The week of April 19, 2015

The next tech bubble is about to burst

By Joe Kukura

My timer for the bursting of this tech bubble currently stands at nine months. That’s when investors and venture capital markets will stop throwing around billions in Monopoly money, companies without any profits will lose their suspiciously optimistic valuations, and startups will crater. Unicorns will die, skies will fall, and parents’ basements will be resettled. We saw this with tech in 2000, with banks in 2008, and according to my Magic 8-Ball, we’re going to see it again very soon.

But don’t take my Magic 8-Ball’s word for it. Listen to the the nervous predictions from the very big-name venture capitalists whose money is financing this current boom:

  • In a blog post last month, Mark Cuban explained “Why This Tech Bubble is Worse Than the Tech Bubble of 2000.” “If we thought it was stupid to invest in public internet websites that had no chance of succeeding back [in 2000], it’s worse today,” Cuban wrote. It’s worse, he argues, because the risk is concentrated on individual angel investors and crowdfunders rather than a broader public stock market. “I have absolutely no doubt in my mind that most of these individual Angels and crowd funders are currently under water in their investments.”
  • Andreessen Horowitz cofounder and megabucks financier Marc Andreessen recently submitted his Twitter followers to an 18-tweet rant declaring that startups’ burn rates were too high and their executives too inexperienced. “When the market turns, and it will turn, we will find out who has been swimming without trunks on: many high burn rate co’s will VAPORIZE,” Andressen warned.
  • Union Square Ventures cofounder Fred Wilson, dubbed “New York’s No. 1 VC,” wrote his own alarmed essay on startup burn rates. “At some point you have to build a real business, generate real profits, sustain the company without the largess of investor’s capital, and start producing value the old fashioned way,” Wilson wrote. “We have multiple portfolio companies burning multiple millions of dollars a month.”
  • Benchmark Capital partner Bill Gurley declared a bubble during a discussion with author Malcolm Gladwell at South by Southwest (SXSW) last month. He calls it a “risk bubble,” with billions being invested in young companies with little track record of success. “We’re in a risk bubble,” Gurley said. “We’re taking on, in these startups, these … so-called unicorns, a level of risk that we’ve never taken on before in the history of Silicon Valley or startups.”

Few of these VCs will actually use the term “tech bubble.” They have investments whose value they would probably prefer to not destroy. They’re hedging their bets by calling it things like a “risk bubble” (Gurley), an “escalating risk of a catastrophic down round” (Andreessen), or “Burning cash. Losing money. Emphasis on the losing” (Wilson). These semantic distinctions may seem important now, but they’ll seem quaint when people start losing their jobs.

My timer for the bursting of this tech bubble currently stands at nine months.

It doesn’t matter how you label a market fueled by speculative ignorance of traditional valuation metrics. Such a market is still unsustainable. Looking at the 83 startups Fortune magazine lists as “unicorns”—Silicon Valley’s jargon for a startup valued at $1 billion or higher—we see a disproportionate number with risky underlying economic factors.

Lots of ‘unicorns’ don’t actually make money

“In Silicon Valley, you have more people employed by money-losing companies probably than you ever have before,” Gurley said at SXSW. “Which is tenuous, because when the capital slows, then those [jobs] aren’t real anymore.”

“Probably” because it’s difficult to know how many people are employed by money-losing companies. But it’s not uncommon for money-losers to go on hiring sprees. Twitter and Amazon continue to hire like mad, and neither has ever been profitable. Snapchat and Dropbox are admired as decacorns (unicorns valued at $10 billion or higher), though both have little to no revenue. Dropbox is locked in an epic spending battle with competitor Box, neither with a coherent plan to eventually pay the bills they’re racking up.

A few of the underwater unicorns have made meager efforts to monetize lately, none of them particularly successful. Twitter, Box, Spotify, and Shazam have launched marginal monetization attempts, often with small numbers of advertisers or buyers. All four companies are almost 10 years old; Amazon’s pushing 21. As Dan Lyons wrote in a lovely Valleywag diatribe, “If you can’t make money after 10 years, what does that tell you?”

It tells you that bleeding-edge technology becomes synonymous with “bleeding money.” And even the startups that do make money have substantial risk looming.

The gig may be up with the ‘gig economy’

“Trying to predict what’s going to cause all this to come down is hard to do, I don’t know,” Gurley said at SXSW. “I do think you’ll see some dead unicorns this year.”

Even the startups that do make money have substantial risk looming.

One prediction? The courts may become unicorn killers, if they rule that “sharing-economy” companies have to start paying their workers as employees. Uber and Lyft both face lawsuits that could force them to classify drivers as employees and provide them with benefits, which would take a huge chunk out of company profits.

Same goes for Instacart, another unicorn threatened with a class-action lawsuit from contractors demanding employee status, overtime pay, and gas money compensation. Aspiring unicorns Homejoy, Caviar, Handy, and Postmates also face similar legal action from their workers. As class-action attorneys smell unicorn blood, you can expect more similar lawsuits against apps and services whose profits depend on the labor of independent contractors.

How the blue chips will suffer

It’s tempting to believe that little startups with quirky one-word names will be the first to fall, but surely the blue-chip tech firms like Google, Apple, and Facebook will ride it out. Apple has more cash on hand than the U.S. government; it’s not going away anytime soon. But legacy tech firms may have to get leaner with far fewer massaged, pampered, and free-meal-fattened employees.

This tech boom runs on Monopoly money—and as we saw 2000, that money can quickly disappear. The startups relying on easy VC cash then wither away, which indirectly hits the revenue of larger and more established companies. Next, you begin to hear about the “accounting irregularities” that affect seemingly unrelated industries like telecom and real estate. Then the bust goes nationwide. We’ve all seen this movie before.

The courts may become unicorn killers, if they rule that “sharing-economy” companies have to start paying their workers as employees.

But unlike previous bubbles, the bursting of the Silicon Valley’s current VC madness may not tank the economy everywhere. That’s because this time the paper wealth generated by the bubble hasn’t traveled very far.

Income inequality as a service

While Silicon Valley and New York City are paying larger-than-ever salaries, the U.S. median income has dropped by a couple percentage points. Still, most top tech firms insist on doing their business within a certain, select few-dozen ZIP codes contained entirely in Northern California and New York City.

In these select areas, money-losing tech firms drive up the price of everything from housing to a loaf of bread. This cost-of-living overvaluation not only causes displacement and gentrification, it inflates other bubbles—in corporate office space, in the cost of housing and rental units, in salaries, and in the overall employment market. When the tech bubble bursts, it won’t hurt just tech workers: It’ll affect cooks, custodians, assistants, TaskRabbit rabbits, and Uber drivers. Even if you don’t enjoy the startup spoils, you’ll feel the sting when this cash stops flowing.

The bubble is not going to burst overnight like that the time in 2008, when Lehman Brothers suddenly and unexpectedly collapsed in a single day. This one will be a steady stream of deepening paper cuts, like the era of the first dotcom bust when Fucked Company was required daily reading.

And those bad old days may be here again soon.

Illustration by J. Longo