Silicon Valley Vaporization: Are Startups Burning Too Much Cash?

Silicon Valley Vaporization: Are Startups Burning Too Much Cash?

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Are too many startups burning too much cash too quickly? (Image Credit: Flickr by Adam Cohn / CC)

SOMA, the Flatiron district, Palo Alto, and London Shoreditch. They’re some of the hottest addresses in the business world. Rents for commercial space there have skyrocketed, thanks to one thing: astronomical tech company valuations. For those of us who remember 1999/2000, what goes up can go down. And the bursting of a bubble can be a painful experience.

Over the past few years, venture capital, private equity and other investors have bestowed billions of dollars on companies in the tech sector, which range from bona fide going concerns to enterprises that are little more than a guy with an idea and no revenues—yet.

All that capital coursing through the veins of America’s tech sector is invigorating, but it could also turn out to be a dangerous prelude to a fatal hemorrhage if those startups don’t have the self-control to deploy it wisely. A cash-fueled scramble for talent and space has some tech companies gleefully signing long-term leases requiring them to spend a mind-blowing $62.17 a square foot for an address in San Francisco’s SOMA district or $82 a square foot in London’s Shoreditch district; it also has them spending ridiculous amounts of investor money on building things like cage-fighting arenas and climbing gyms for the employees, or bringing in daily catered lunches and massage therapists.

All that spending seemed like a brilliant way to attract talent a few short years ago. But now some of the same venture capital and private equity investors writing giant checks have begun wondering: is it all getting out of control?

What they really should be asking is: are we contributing to the problem?

Mark Andreessen, the prominent VC at Andreessen Horowitz, has invested in mega tech brands such as Airbnb, Facebook, Groupon, GitHub, Jawbone, Lyft, Pinterest, Buzzfeed, Skype, Twitter, and Zulily. His firm’s return on its $250,000 investment in Instagram alone was $78 million.

Jim Goetz of Sequoia Capital put about $60 million into WhatsApp, and this year Facebook bought it for $19 billion. Sequoia turned its $60 million investment into $3 billion.

Benchmark Capital, co-run by another prominent VC, Peter Fenton, reportedly made around $800 million on its initial investment in Twitter, back in 2009 when the company only had about two dozen employees.

Those massive returns are rewards for taking bold risks. But they are also providing the cash that’s fueling a thirst to do it again and enabling VCs to double down on their next bets, inflating the valuations of their portfolio companies to a level that could turn out to be as ridiculous as those office rental rates.

Benchmark’s investment in Uber gave the ride-sharing company, which reportedly has about $250 million in revenue, a $17 billion valuation. Andreessen Horowitz was part of a $200 million funding round on Pinterest that pegged the value of that company at $5 billion, despite the fact that the company “still makes little revenue,” according to the Wall Street Journal. Another Andreessen portfolio company, Airbnb, raised $500 million in April, giving the company a $10 billion valuation, roughly 40 times its rumored 2013 revenues of just $250 million. Apparently, that was too low, because Airbnb’s valuation was recently bumped up again, to $13 billion.

VCs have been inflating their own tech bubble, and now they’re getting nervous.

In September, Marc Andreessen began airing his worries via Twitter, where he made an 18-point argument that the bubble is about to pop. “New founders in last 10 years have ONLY been in environment where money is always easy to raise at higher valuations. THAT WILL NOT LAST,” he tweeted. “Lots of people, big shiny office, high expense base = Fake “we’ve made it!” feeling. Removes pressure to deliver real results.” Never one for understatement, Andreessen added in another tweet: “Many high burn rate companies will VAPORIZE.”

Bill Gurley, a partner at Benchmark, is worrying too. “Every incremental day that goes past I have this feeling a little bit more. I think that Silicon Valley as a whole or that the venture-capital community or startup community is taking on an excessive amount of risk right now,” he told the Wall Street Journal. “Unprecedented since ’99. In some ways less silly than ’99 and in other ways more silly than in ’99.”

But is their worry a reason to back away from the tech sector? Depends on which end of the investment you’re on.

“Ordinarily, when someone criticizes me for only making 312 times my money, I let the logic of their statement speak for itself,” said Marc Andreessen’s partner Ben Horowitz.

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