That a startup bubble existed is no longer really in question; you don’t get 130+ privately-owned companies valued at more than $1 billion before they’re even a decade old unless there’s some 1920s-style speculation going on.
The question now is, what’s the aftermath of this bubble going to look like? The big bursts we’ve seen in the past have primarily involved publicly-traded companies—the Big Bank shakeup of 2007 that led to the Great Recession, the dot-com downslide that cut the value of the Nasdaq down to mere stubble in the early 2000s, Beanie Babies in the 1990s, etc.
With startups, we’ve got a bunch of privately-held shares that could have a very different ripple effect when their valuations plummet back to Earth. The shape and pace of the plummet could also be a bit unusual.
Early Exits & Expertise
Investors in startups used to hang onto their shares for quite awhile, typically only divesting after a buyout or an IPO; that’s when they saw the big bucks coming in, by and large. Now, thanks to a confluence of factors neatly spelled out by others, there’s a substantial market for trading those private shares, and investors are taking increasing advantage of these oppotunities to cash in early.
On one hand, the secondary market for private equity in tech startups has helped drive the bubble’s growth: you need a large group of speculators to really drive values up before they can crash back down in an epic yet predictable slide, so extending startup ownership to the average investor provided the numbers needed for a true bubble to form.
The fact that early investors are leaving, though, is also being taken as a sign of slower growth ahead for startups—a perception that will help drive the bubble’s ultimate deflation (something we’re starting to see the beginning of).
Human Capital
Perhaps more importantly, early investors were usually able to offer startups their expertise as well as their cash, creating additional value. Venture capitalists and startup incubators are largely made up of former (and current) entrepreneurs and startup mavens—people who know how to build a company and see an actual return on value, not just how to make profitable trades.
However, when they exit early, they aren’t just sending a signal that perceived values are going through a downturn. They’re taking away real value in terms of knowledge and guidance, making it that much harder for startups to succeed just when things are about to get a whole lot tighter capital-wise.
The touchdown may be gentler than we expect as the secondary market takes some time to fizzle out, but the value lost will be just as real as every bubble before, and the early investors backing out for fear of the bubble are at least as responsible as the speculators to whom they’re selling.
As the unicorns are marched like lambs to the slaughter, far too many “investors” are stepping back and watching the bubble-deniers eat crow.
