Steve Blank, the tech entrepreneur and professor whose methodologies launched the "lean startup" movement, warns that the Silicon Valley bubble is going to burst. There will be a crash not unlike the dot.com bust of 2000, he explains, partly because investors are making unreasonably high bets on private companies--though they won't admit that they, too, are feeling the pressure from shareholders.
"VCs won't simply admit that they're in a giant Ponzi Scheme," says Blank. "And then, they have to play along, because they've taken money from their investors, and their investors expect a certain return, but it's no longer an honest game. That's why it feels like 1999 again."
To back his point, Blank referred to a scene from the classic 1942 film, Casasblanca. In it, Captain Renault, the French head of police, orders the immediate closure of a café, insisting that he wasn't aware that gambling was occurring at the restaurant -- though moments later, a lackey approaches him with his "winnings, sir."
Blank isn't the only voice decrying the Silicon Valley tech bubble. The root of the problem, as Inc.'s Jeff Bercovici has detailed at length, is that investors are valuing more companies in the multi-million and billion-dollar range, though the risk is unlikely to pay off down the line. Many of these companies bring in little (sometimes zero) revenues, and often aren't profitable. Even the biggest names in tech boast valuations that are well-above their revenues: Uber's $50 billion valuation represented 100 times its sales, and Airbnb's $25 billion represented 28 times its sales, according to 2015 data from CB Insights.
On a broader level, Blank argues that the fundamental purpose of venture capital has changed, inasmuch as VCs used to care more about sales and profit. From their perspective, "there was an unspoken but pretty solid rule: We needed five consecutive quarters of profitability and increasing revenues to go public," he explains. "The role of venture capital was to teach you how to turn your idea into a profitable company. The role of venture capital now is the greater fool theory."
What happens when the market crashes?
If and when the bubble bursts, there may be some immediate benefits for entrepreneurs: Rent in major cities such as New York City and San Francisco could drop, and it could also be easier for businesses to hire engineering talent, sans competition. Long-term, however, startups are likely to find it harder to raise money, and businesses that rely on other startups -- for things like accounting, shipments, or other infrastructure -- could see price hikes, or the disappearance of those services altogether.
Blank echoed Barry Schuler, the managing director of VC firm Draper Fisher Jurvetson, who previously told Inc. that it's the late-stage investors who "stand to get hurt," less so the public.
"Nowadays, most of the liquidity is happening for large companies paying for startups and hedge funds buying into the latest round. So when this crash happens, it's mostly going to affect the later stage investors," Blank said. That's different from what happened when the bubble burst previously, inasmuch as "It [the '99 crash] destroyed a lot of public value, not just private capital. Your grandmother got hurt as well."
Still, it's worth pointing out that some public money is making its way into late-stage VC deals, from mutual finds like Fidelity, Janus, and T. Rowe Price, and also (indirectly) from pension-backed hedge funds and private equity. Five mutual funds that are the most active startup investors made 45 investments in 2014, compared to just 18 in 2013.
For entrepreneurs, Blank warns, the future is clear: "Startups are going to find it much, much harder to raise money, and the liquidity pipeline will bounce back to the good old days--when you actually had to make money to have some liquidity event [go public]."