This column is by Dave McClure, Founder, 500 Startups
Abstract: the press have been whining “there’s another bubble in tech!” for years but it hasn’t happened (yet)… meanwhile VC-funded startups continue to raise capital, drive innovation, and disrupt incumbents. While some claim the recent downturn in unicorn financings and valuations is proof they were right(finally!) they couldn’t be more wrong — valuations have calmed down, but tech entrepreneurs and investors aren’t going anywhere. In fact, that ugly little asset class called Venture Capital is poised for monstrous growth as thousands of startups aim to disrupt EVERY public company, and since VC fund returns have risen over the past decade they don’t completely suck as much as they used to.
No, the next bubble is NOT in tech where innovation and capital are never in short supply… rather, the REAL bubble is in far-too-generous P/E multiples and valuations of global public companies, whose business models are being obliterated by startups and improved by orders of magnitude. As more Fortune 500 CEOs recognize and admit their vulnerability to disruption, expect them to hedge their own public valuations by buying the very same unicorns that keep them awake at night… Welcome to the Unicorn Hedge.
Everybody in the press loves to write stories about the next “Tech Bubble”.
Of course, they all think they’ve seen this movie before — twice in fact, in 2000 and in 2008. They think they know the script. They think they know the actors. They love the rollercoaster ups and downs, and just like M. Night Shyamalan they love a big TWIST right at the end… except the twist that’s coming isn’t the one they’re expecting. The REAL twist will be in public markets, not private markets. And I’m not talking about tech IPOs, I’m talking about NON-tech public company dinosaurs that have been hanging around for decades. They’re about to get disrupted by a unicorn / comet.
The REAL twist won’t be tech founders or investors losing all their money on over-valued unicorns (though indeed, that will happen too) — the REAL twist will be watching a bunch of senile, senior-citizen Fortune 500 CEOs & out-of-touch Gordon Gekko private equity “Barbarians at the Gate” get beat like a drum by tech startups and VCs half their age and twice as greedy.
The REAL twist is Wall Street finance getting disrupted by Silicon Valley tech (and, by NYC and LA tech too). The REAL twist is the S&P 500 not realizing their avg P/E multiple should be ~5–10 instead of ~15–25.The REAL twist is big oil & gas and automotive companies not realizing their market caps aren’t just overvalued, but that in 10–20 years THEY WILL GO TO ZERO as electric power and autonomous vehicles become the norm. The REAL twist is thousands of public companies hemorrhaging billions in losses and value over the next ten years, like gigantic, collapsing Manhattan skyscrapers in slow motion… except that it might not be that slow.
Introducing The Unicorn Hedge
This is the reason Unilever bought Dollar Shave Club for $1B. This is why Walmart is buying Jet.com for $3B (although that may be a bit desperate). This is why GM bought Cruise for $1B, why they invested $500M in Lyft, and why they may even have considered buying Lyft for $5B. Of course, this might be risky, but it’s no more risky than not doing anything and expecting to keep your CEO job intact and the stock price rising. Hedging your public company stock by buying potentially disruptive unicorns for only 5–10% of your market cap may be one of the simplest ways to defuse the startup threat and keep on trucking… this is the Unicorn Hedge.
For those paying attention, unicorns and disruption aren’t news. You may have heard predictions of disruption for the first time in the mid-90’s, and you might have been skeptical after the 2000–01 dot-com crash. Except internet juggernauts like Amazon and Google were started in the 90’s. And you might have been skeptical again after 2008–09, except social platforms like Facebook and LinkedIn and Twitter and YouTube were started in mid-2000’s (and also the 2nd coming of Apple, Steve Jobs, & the iPhone).
No surprise, most of the now-public tech giants are investing in and buying OTHER tech startups and unicorns to stay on top of their game. Microsoftbought LinkedIn and Skype.Google bought YouTube andAndroid. Facebook boughtWhatsApp and Instagram. In fact in the past five years ALL of the top 5 highest-value public companies are tech companies.So what do you think is more overvalued? The average unicorn or tech IPO? Or the average non-tech public company that hasn’t innovated in over a decade?
Even for those NOT paying attention, ever since Marc Andreessen wrote “Software is Eating the World” five years ago and “The Social Network” movie became a blockbuster hit for millennials, smart people everywhere know The Next Revolution Will Not Be Televised… it will be untethered, unplugged, and viewed on a mobile phone running iOS or Android or Miui, and shared on Facebook, SnapChat, or Instagram. Or maybe on some new multi-user immersive VR or AR platform like Oculus or HoloLens or Magic Leap or Minecraft. Or, perhaps something even newer out of Seoul or Shanghai instead of Silicon Valley, delivered via drone or autonomous vehicle or via Hyperloop. Innovation isn’t coming from NASA or Detroit anymore, it’s coming from Tesla andSpaceX, from Stanford and Berkeley, from 500 Startups and Y Combinator, a garage in Bucharest or Bangkok or Bangalore, or a startup accelerator in Mexico City, Istanbul or Lagos.
Now it’s true that tech bubbles do happen. However, it’s also true some of the most valuable companies on the planet were started at the same time. After Lehman blew up summer 2008, I got my first job in venture capital working for some PayPal Mafia colleagues at Founders Fund, running the FF Angel program and Facebook fbFund incubator. Between fall 2008 / spring 2010, I invested in 3 unicorns: Twilio,Credit Karma, and Lyft (then Zimride). When we invested all 3 companies were valued <=$5M. Seven years later, all three companies are now valued at >$3 Billion.
Now of course I didn’t just invest in 3 companies, I had to make lots of little bets in over 40 startups to get lucky enough to discover those outliers. Most of my investments failed, some had small exits between $5–25M, and a few like SendGrid, TaskRabbit, and Life360 are now valued at over $100M (we call those companies centaurs). Another one, Wildfire Interactive, was acquired by Google for $350M. And the most successful ones turned into the 3 unicorns I now brag about all day long (Twilio [NYSE: TWLO] just went public in June). Whether I was smart or lucky is up for debate, but regardless the $3M I invested in those companies for Founders Fund is now worth ~$300M. Not bad for a rookie VC in the middle of a bubble, eh? I’ll take lucky over smart any day. (Peter & Sean: thanks for giving me a shot 😉
As it turns out, most unicorns and many tech IPOs are perhaps overvalued, but a few of them are actually UNDER-valued as well. Remember when Facebook went public at a valuation of over $100B? And then dropped like a rock to less than $50B in under 3 months? And THEN rose like a rocketship over the next four years to almost 7X its post-IPO bottom? Who would have guessed that could happen?
You’d be happy as punch to have bought FB at the IPO price, but you’d be even happier to have bought it when it was valued at between $5B–50B on the private market. Just ask Yuri Milner, founder of DST Global, arguably the godfather of the Unicorn investment. In 2009 Milner invested $200M in Facebook at a $10B valuation, and everyone thought he was crazy. Turns out he *was* crazy — LIKE A FOX! — and now Facebook is worth over $300B. Milner also famously invested in a bunch of other late-stage tech companies including AirBNB, Twitter, Spotify, Snapchat & WhatsApp. Most Russians will claim first-man-in-space Yuri Gagarin as their hero, but my favorite Yuri’s last name is Milner! (Mr. Milner, pleez to forgive meme joke, da?)
Of course sometimes tech does get ahead of itself, and it’s rare that even unicorns turn into Facebook, but many folks who got access to Uber orAirbnb shares at below $5B a few years ago might want to pat themselves on the back for making such a smart decision. Sure, there will be plenty of unicorns who go bust after receiving too much capital at too generous valuations, and many of those unicorns will have their horns cut off and get sent to the glue factory. But SOME unicorns are NOT overvalued and NOT over-funded — a few are the real deal, growing like crazy, and scaring the bejeezus out of CEOs at non-tech public companies they’re competing with. A few might be lucky enough to become the next Uber, Airbnb, or Twilio.
THIS is the reason private equity and mutual funds are scrambling to figure out how to get into tech startups earlier & earlier, rather than waiting until they go public later & later, long after they’re worth billions. They don’t want to miss out on the value created before those companies IPO, or even before they get to unicorn valuations of $1B+. As larger investors realize this — private equity, mutual funds, corporates, and sovereign wealth funds — they’re jockeying to get access to early-stage A/B/C rounds by investing in venture funds. Or, if they can get an allocation, by investing in unicorns directly when they get to later Series D/E/F rounds. The private market unicorn is the new IPO. Whether or not valuations make sense, demand for access to this new “stage” of capital is huge & growing.
Lastly, we should observe this is definitely a global story, not just Silicon Valley or US. This is why China is investing billions in their own unicorns, as well as those in Silicon Valley. This is why Tiger & Softbank & Sequoia are investing in India / SouthEast Asia and other emerging markets. This is why Saudi Arabia wants to take Aramco public at >$2T (Saudi Aramco is the world’s largest company by revenue), and convert all those oil & gas dollars into innovation & tech investments as fast as they possibly can. It’s also why the Kingdom’s Public Investment Fund invested $3.5B into Uber at over $62B valuation, and wants to do even more. Hello, global venture capital.
This is why every country on the planet is trying to duplicate the Silicon Valley ecosystem in their own backyard, rather than California or Beijing. There are now over 3 billion smartphones around the world, and many of those customers speak English — but many more speak Mandarin, Spanish, Arabic, Hindi, or Malay. You can expect many future unicorns to come from the US & China, but others will come from Nigeria, Pakistan, Brazil, & Indonesia. This is why 500 Startups invests in over 50 markets around the world. We might be early, but we sure as hell ain’t gonna be late.
Summary: expect more VCs, and expect more Unicorns. Expect more investment in Startups and Innovation, and expect more Disruption.
To avoid this, expect more public company CEOs to spend some of their market cap buying a Unicorn or two…
Welcome to the Unicorn Hedge.
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