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Tech Bubble? What To Do Now?

August 8, 2011

Investopedia defines a tech bubble as a “pronounced and unsustainable market rise attributed to increased speculation in technology stocks. A tech bubble is highlighted by rapid share price growth and high valuations based on standard metrics like price/earnings ratio or price/sales.” Furthermore, “during the formation of a tech bubble, investors begin to collectively think that there’s a huge opportunity to be had, or that it’s a “special time” in the markets. This leads them to purchase stocks at prices that normally wouldn’t even be considered…a bubble may end with a crash, or may simply deflate as investors slowly lose interest and sales pressure pushes stock valuations back to normalized levels” (see Investopedia “Tech Bubble”)

Are we in a tech bubble? Many analysts have weighed in on this question in recent months, and they are divided as to whether there is indeed a tech bubble or not. One thing is certain, though:  despite the tech bubble, there has never been as good a time to start a technology company than now.  Why do I say this? For the following reasons:

1.         Technology advancements, including programming language improvements that have made yesterday’s seemingly complex tasks easier when actually done today, mean shorter product development cycles. If you have an idea for a product, and you act on it now and put up your own company, chances are the product will make its way out of the door and into your target market’s homes in a relatively shorter time compared to, say, 10 years ago.

2.       It does not take that much anymore to start your own technology company.  The rise of open-source means that software development is now much cheaper compared to a few years ago. In an article entitled “You Don’t Need to be Rich to Be An Entrepreneur,”  Martin Zwilling maintains that “only a few years ago, it would cost at least a million dollars ($1M) for a team of professionals to produce any commercial software product. Now, with open source software components, and low-cost development tools, the same job can be done by one good hacker for a few thousand dollars.” Furthermore, Chris Devore, in “Carlson’s Law, Software Innovation and Venture Capital,” says that “between powerful, open-source development frameworks like Ruby and PHP and cheap, pay-as-you-go cloud infrastructure services like Amazon Web Services, Urban Airship and Twilio, world-changing software innovations can now be created and brought to market by small teams of two or three developers. Ideas that once required millions of dollars of venture capital to build now require hundreds of thousands – or for the right team of motivated entrepreneurs, none at all.”

3.         The advent of online distibution, viral, social and new media platforms have lowered marketing costs, making it easier for tech startups to market their products. In “Money Ball for Startups: Invest Before Product/Market Fit, Double Down After,” Dave McLure writes: Marketing now typically means using a variety of online distribution channels via paid & organic search (SEM/SEO) on Google, viral/social amplification on new media platforms & social networks like Facebook, Twitter, & YouTube, and the quickly-growing mobile platforms of Apple iPhone & Google Android. With the exception of search, most of these distribution channels didn’t exist 5 years ago, yet they now easily reach over 100M-500M+ users, with very low cost and measurable marketing campaigns such that even a small team can reach billions of people globally.”

4.         There is an abundance of available capital from both traditional VCs and angel investors on the market. This means that tech startups, as long as their ideas or products are viable, can get access to this capital. JS Cournoyer writes in “The Implications of Combining Excess Supply of Capital with the War for Talent in the Digital Economy,” that “as stock markets continue to be volatile and we start to see more exits however small, we should see a steady increase in angel investing activity, resulting in even more capital in the market. More capital means higher valuations, bigger seed rounds that close faster, and less reliance on VCs to get companies to exit. In addition, many VCs already invest at this stage and more will do so over the coming years, further increasing supply. The good projects will continue to be oversubscribed and the decent ones will continue to get funded for years to come, keeping the market in an oversupply state for years.”

The excess supply of capital, as explained in the immediately preceding section, means that there is a tendency to increase the valuation of a startup very early in the game. As explained by Mark Suster in “On Bubbles…and Why We’ll be Just Fine,”  “a bubble occurs when a market is willing to pay greater than intrinsic value for an asset class.” Adding to the higher valuations are investors’ fear of missing out, or what Suster calls, FOMO.  Suster further explains that higher valuations during the early stages of a startup’s life is not necessarily bad, given the changes in market conditions from the last time a bubble happened. These changes, which were affirmed by Ben Horowitz in an online debate with Steve Blank on whether there is a coming tech bubble with (see Debating the Tech Bubble with Steve Blank: Part II), include

a.       Larger number of Internet users and widespread use of broadband

b.      The ubiquity of smart phones and Internet-based technologies

c.       Software eating the world

d.      The Proliferation of social distribution

As I mentioned above, there is a real danger though that investor behavior triggered by FOMO may lead to investors not exercising due diligence before putting money in a startup. As Fred Wilson states, “there are a few storm coulds out there that we need to be watching. In particular, I think the competition for “hot” deals is making people crazy and I am seeing many more unnatural acts from investors happening. If it were just valuations rising quickly, I’d be a bit less concerned. But we are also seeing large deals ($5mm to $15mm) getting done in a few days with little or no due diligence. Investors are showing up at the first meeting with term sheets. I have never seen phases like this end nicely.” (see Storm Clouds).

I hoped that I have adequately explained above the reasons why there is no time like the present to put up your own tech startup. As an entrepreneur, don’t be deterred by all the talks of another tech bubble. Instead, build up your business model and never let go of your vision to create value for your company. Only in this way can you survive another tech bubble, if it indeed occurs. Remember that Google and Salesforce.com survived the last tech bubble by doing just that.

Jerome Gentolia is Co-Founder of ComeUnite and Tech-Launch Solutions

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From → Entrepreneurship

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