The thing about a market bubble is that you don’t really know how big it is until it pops. So it doesn’t pop, and doesn’t pop, and doesn’t pop, until one day it finally pops. And by then it’s too late.
The dot-com collapse two decades ago erased $5 trillion in investments. Ever since, people in Silicon Valley have tried to guess exactly when the next tech bubble will burst, and whether the latest wave of investment in tech startups will lead to an economic crash. “A lot of people who are smarter than me have come to the conclusion that we’re in a bubble,” said Rita McGrath, a professor of management at Columbia Business School. “What we’re starting to see is the early signals.”
Those signals include businesses closing or being acquired, venture capitalists making fewer investments, fewer companies going public, stocks that appear vastly overpriced, and startup valuations falling.
Then you have a company like Uber, valued at $70 billion despite massive losses, and beleaguered by one scandal after another. In 2017 alone Uber has experienced a widely publicized boycott that led to an estimated half-a-million canceled accounts, high-profile allegations of sexual harassment and intellectual property theft, a leaked video showing its CEO cursing at an Uber driver, a blockbuster New York Times scoop detailing the company’s secret program to trick law enforcement, and multiple senior leaders either resigning or being forced out.
“As someone trying to raise [venture capital] right now, I am very concerned that this is going to implode the entire industry,” one person wrote in a forum on the technology-focused website Hacker News earlier this week. It’s understandable that investors and entrepreneurs would be “watching this Uber situation unfold closely,” as Mike Isaac, the New York Times reporter, put it in a tweet about the Hacker News post. Especially at a time when rising interest rates give investors more options, and ostensibly make the highly valued pre-IPO companies like Uber less attractive.
But how much is the tech industry’s fate actually wrapped up in Uber’s? If Uber implodes, will the bubble finally pop? It’s a question that’s full of assumptions: Uber’s fate is uncertain, and nobody really knows what kind of bubble we’re in right now. Yet it’s a question still worth teasing apart. Trillions of dollars, thousands of jobs, and the future of technology all hang in the balance.
“These bubbles swing back and forth in fear and greed,” McGrath told me, “and when Uber stumbles, it triggers fear. Part of this bubble is created basically in a low-interest-rate environment. Money from all over the world is pouring into this sector because it has nowhere else to go.”
This is a key point— perhaps the key point that will determine whether Uber lives or dies. Uber isn’t worth $70 billion because it is actually worth $70 billion. Its valuation is that high despite the fact that it’s not profitable, and despite the fact that it has little protection from competitors baked into what it is and does. Uber’s valuation, in other words, is a reflection of the global marketplace and not a reflection of Uber’s own durability as a company.
“To me, it’s a big question of whether they are going to be able to sustain the business model,” McGrath told me. “They have been very disruptive to incumbents, but there are no significant barriers to entry to their model. If you switch [services], you maybe have to re-enter your credit-card information and download a new app, but from there you’re good to go. There are pundits who say it’s only a matter of time.”
And then what? If Uber goes kablooey, what happens to all the other unicorns — the 187 startups valued at $1 billion or more apiece, according to the latest count by the venture capital database CB Insights?
Despite Uber’s influence, it’s unlikely that the company’s potential failure would set off too terrible of a chain reaction in Silicon Valley, several economists told me. “You need to make a distinction,” McGrath said, “between the startups that are really creating value and have something that will protect them in the event of imitation — versus the ones that are built on a lot of assumptions that really haven’t been tested yet, and money has been pouring into them because [it] have nowhere else to go.”
One instructive example is Theranos, the company known for its needle-free blood-testing technology. A few short years ago, it was roundly considered a Silicon Valley success story, valued at some $9 billion. Then, The Wall Street Journal revealed in a deeply investigated series of stories that the technology didn’t actually work as claimed—information that led to federal sanctions, lab closures, and ultimately Theranos’s announcement that it would leave the medical-testing business altogether. Theranos failed spectacularly, but it didn’t pop the bubble. So perhaps that’s a sign that the bubble isn’t going to pop all at once the way it did last time. The key is whether investors see a significant failure—like Theranos, and maybe Uber—as a one-off, or as a reflection of a systematic problem bubbling under the surface.
“One hypothesis could be that if a large pre-IPO tech company fails, then the source of capital for the others will start to shrink,” said Arun Sundararajan, a professor at New York University’s Stern School of Business. “That’s part of, I am sure, what happened during the dot-com bubble. But we are in a very different investment environment now.”
There are two big changes to consider. For one, practically every company is now a technology company. Silicon Valley used to make technology that mainstream consumers didn’t care about — or didn’t know that they even used. Not so, today. Technology is pervasive throughout the economy and throughout culture, which creates a potential protective effect for investors. “The investments into these companies are creating new business models in massive swaths of the economy, as opposed to being insulated,” Sundararajan said. “Also, a bulk of the money going into these companies is coming from players who are not dependent on the success of tech alone for their future financing.”
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This is the second change to consider: Whereas tech investments were once made by a relatively small group of venture capitalists who funded companies that then went public, that’s no longer the case.
This is the second change to consider: Whereas tech investments were once made by a relatively small group of venture capitalists who funded companies that then went public, that’s no longer the case. “Even if you put Uber aside and look at some of the larger recipients of pre-IPO investment over the last few years — it’s a very different cast of characters,” Sundararajan told me. “There are large private equity firms that are much more diversified than, say, Kleiner Perkins was 20 years ago.”
Sundararajan’s referring to Kleiner Perkins Caufield & Byers, the venture capital firm that “all but minted money” in the 1990s, as the writer Randall Smith put it. Back in the day, the company made its investors enormous sums of money with early investments in Google and Amazon, but has stumbled in recent years.
All of this means that the investment infrastructure supporting technology companies has changed, and that’s largely because of how technology’s place in culture has changed. “If Uber fails — and there’s no guarantee that it will — all of Uber’s investors won’t say, ‘Were we wrong to invest in tech?’” Sundararajan said. “They will say, ‘Did we misread the capabilities of this one company?’”
If anything, Sundararajan says, Uber is getting a tough, public lesson in how not to run a business. The company, for its part, is doubling down on attempts to rebuild its image. In a conference call with reporters on Tuesday, executives for the ride-sharing service expressed support in Travis Kalanick, Uber’s embattled co-founder and CEO.
“By now, it’s becoming increasingly apparent that the issues that are putting Uber in the news frequently don’t have much to do with either its business model or its identity as a tech company,” Sundararajan said. “If there is a serious reduction in Uber’s value over the next year, the lesson that people will take away is one of better corporate governance for early-stage tech companies — so that, as they get into a later stage, they are not in a position where the tradeoffs they made early-on ended up being more harmful than good.”
Meanwhile, many investors are shifting their focus away from platforms and to the underlying technologies that, if they succeed, will outlast any given brand — for example, sensors for self-driving cars, autonomous medical technologies, myriad robotics, and so on. This, too, has an insulating effect against any single company’s failure.
Uber, which may or may not fail, may or may not bring down the rest of the economy with it. But the bubble is still likely to burst sooner or later. “There was this fog hanging over Silicon Valley in 2001,” Roelof Botha, a partner with VC firm Sequoia Capital, told Bloomberg Businessweek last fall. “And there’s a fog hanging over it now. There’s no underlying wave of growth.”
Since 2015, CB Insights has counted 117 down rounds in tech, instances when a company raises more money by selling existing shares at reduced value. A down round doesn’t mean a company will fail, but it does signal a warning about the market it’s operating in.
The lesson here is that people trying to raise venture capital shouldn’t be worried about what Uber, specifically, might do to the economy if the company fails. There are plenty of other hints that a market correction is already well under way. The question now is whether the bubble will pop as dramatically as it has before, or simply go right on deflating the way it seems to be.
This story originally appeared on TheAtlantic.com.
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