This is due to a paradox
The real difference between the two eras is in the capital markets themselves. Venture money collapsed post-2000, came back up, fell again after the financial crisis, then rebounded to record levels after 2014. The number of new start-ups has proliferated. Yet the number of IPOs has fallen. This is due to a paradox – while technology has made starting a company cheaper, becoming a success is now more expensive. That is because of an arms race to build the next “unicorn” start-up, one with a market capitalisation of over $US1 billion.
As University of California academics Martin Kenney and John Zysman put it in a forthcoming paper on the shifts in start-up funding, entitled Unicorns, Cheshire Cats, and the New Dilemmas of Entrepreneurial Finance, “start-ups are each trying to ignite the winner-take-all dynamics through rapid expansion characterised by breakneck and almost invariably money-losing growth, often with no discernible path to profitability”.
Over the past five or so years, there’s been a massive growth in the number of venture-capital-backed unicorns. Companies such as Uber, Lyft, Spotify, and Dropbox can lose money hand over fist, and yet still continue to grow in valuation. Indeed, it is all part of the new business dynamic.
Low barriers to entry result in many competitors and a race to spend as much as possible to grab market share. Not only do the private companies that emerge from this unproductive cycle become bloated, so too do the venture funds themselves. Billion-dollar venture funds, once unheard of, are now commonplace. Last year, Sequoia raised an $US8 billion seed fund, and SoftBank a whopping $US100 billion fund.
Big, of course, begets big. As more and more heavyweight VCs bid up the value of start-ups, others have to follow. It’s up or out. The result has been not only a new bubble in IPO markets, but the undercutting of a host of public companies that actually have to worry about profits. The classic examples would be Uber’s disruption of the taxi industry, or Airbnb’s of hotels.
Distorts capital and labour markets
This may be good for some of the VCs who can use the inflated values of unicorns on their books to raise more money and charge more management fees. But I can’t see how it is good for economic value overall. Massive debt financing of unprofitable firms to create monopolies might benefit some entrepreneurs and investors, but it distorts capital and labour markets and is anti-competitive.
As long as investors are willing to accept growth as a metric for value, the music can keep playing. But as the University of California academics note, “unicorns are mythical beasts”. This year, their financial reality, as well as the sustainability of the current funding model, will be subject to some much-needed testing.
Some of the new crop of hyped-up companies may eventually turn into Cheshire cats, disappearing and leaving behind only the grins of those who got out before the bubble burst.
from news Viral City http://bit.ly/2G2hOHq
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