Is Another Crash in Silicon Valley’s Future?

Last Thursday, American Public Media program Marketplace had some  very interesting things to say about the state of Silicon Valley’s venture capital. Kai Ryssdal interviewed tech correspondent Molly Wood to discuss the influx of tech companies worth over a billion dollars (known as “unicorns”). “There are more than 80 of these startups,” says the Marketplace blog, “except lately there’s been more and more speculation that the valuation of some of these companies is about as mythical as unicorns themselves.”

In brief, Ryssdal and Wood discussed…

  1. That it should be harder to become a unicorn – a lot of unicorns have low growth margins. Fred Wilson, venture capitalist, says a lot of these companies even have negative gross margins, meaning they’re selling these products for less than it costs to make them. When valuation is off, and IPOs are on the line, investors tend to get cold feet…could there be a crash in the near future?
  2. There’s been a change in attitude – People are starting to feel like this investment streak is out of hand, and that investors should pull back. There are only so many Tinder clones out there that will ever become something special.
  3. This might be different from the dotcom crash – Some venture capitalists say there won’t be a crash and that there is no bubble. Spending in the third quarter was way up—but you could argue that that’s the sign of a bubble. “Whether or not it’s true, you’d look at it and say that’s not right, that can’t last forever,” says Wood.
  4. FOMO may be a problem – People have fear of missing out, so even in the event of a crash, people are going to keep coming here trying to seek their fortune, and that’s what could make a crash worse.

The Marketplace’s report makes it seem as though a crash looms inevitably in the future. But the tech community has been buzzing about this possibility for a couple months now, and have some differing opinions.

Tech Crunch says that what’s happening in Silicon Valley currently isn’t a bubble. “Despite sources like Silicon Valley News reporting that the second quarter of 2015 was the largest quarter in Silicon Valley since 2000, investors assure everyone that no one is speculating, but rather investing in those high-demand segments and verticals that are showing significant sustainable revenue and viable metrics,” says Crunch Network contributor John Rampton.   

The article then goes on to summarize a report released by Ernst & Young about the health of the global IPO market, which point to evidence that although the NASDAQ Composite is at similar levels to 15 years ago, current valuations of companies are just more realistic than they work back then at the time of the crash.

Rampton insists that, “the market factors have changed compared to other periods when the bubble burst, making it like comparing apples to oranges.”

An article from The Economist agrees that if there is a crash, it won’t be as bad this time as with the dotcom catastrophe. “Today’s technology businesses are selling services and products from which they already generate income, rather than just saying that one day they might. And the group of people doing the investing is much smaller now than it was then. The risks are on fewer shoulders.” (But the author also points out that, “if the risks are limited to a smaller number of people, so are the benefits.”)

The article goes on to summarize many of the ways that current venture capital can both help and hinder growing startups in the rush to find the next big money maker.

One problem the author notices is the growing price of talent. “Competition for skilled workers ‘is more intense than I have ever seen it,’ says Jim Breyer, a prominent venture capitalist. The average software engineer in San Francisco now earns $150,000, according to Glassdoor, a database for employer reviews and job listings.”

Maybe Marketplace’s warnings for a crash are correct, maybe TechCrunch and The Economist’s more optimistic predictions will ring true. A few things are for certain, though. There’s a lot of money floating around Silicon Valley, and the competition for hiring talent is just as fierce as it ever was.

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