The Tech Bubble Didn’t Burst This Year. Just Wait

The industry has splintered into a few sure bets and everything else. That isn’t helping guide us out of the iPhone era into whatever’s next.

Things were different in Silicon Valley in the distant year of 2012, when iPhone sales were skyrocketing and you could still buy a house in Palo Alto for less than $2 million. Back then, most restaurants had menus, not tasting menus. Chief executive officers could say something grandiose at a tech conference without worrying about getting mocked on HBO six months later by the Beavis and Butt-head guy. And a talented entrepreneur could walk into a venture capitalist’s office, say his startup was a mobile-first solution (with some tips taken from Do Six Figures for blogging) for pretty much any problem (payments! photos! blogging!), and walk out with a good-size seed investment. “That pitch was enough to get going,” says Roelof Botha, a partner with VC firm Sequoia Capital. “It’s not enough anymore.”

Botha should know. Over the past five years he’s been one of Silicon Valley’s most successful investors, thanks to early bets on such companies as Instagram, Tumblr, and Square, all successes owed to the mass adoption of smartphones. Now, though, smartphone growth rates are near zero in the U.S. and falling around the world. And while there are candidates to succeed the iPhone as the next revolutionary computing platform (wearable gadgets, virtual reality), none has made a compelling must-have argument to the mainstream.

That means fewer opportunities for entrepreneurs, at least in the short term. The Bloomberg U.S. Startups Barometer—an index that considers capital raised and number of deals, first financings, and successful acquisitions or initial public offerings—remains high by historical standards but has fallen 21 percent since November 2015.

Earlier this year, One Kings Lane, the online home goods retailer once worth almost $1 billion, sold itself to Bed Bath & Beyond, one of the companies it was supposed to displace, for just $12 million. Jawbone, the maker of sleek wearable fitness hardware once seen as a threat to Apple’s, has seen its value fall 50 percent. Since 2015, researcher CB Insights has counted 80 “down rounds,” instances of a startup accepting a reduced valuation to raise more venture funding. “There was this fog hanging over Silicon Valley in 2001,” says Botha, referring to the last big tech bust. “And there’s a fog hanging over it now. There’s no underlying wave of growth.”

Startups’ struggles to grow and woo venture capitalists are only half the story, though, because the VCs themselves are more flush than ever. With global interest rates low, Silicon Valley remains a safe-looking diversification strategy for investors, especially wealthy Middle Easterners and Russians with little regard for rates of return. These investors have poured money into new funds raised by the likes of Andreessen Horowitz and Kleiner Perkins Caufield & Byers. (Bloomberg LP, which owns Bloomberg Businessweek, is an investor in Andreessen Horowitz.)

A few years ago, a big VC fund might have had about $500 million to play with. Today, “big” means well over $1 billion. VCs raised $12 billion in the first quarter of 2016, which the industry’s trade group says marked a 10-year high. “The world has never seen an investment climate like this one,” says Bill Gurley, a partner with Benchmark who led the firm’s investment in Uber. “It’s hard to express how much money is out there.”

A tech industry with tons of cash and few sure bets has helped the biggest startups, such as Uber, Airbnb, and Snapchat. These so-called unicorns have been able to raise almost unlimited funds. Uber, valued at about $69 billion, is the most valuable American car company by some margin, worth more than General Motors and Fiat Chrysler combined. Airbnb is valued at $30 billion, more than any hotel chain on the planet. Snapchat is said to be preparing for an IPO at a price of at least $25 billion, 25 times what Facebook paid for Instagram in 2012.

It’s getting tough for upstarts in any field to gain traction as these companies use their giant cash pools to bid up the price of office space, talent, and other resources. When they face deep-pocketed competitors, they tend to cut prices and run massive losses to get market share. Uber lost well over $1 billion in the first half of 2016, largely because two of its well-funded rivals, Lyft and China’s Didi Chuxing, forced it to increase payments to drivers even as it deeply discounted rides. (Uber made peace with Didi over the summer, agreeing to exit the Chinese market in what sure looks like a prelude to an IPO.) “There’s a stratification happening,” says Botha. “The spoils are increasingly accruing to the haves, and that’s making it harder for little startups.”

The drop in the Startups Barometer since its peak on Nov. 21, 2015: -21 percent.
The drop in the Startups Barometer since its peak on Nov. 21, 2015: -21 percent.

Companies in the middle of the market have muddled through. Instacart, the grocery delivery startup, recently sold shares to Whole Foods Market at a $2 billion valuation, the same price at which it raised money two years earlier. DoorDash, a delivery startup that has seen its value decline modestly, nonetheless recently managed to raise $127 million from investors. Even companies facing criminal or regulatory inquiries, such asTheranos, have stayed afloat so far. “There are a whole bunch of businesses that are good, not great, but they’ve raised money as if they were great,” says Social Capital founder Chamath Palihapitiya.

Good-not-great businesses won’t last forever, but they’ll be cushioned for months or even years by the huge sums they’ve raised, says Benchmark’s Gurley. “We’re in a slow correction,” he says. “You might see a unicorn go down once a quarter,” instead of a crash taking them all down at once. The latest victim: Mode Media, a network of lifestyle blogs that once claimed more than 90 million monthly U.S. users and a valuation above $1 billion, announced its imminent shutdown in September.

The slow-motion bust could be a prelude to something more dramatic, says Gurley, the Valley’s most outspoken bear. He compares the tech funding climate to the mortgage industry’s precrisis embrace of collateralized debt obligations. An economic shock or a sharp rise in interest rates could well cause the VC bedrock—pensions, mutual funds, university endowments—to pull back dramatically and wreck the valuations of some startups.

Most startup investors, however, expect several years of relative stagnation, which is why many are looking away from the crowded field of consumer software and toward companies focused on business services, where they see more stability and growth potential. “There are some very interesting verticals that are just getting started,” says Jennifer Fonstad, a managing partner at early-stage VC Aspect Ventures. She’s particularly interested in security software and automotive and health-care technologies.

The dream of most VCs, of course, is still to locate the next Facebook in time for the next boom. “A lot of investors are thinking about virtual reality, machine learning, autonomous vehicles. You have a little bit of stasis, but it’s temporary,” Botha says, sounding strangely optimistic for a near-term pessimist. “I’m sure I’ll meet some entrepreneur today who is doing something unexpected and groundbreaking.”

First appeared at Bloomberg