US venture capitalism betrays signs of a bubble set to burst

 

BUSINESS OPINION:Rewind the clock six years and you could have been at a property conference in Dublin, with estate agents, bankers and developers, writes JOHN McMANUS

SILICON VALLEY is as close as US capitalism comes to perfection. Insiders like to describe it as an ecosystem where ideas are generated and turned into businesses in an ever-accelerating virtuous cycle. In the process, wealth is created and people are employed. The American dream lives on.

The ecosystem has many parts including entrepreneurs, tech companies, universities and law firms but it is the 400 or so valley-based venture capital firms that keep the whole show on the road. It is their relentless search for profit that pushes the whole thing along and has given the world Google, Apple and, more recently, Facebook.

Hearing a valley venture capitalist describe the investment process is something of an eye-opener as the 24 finalists in this year’s Ernst Young Entrepreneur of the Year competition are finding out on their “CEO Retreat” which is being held in nearby San Francisco.

Venture capital in the valley is about ideas and people. It is about growth and not revenue. One venture capitalist candidly described a recent deal to the visitors in the following terms: “On a revenue model, it was a crazy price; on a growth basis I think we will do okay.”

Doing okay in this context is either selling the company or floating it on the stock market at a valuation that will return a multiple of the original investment. The fact that the company in question may not be making any money itself does not necessarily have to be an obstacle as long as it is growing and has the potential to make buckets of cash. The company doing the acquiring does not even have to be profitable as long as the investors behind it are of the same mindset.

The sang froid of the venture capitalist is evenly matched on the other side of the table, with one prospective Irish valley entrepreneur saying his experience was that a pitch to a venture capitalist explaining how you are going to make money was a “turn-off”; most want to focus on “the team and the idea”.

For the visiting Irish entrepreneurs, it was hard not to be impressed by the turbo-charged capitalism on display, even if the almost evangelical zeal of some they met was disquieting. This was particularly the case with Keiretsu Forum, an organisation that facilitates start-ups to pitch ideas to serial entrepreneurs who might invest with them. Think Dragons’ Den on steroids.

Many, however, struggled to relate it all to their own business back home where cash, not ideas and teams, pays the bills. And it was hard not to think back to more recent events at home when listening to the members of the Silicon Valley ecosystem discussing the venture capital process. Rewind the clock six years and you could have been at a property investment conference in Dublin, with the panel replaced by bankers, developers, estate agents and other members of the Irish property ecosystem.

After a decade of extraordinary success, they would have told you that the Irish property market was on a sustainable path and could continue to defy common sense. Prices and demand would continue to rise even though apartments in Ballsbridge that had not even been built cost more than existing ones in Paris. And of course it wasn’t sustainable, but the banks and developers either could not see it or did not want to see it.

The question is whether – as many believe – something similar is happening in the valley ecosystem. Has a bubble developed that the players can’t or will not recognise? Has the virus consumed the host to the extent that the valuations and deal flow needed by the valley’s venture-capital-led ecosystem to sustain itself means they are ramping and selling the tech equivalent of overpriced apartments in Ballsbridge?

If there is a bubble in the valley, it will burst and the question nobody seems very keen to talk about is whether the dramatic fall in the price of Facebook shares post its flotation is the first real signs of it deflating.

The official line from the ecosystem is no. One banker who spoke to the group visiting this week attributed the Facebook debacle to a combination of mispricing – nothing was left on the table for those who bought the shares – and a general weakness in sentiment which has resulted in almost every company that floated this year underperforming. It sounded a bit like all that talk of soft landings in 2008.

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