Billion Dollar StartUps

It has gone crazy-we have now entered an era of “billion dollar startups.” Venture Capitalists just seem to be throwing even more cash at these companies and are driving their valuations ever higher into the stratosphere. The last time craziness peaked was back in 2000 when a record 28.4 billion US dollars was blown on startups, around about the time when the whole system was about to pop. Remember the era when making a profit was unfashionable, lacked ambition and what really mattered was a business plan that focused on conquering the market? When investors started worrying about the profitability of the business, the ivy league brigade in white shoes, would tap their investors on the shoulders and tell them that “profit is for wimps”. After all, the business goal is global domination. They would say, “be patient and think big.” For a while investors bought the spin and gave-up short term profits for anticipated bigger profits sometime in the future. But many of the dotcoms, this is the era I‘m referring to, never made a profit, investors realised that they had bought an illusion, the dotcom bubble popped and the rest is history.

Well, 14 years on and they are at it again, but this time the level of craziness has broken the 2000 record. In 2013 there were 28 start-ups with valuations of a billion dollars or more, this year that figure, since October 7, has risen to 49 start-ups, at this rate it is likely to be double that of 2013.

What is driving this parabolic rise in startups with valuations of one billion USD or more?

Maybe it has something to do with a lengthy period of artificially low interest rates, a policy followed by the central banks to try and mend the last financial crisis back in 2008. Venture Capitalist Fred Wilson believes that years of loose monetary policy is behind the drive. “We’re not in a normal valuation environment,” said Wilson. “They (central banks) have flooded the market with cheap money in an attempt to heal the wounds (losses) of the financial crisis….”

So in other words, there’s been a tsunami of cheap money. Of course, for those privileged few who have access to it. Regretfully, for the vast majority of the public, all they have experienced is dwindling public services and austerity.

Perhaps we live today in a kind of feudalism, with austerity for the peasants and an abundance of capital for the elites, no wonder there is public discord and disillusionment with governments and the system. Those with access have been intoxicated by the “funny money,” they are drunk on it. When you are intoxicated you do funny things, you take huge risks, particularly when yields in safe assets have been reduced to microscopic levels. The Wall Street expression comes to mind, investors are "picking up nickels in front of a steamroller." When Investors welcomed yields in Greek bonds of around six percent it underscores how intoxicated they have become, they have lost their perception of risk. This is something that could come back to haunt us in a big way. The reality is that the Greek state is bankrupt and unlikely to payback their debts, moreover, it has recently been downgraded to emerging market status. How can you get excited about Greek bonds?

Back to VC investing, take a look at what happened to Dropbox, the online storage provider. In a deal decided behind closed doors, a group of Wall Street firms and VC funds decided to chip in up to 250 million US dollars, and with a magic stroke of the pen, they multiplied its “valuation” 2.5 times, from $4 billion to $10 billion, “according to unnamed sources” that routinely leak this stuff to the Wall Street Journal.

With that same magic pen they also jacked up the future valuations of all other startups, and many more billions of US dollars of wealth was created. There were no factories, no machines, no workers were employed, there was no production and yet billions of dollars of wealth was created with what? Just a magic pen!

And it continues....

In March, it was leaked to the Wall Street Journal that apartment-rental site Airbnb was raising 500 million US dollars in its seventh round of funding. During the negotiations, again behind closed doors it was decided to give Airbnb a valuation of $10 billion, up from $2 billion in 2012.

So I went on line to check out Airbnb, according to the website it was “Founded in August of 2008 and based in San Francisco, California. Airbnb is a trusted community marketplace for people to list, discover, and book unique accommodations around the world — online or from a mobile phone.” In other words it brings people who have accommodation to let and people who need accommodation together. But how can it have a market capitalization larger than Hyatt Hotels ($9.4 billion), which actually owns valuable fixed assets, land, buildings, real estate.

So what is their game plan?

Maybe to ratchet up the valuation in large increments with small amounts of actual money and in the process create hype before any financial information about the company is known to the public. As the mystique builds, more money comes rushing in, which then creates fat paper gains for the old money.

It’s the old pump and dump story.

But we know how this all ends, eventually the liquidity evaporates, that happens in a flash and the pack of cards come tumbling down. Those companies operating on sound business models, then survive and thrive, albeit at more realistic valuations. Most of the others just vanish. VCs usually get out before the crash, but it is their post IPO investors that buy into the hype that often lose it all.