It seems like almost every
day now I see someone who believes we are in the midst of tech bubble (a world in which companies are valued far above their true worth). The most
common arguments people mention are 1) startup valuations are massive and
dissociated from underlying value 2) public technology companies are overpriced,
and 3) MBA-types are moving to Silicon Valley to get a piece of the gold rush.
In this post I will address each of these points and argue that we are not in a bubble.
Startup valuations are too high
Argument: Nosebleed startup valuations are the most
commonly cited indication that we are in a bubble. Airbnb and Dropbox are
valued at $10 billion each. Snapchat and Pinterest are valued at $4 billion
each and they don’t even have revenue. Facebook bought Oculus for $2 billion
before consumers could even get their hands on the product. Whatsapp is just a
Most people have become
comfortable with the idea that even though young startups are likely to fail, seemingly
high valuation can be reasonable if there’s a sufficiently likelihood of success.
Early stage venture investing follows a power law, and the billion dollar
outcomes can justify valuations for a whole set of startups. This is why two
founders with an idea and a prototype can raise money at a $5 million
valuation; early stage startups are treated as part of a basket.
For mature companies like
Microsoft, valuation is best understood on an individual company basis, as a
discounted stream of future cash flows. Huge companies trade at a reasonable
multiple of their earnings because dramatic growth is typically out of the
I believe the mental error
here is categorization. When people criticize multi-billion dollar valuations,
they are bucketing them alongside mature public companies, when really they
should still be considered as a basket that will follow a power law of
outcomes. The right question is not “is Snapchat worth $4 billion?”, but
rather, “is there a 10% chance Snapchat is worth $40 billion?” .
We live in a world with over
1.5 billion smartphones and more sophisticated technology than ever before,
which means startup potential is greater than ever. When you combine this with
an understanding of these companies as part of an overall basket, multi-billion
dollar startup valuations seem reasonable.
Public markets are overpriced
Argument: Tech high-flyers like LinkedIn and Netflix
are trading at hundreds of times their earnings. We are seeing the most new
tech IPOs since the tech bubble in 1999, and many of them are for companies
that are quickly burning cash. The NASDAQ is closing in on its all-time highs
from 1999 bubble, and the small-cap tech stocks are at some of their highest
P/E ratios ever.
There is some truth here;
tech stocks are expensive right now by any measure. However, that doesn’t mean
While it’s true that younger
smaller tech companies are richly priced, the mature tech companies like
Microsoft, Google, Apple, Cisco, Yahoo, etc. are trading at very reasonable levels. Also,
younger, struggling companies like Groupon, Zynga, and King have stock prices
that reflect their situations.
Investors are evaluating
each company on an individual basis and valuing businesses that at least make
sense and have workable business models. This is very different than the last
bubble when companies erroneous business models got great valuations as long as
they were “tech”, and mature companies valuations were rising with the rest of
What we really have in the
public tech markets is highly priced young companies and moderately priced
mature companies. If you believe that some of the young companies are poised to
disrupt the incumbents, or if you take a basket view to young tech companies,
then public market valuations aren’t so scary.
Outsiders are migrating to startups
Argument: Five years ago, consultants were competing
to get into business school, MBAs were funneling back out to Wall Street, and
bankers were quitting to work at PE funds. Now, everyone is just joining a
With this argument, the
premise is true; more people are starting and joining startups than ever
before, and they’re coming from a much more diverse set of backgrounds.
What’s not necessarily true
is the conclusion, that this migration of talent is a bad thing that indicates
a tech bubble.
The largest new source of
tech workers is the veterans of banks, consulting firms, and business schools. This
demographic is widely assumed to be “in it for the money”, and so skeptics
believe they will be unable to build the revolutionary companies that drive
innovation forward and create massive value.
I have a more optimistic
view ; I think the majority of this crowd was unsure what they wanted to do,
but knew they wanted to work hard and feel important. It seems plausible then
that they could discover the startup world a little late and fall in love with
it just like anyone else.
Instead of viewing this
influx of workers as a sign of a bubble, it should be viewed as the logical
extension of an increasing attractive industry in a country with fluid labor
A bubble is one of those
things that can only be identified in hindsight, not because we don’t have
enough information right now to know, but because it has not yet been
determined. If companies collapse and lose their ability to grow and earn
money, then we will have been in a bubble. If enough startups succeed in the
ways we hope and expect, then we will not have been in a bubble.
I believe the latter is more
likely to be true, that tech is poised to continue on a trajectory of massive growth.
The market for startups today is different than it has ever been. Over a
billion people have a computer in their pocket at all times, and billions more
have access to the internet. Software can be deployed from the cloud and run on
a massive scale instantly. Industries that never used technology before are
welcoming software into their businesses with open arms. Large amounts of
capital are available to startups at every stage, and there is a bigger pool of
talent wanting to work in startups than ever before.
Yes, capital is plentiful
and cheap, expectations are high, and new tech workers are flooding in from
every corner of New York. This may scream, “bubble!” to you, but remember that technology
is not zero-sum game. All of this could very well signal the influx of capital
and labor that is necessary to create a virtuous cycle that can grow an
industry at a massive scale.
 In fact, the bar is even lower. The real question
should be is the integral of graph of probability vs. outcome worth more than
 As a side note, although on some level I
understand the reaction to be skeptical of MBAs entering startups, I think it’s
an unsubstantiated bias and drives an unwelcoming culture that we should not