Update: Jocke just said in a tweet that I completely misunderstood the article, and he promised to clarify and educate me. No one would be happier than I if he have time to do that.
A blog post by my friend Jocke made me think, are we in a bubble? After tweeting a bit with Jocke, I find that I have to at least explain my thinking, even if I draw the wrong conclusions. Compared to some of my friends, I am not in the VC business, although I have been involved in a number of startups and do know what it implies selling, buying and investing in companies. Specifically regarding control over a company. And business models, yes, I know that.
Anyway, what is it that I see? If we look at what Jocke saw in the graph, the average successful startup raises $25.3M and sells for $196.8M. What I am looking for are things like what the revenue (or turnover) is, what the burn rate is, and have that compared with the value, the size of the future market and what success the products might have.
This because I see an investor wanting the money invested back and it can happen in basically two ways: by selling the shares and by getting dividend. And if companies in the startup phase is growing from $23.5M to $196.8M, that is of course growth in value that is extremely good for an early investor, but what is the situation for the later investor?
Should the value continue to grow another 7-8 times, or should the later investor be happy with just the normal expected growth of maybe 10-15% on a y2y basis? And where does this growth come from? Evaluation once again based on future value, or expectation that actual revenue will grow enough?
And if we look at a number of investors, and a number of investments, each investor of course does not expect revenue on every investment, but as an average an investor most certainly want growth that is above other investment instruments. And if every investor expects that, we as a total can say that investment as an instrument should grow with say 15-20% on a y2y basis. If it grows faster, I ask where that extra money is coming from? Just evaluations? Evaluations plus external capital that might come from borrowed money where the shares are security?
What would be interesting to see, as pointed out by CityNetworks, the graph do not show the non-successful startups. The ones the investors have invested in that failed.
The reason why I am nervous we are in a new bubble is if the investments are done in series where money invested comes from another sale based on another potentially grossly positive evaluation. And then repeated among investors and companies. And that no new money is injected in the spiral. Or if the newly injected money comes from for example various loans where the shares in the over evaluated organizations is security. Loans that must be paid back one day.
Anyway, where does the revenue from then? Well, call me traditional, but I am a guy that likes look at revenue, market share and such figures. Is the operation of the organization possible sustainable based on the revenue? Is further development possible to do without external capital? Is it in the future? If so, when? And, most important, is the business model so positive that it can start give money back in one way or another to the investors?
If it is the case that the evaluations are increasing in a spiral, simply because investors can invest more because the last exit was so successful, that series of investments and exits might one day collapse. Was that not what happened 2001? Not an IT-bubble, but an investment bubble. Of course we do not know that as we do not know the failures among the startups discussed in the article Jocke refers to, but just looking at difference between investment and exit values, well, that to me is a too simple picture (as Jocke says) as there are other parameters that one must look at before drawing conclusions. If we just look at the almost 8-fold difference between investment and exit, that growth to me is too large to be healthy.