internet / technology bubble of the late 1990s and early 2000s, many venture capital firms ignored the more “traditional” metrics of assessing a company’s business and valuation in favor of… a more speculative approach, to put it kindly.
Being in the “angel” phase of a company’s business model often means that the companies are pre-revenue – which makes them tough to value for anyone.
That’s when investors start looking at these more “creative” metrics and assigning value to users, page views, active registrations, and so on, to guesstimate if the business is viable and if they’ll ever see an ROI.
Anticipated growth rates also become more common, and people focus more on sales than profits.
VCs may also analyze a company’s business model in relationship to market demands or voids in the marketplace, with an experienced investor team that understands the capital and opportunity costs in the space.
But during that time period, none of the “analysis” above really played a role: it didn’t matter whether or not you were profitable, possessed a strong business model to execute on, or even had a desirable target market.
The fundamental question was how large your (potential) customer base was and what it was anticipated to be in the near to long-term.
Consumer awareness and company expansion trumped any and all quantitative analysis.
We’re Going Back to the Future
Countless articles and news reports (as of January 2014) are saying that investors have been experiencing their best year in the market in over a decade.
With over $50 billion raised in IPOs in 2013, the market has not seen capital raising efforts this successful since the technology boom of the 1990s/2000s.
While there’s definitely diversity in the IPO offerings, technology and biotechnology lead the pack by a considerable margin.
And although the number of venture capital firms has shrunk considerably from the last bubble, that hasn’t even made a dent in the amount of capital that’s flowing freely to technology start-ups.
In the third quarter of 2013 alone, more than $8 billion in capital was raised for technology companies (up close to 20% over Q3 of 2012).
In 2000, by contrast, tech start-ups received over $100 billion – so there’s quite a ways to go, but we’re clearly headed in that direction… which begs the obvious question:
Is history repeating itself?
It’s tough to tell, but there are signs that it may be.
Twitter, as an example, one of the most successful IPOs in 2013, is valued at over $30 billion.
While Twitter’s revenue appears to be growing faster than Facebook’s revenue, it’s still heavily dependent on advertising revenue and, as of January 2014, it’s trading at more than 58x its past 4 quarters of revenue (Facebook, meanwhile, was at “only” ~19x revenue and LinkedIn was at “only” 15x).
As a point of context, in February 2000, Cisco, the computer technology giant and one of the largest companies during that period, was trading at more than 140x price to earnings!
Not exactly a one-to-one, but you get the idea.
In the words of Marty McFly, “Wait a minute, Doc. Ah… Are you telling me that you built a time machine… out of a DeLorean?”
It’s Like a Finger Pointing at the Moon
According to reports, there were 45 technology IPOs in 2013 and 2014 is poised to be an even stronger year.
There are almost 600 technology-based companies in the IPO pipeline for 2014 that are each valued at $100 million or more – and that mix is split almost evenly between private equity and venture capital firm investments.
Popular tech companies like Alibaba, King.com (makers of the Candy Crush virus), and Dropbox all have valuations in the billions, with investors eager to pour money into these companies because of their expected growth potential.
And there are even 30 companies with a valuation of over $1 billion each, also in the IPO pipeline.
But you may not be aware of another fact: there have only been 45 venture capital-backed technology companies that have successfully exited with a valuation greater than $1 billion between 2004 and 2013 (source: CB Insights).
Yes, that’s right: somehow the tech industry is going to unleash almost 70% as much value in a single year as it has in the past ~10 years, combined.
Now, you might say, “But the valuations are nothing like the old tech boom. At least these companies have revenue! If companies don’t have a legitimate business model with interim revenue goals, the market will hammer them!”
With IPOs, this is somewhat true: unlike the 1990s, you really can’t go public unless your business has a good $50-$100 million in revenue and some predictability and visibility into sales.
But if pre-revenue companies like Snapchat are shunning social media darling Facebook’s $3 billion dollar CASH offer…
Well, if it looks like a duck and walks like a duck, then maybe it’s the apocalypse being digitally streamed.
Don’t get me wrong: some companies will go on to be tremendous successes, just like how Google, Amazon, and eBay became huge successes out of the late 1990s.
I live in DC and I can tell you firsthand how Uber is a necessity in certain parts of this city.
Whether it prospers or fails in the long-term, it’s a real business that satisfies a real need and generates real revenue, and which has a viable growth plan.
But we never remember the big winners as much as we remember the big losers.
Does anyone remember Webvan.com?
As fast as the company raised cash in 1999, they burned through it even more quickly by 2001. The company was such a colossal failure that it left the San Francisco Bay Area with Webvan relics, even to this day.
My bet is that when the dust settles and the market looks around to see who the winners and losers are after this technology sequel, it will be the shareholders of [FILL IN SELECT COMPANY] left holding the bag, while the start-ups and venture capital firms that cashed out upon going public will be long-forgotten but obscenely wealthy.
Today is Tomorrow; It Happened
So what’s your takeaway from all this?
Sure, you may not like the start-up environment… maybe you prefer something more corporate.
But if it’s true that history repeats itself, we are at the root menu of the playback sequence on a DVD of the sequel.
And you don’t even need to move to Silicon Valley or San Francisco: new tech companies and venture capital firms are littered throughout the world, and will continue to recruit top talent during this technology resurgence.
I’m not a gambling man (in public), but if I were, the next 2 to 3 years are going to be a bright green roulette table where all the numbers are the same and the color is metallic.
Technology companies are where the business growth, employment opportunities, wealth generation and overall business excitement will come from over the next few years.
There’s no guarantee that every technology company will go on to command a billion dollar valuation, or that every venture capital firm will see an exit big enough to make everyone at the firm millionaires.
And you’ll need to get the timing right: if you join one of these companies, get a generous equity or carry package, and things seem “too good to be true” at first, but then keep getting better and better… well, that’s probably your cue to exit stage left.
I don’t even know if this technology run we are on will end in 2014, evolve into 2015, last for the next decade, or come crashing down somewhere in between. I also don’t know who the winners or losers will be in the near-term or long-term.
I just know a good sequel when I see one, and this looks like a good sequel.
The suspense is terrible… I hope it’ll last.
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