Irrational Exuberance:
A Crash in Tech
Startups is Coming
Jeffrey Funk
Independent Consultant and
Retired Professor
Nobel Laureate Robert Shiller

Irrational Exuberance, by Nobel
Laureate Robert Schiller
 Schiller’s describes economic bubbles in terms of a
 “psychological epidemic”
 and thus illuminates “why it is so difficult for smart money to
profit by betting against bubbles:
 the psychological contagion promotes a mindset that justifies the
price increases, so that participation in the bubble might be called
almost rational”
 He continues: “a new speculative bubble can appear
anywhere if a new story about the economy appears and if
it has enough narrative strength to spark a new contagion
of investor thinking,”
 one in which members of the news media “amplify stories that
have resonance with investors, often regardless of their validity”

Or In Simpler Terms
 Booms and Busts Occur in Cycles of Every 10 to 20 Years
 During a boom, price increases lead to more price increases as each
increase provides more evidence that increases will continue
 The media (and financial sector) provides reasons for price increases
thus creating a “narrative” that encourages further price increases
 Rising prices for Internet companies in late 1990s led many to believe that
rises would continue
 New Age Economy of Internet companies justified price increases
 These companies would deconstruct and disintermediate value chains
 During a bust, the opposite happens with a new narrative driving price
declines in which these declines drive further price declines

US Venture Capital Financings Rose Six
Times Since 2003:
Now higher than previous peak in 2000
2017 Venture Capital Report, Wilmer Hale Silicon Valley’s Unbridled Optimism Gets Fresh Reality Check , WSJ Journal, Jan 22, 2019

But the Number of IPOs Has Not Kept Pace
Kenney M and Zysman J, Unicorns, Cheshire cats, and the new dilemmas of entrepreneurial finance, Venture Capital 2018.

Wilmer Cutler Pickering Hale and Dorr, posted on Harvard Law School website, https://corpgov.law.harvard.edu/2017/05/25/2017-ipo-report/
Why? Because Startups are Taking Longer to Go Public
(Increase from 2.8 in 1998 to 7.7 in 2016)

And Ones Going Public Have Less Profitability than ones
in 1980s and early 1990s (but similar to 1998 and 1999)
A Lack of
Profitability*
is Big
Reason Why
Startups
Aren’t
Going Public
According to Wall Street Journal:
Palantir is among a host of “unicorns”—
startups valued over $1 billion—that are
losing money years after inception. Uber
Technologies Inc. and WeWork Cos. have
burned through more than $8 billion and $2
billion, respectively, and still lose money.
That’s in contrast to an earlier generation.
Facebook Inc. turned an annual profit after
five years.
Corrie Driebusch and Maureen Farrell, Market Ha
Never Been This Forgiving to Money-Losing Firms,
Oct. 1, 2018
*and Sarbanes-Oxley

Classic Case of Irrational Exuberance
 Price increases lead to more price increases
 Media creates a “narrative” that justifies price
increases
 In current speculative bubble,
 increases in both VC funding and valuations of Unicorns are
driving expansions in bubble
 both types of increases demonstrate new era of productivity
improvements to investors, entrepreneurs, policy makers,
and media
 productivity improvements driven by smart phones, Big
Data, Internet of Things, AI, blockchain, driverless vehicles,
and robotics

What Happens Next?
 But How Will Current Bubble Burst?
 What Will be the New Narrative?
 And When Will the Bubble Burst?

CountofRounds
Number of VC Rounds >=$100M 3-Month Moving Average
More Startups Raising Money Privately Through Multiple Rounds
with VC funds than Before: Monthly Count of VC Deals,
Raising $100M or More Since 2007
Here’s When $100M Venture Rounds Took Over, Jason Rowley, July 225, 2018

The VC unicorn obsession is creating an early-stage funding wasteland, FLAVIO LOBATO, IKOVE CAPITAL@FLAVIOLOBATO NOVEMBER 17, 2018 2:33 PM, VENTUREBEAT
Unicorns now have total valuations
exceeding $500 billion and VCs probably
expect twice that much at IPO time
Longer Time to IPO and Multiple Funding Rounds with Private Investors
Led to Growing Number and Value of Unicorns (>$Billion Valuations)

The VC unicorn obsession is creating an early-stage funding wasteland
FLAVIO LOBATO, IKOVE CAPITAL@FLAVIOLOBATO NOVEMBER 17, 2018 2:33 PM, VENTUREBEAT
These Unicorns Receive an Increasing Amount of
Total VC Investments in U.S., Reaching 25% in 2018
What happens to Venture Capital
if a few big Unicorns fail?

Investment
Deals in
Early Stage
Startups,
so-Called
“Seeds”,
Have Fallen
40% in Last
Three Years
Silicon Valley’s Unbridled Optimism Gets Fresh
Reality Check , WSJ Journal, Jan 22, 2019

Unicorns are Growing Even Faster Globally: New
ones in 2018 shown below - 379 in Total
In venture capital, it’s still the age of the unicorn, Techcrunch, Howie Xi, Nov 11, 2018

How Many U.S. Unicorns are Unprofitable?
 Good data isn’t available because private companies don’t
report profits like public companies do
 But 82% unprofitable percentage for startups that did IPOs
in 2018 suggests high percentage for remaining Unicorns
 profitable startups more likely to go public than unprofitable
ones so remaining Unicorns are likely to be unprofitable
 Plus the many examples of unprofitable Unicorns
 ones with huge valuations (Uber, Lyft, Palantir, WeWork)
 one that recently did IPOs: see next slide
 Slide 12 suggests a few big failures (e.g., Uber, Palantir,
Lyft) could upset the VC system
https://www.sramanamitra.com/2018/06/07/billion-dollar-unicorns-box-continues-to-grow-but-profits-still-absent/.. Silicon
Valley tech bubble is larger than it was in 2000, and the end is coming, CNBC, Keith Wright, 22 May 2018.
https://www.investopedia.com/news/new-tech-bubble-threatens-massive-losses/

Many IPO-Achieving Unicorns are Still Unprofitable
 Of 65 who exited the Unicorn list in recent years
 One valuation fell below $1Billion
 26 were acquired
 3 shutdown (Theranos, ModeMedia, Jawbone)
 22 (58%) of 37 Unicorns that did IPOs are still unprofitable
 Profitable in 2018: Pure Storage, Square, Eventbrite, DocuSign,
Sunrun, GoPro, New Relic, Coupa Software, GreenSky, AppNexus,
Twilio, Bloom Energy, Groupon, Vonage, Stich Fix
 Unprofitable: Cloudera, Nutanix, Razer, Box, Coupons, Hortonworks,
Wayfair, Pluralinsight, Blue Apron, Zscaler, Okta, HelloFresh,
Forescout, Dropbox, Mongo DB, Domo, Moderna Therapeutics, Snap,
Quotient Technology, Pivotal, Roku, Lending Club

Who Will Finance America’s Unprofitable Unicorns?
 Venture Capitalists?
 How long can they wait for profits?
 Probably not much longer because VCs are forcing Unicorns to go
public: 2019 is expected to be record year for IPOs
 The Stock Market?
 Will the Stock Market grant these IPOs with high valuations,
ones that provide VCs with sufficient profits?
 Falling Stock Market says No (see two slides down), meaning
poor return for VCs and thus falling investments
 Real Question: How long can hype about technology last?
https://www.researchgate.net/publication/330133478_Hype_About_New_Technologies_is_Rising_How_Should_Decision_Mak
ers_and_Academics_Respond

Record Value of U.S. IPOs expected in 2019
 NY Times: With the Economy Uncertain, Tech Unicorns’
Rush Toward I.P.O. Erin Griffith and Mike Issac Dec 6, 2018
 Fortune: 2019 on Track to Be Record-Breaking Year for
IPOs, Fortune, Oct 19, 2018, Natasha Bach
 CNBC.com: Get ready for the $200 billion IPO shakeup in
2019, December 17, 2018, Eric Rosenbaum
 Inc.com: 5 Huge Tech IPOs to Watch in 2019, Guadalupe
Gonzalez, December 19, 2018
 Barron’s: Get Ready for a Blockbuster Year for Tech IPOs
in 2019, John Swartz, Oct 16, 2018

The NASDAQ Was at an All-Time High in August 2018
But Dropped 23% by Early January
What happened the last time NASDAQ
reached unprecedented levels and investors
became impatient with unprofitable firms?

Similarities and Differences Between Bubbles
 Growth was emphasized over profits in both bubbles
 2000 Dot.com Bubble
 Internet commerce, content, and services provided convenience and
lower cost for both consumers and companies
 More convenience and lower cost through rapidly falling costs and
rising performance of fiber optics, computers, magnetic storage
 2019 Bubble
 Cloud computing, Big Data, wearable, and mobile apps (e.g., demand
economy, m-commerce, fintech) provide convenience
 Cloud computing becoming better through improving performance and
costs of fiber optics, computers, magnetic storage; mobile apps and
wearable by Moore’s Law/smart phones

Big Difference in Magnitude of Benefits
 More Internet Applications Created for 2000 than 2019 Bubble
 2000: Wide number of applications in commerce, content, services
 2019: Cloud computing has many applications, but Big Data limited to
marketing. Successful mobile apps limited to niche services such as
ride and room sharing, which encounter wide resistance
 Bigger Impact of Improvements on 2000 than 2019 Applications
 2000: Faster and cheaper fiber optics, computers, and magnetic
storage drove search, social media, and video; expanded e-commerce
to all industries including fashion
 2019 Bubble: Improvements in Moore’s Law (which has slowed as have
phone improvements) and Internet speeds barely improve economics
of ride/room sharing, wearable, fintech, or m-commerce startups

Large Uncertainties in Other Technologies
 AI’s predecessors have had little impact
 Rule-based AI was hyped 30 years ago and never succeeded
 Big Data and Internet of Things have grown, but little impact on
productivity
 Improvements in machine learning algorithms are not as
visible as Moore’s Law, a big driver of innovation for 50 years
 Robotics have also been hyped for 40 years but slow growth
in them; now Moore’s Law is slowing
 Driverless vehicles will likely take many years
 Electric vehicles (and batteries) also uncertain, VC solar
bubble burst five years ago

Can Tech Sector Become as Skilled at Government
Regulations as They Were With Moore’s Law
 Tech sector no longer limits itself to semiconductors,
computers, Internet infrastructure, and Internet
 Space – Can startups take us to Mars, or even Moon?
 Education – Will online learning solve the education
problem or are bigger changes needed?
 Transportation – How can startups solve the congestion
problem without changing public transportation?
 Utilities and Energy – How can startups make renewable
energy cheaper than current sources?
 Finance – How can startups provide cheaper credit?
Without
Moore’s
Law
enabling
new
opportun-
ities, can
Silicon
Valley find
and exploit
them?

Final Words
 A Crash in Tech Startups may be Deeper and
Longer than in 2000
 Venture capitalists, entrepreneurs, and
universities need to ask better questions
about what is possible and what is needed