10 Tech Bubble Facts - WMNews Ep. 29

Script written by Angela Fafard As startup valuations and tech industry employment rates continue to grow, the potential for another tech bubble looms in the future. Welcome to WatchMojo News, the weekly series from WatchMojo.com where we break down news stories that might be on your radar. In this instalment, we’re counting down 10 crucial facts you should know about a potential future tech bubble.

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Script written by Angela Fafard

10 Tech Bubble Facts - WMNews Ep. 29

As startup valuations and tech industry employment rates continue to grow, the potential for another tech bubble looms in the future. Welcome to WatchMojo News, the weekly series where we break down news stories that might be on your radar. In this installment, we’re counting down 10 crucial facts you should know about the potential tech bubble.

#10: What Is an Economic Bubble?
The Phenomenon

An economic bubble is a period at which point the values of assets are considerably greater than their intrinsic value and they are traded at these prices. Generally speaking, such a period is confirmed when the market subsequently drops prices, which leads to a correction or a contraction in the market and industry as well as a drop in consumer and investor confidence. The first recorded economic, or speculative, bubble occurred during the Dutch tulip mania in the 1630s. Throughout this period, the value of tulip bulbs rose and then fell sharply, and at one point was ten times the annual salary of a skilled craftsman. The problem with economic bubbles is that they’re nearly impossible to predict, and only after the dust has settled are important markers and indicators of an impending bubble discovered.

#9: What Was the Dot-Com Bubble?
The Disaster

The dot-com bubble occurred primarily between 1997-2000, during which industry stock prices rose and fell dramatically and resulted in the collapse of the Internet sector on the stock market. The bubble occurred due to the meteoric rise of dot-com stock prices, as venture capitalists heavily invested in companies that had little to no profit with only the expectation of future revenue. In 5 years, the value of the NASDAQ Composite, which many tech stocks call home, rapidly grew from 1,000 points to over 5,000 by early 2000. The bubble burst on March 11th, 2000 and set off a chain reaction by sinking the NASDAQ, triggering a large volume of company bankruptcies, a slew of high profile lawsuits and eventually a full US economic recession.

#8: What Was the Aftermath?
The Loss

The resulting stock market crash from 2000-02 led to a drastic loss of over $5 trillion in the market value of industry companies. Furthermore, the value of the NASDAQ quickly sunk beginning in March 2000, and within a month, nearly a trillion dollars worth of stock value had disappeared. Large companies began to fold, such as Pets.com, with others declaring bankruptcy amid allegations of illegal accounting practices leading to an exaggeration of yearly profits. The events of September 11th in 2001 further intensified the stock market drop. By the end of 2004, over 50% of the dot-com companies had gone bankrupt.

#7: What Changes Were Made?
The Regulations

As a result of the dot-com bubble, numerous changes were instilled. This included more stringent standards by which a company could launch an initial public offering as well as more restrictions on investment bankers’ research analysts. Enacted on July 30th, 2002, the Sarbanes-Oxley Act (or SOX), is a United States law that enhanced the responsibilities of a public corporation’s board of directors, augmented criminal penalties for retaliation against whistleblowers and the failure to certify corporate financial records. Furthermore, an agreement was reached on April 28th, 2003, titled the ‘Global Settlement’; it revolved around the issue of conflict of interest within investment firms. The agreement was settled between the SEC, NASD, NYSE and 10 of the largest US financial institutions, and required that they literally insulate and separate their banking and analysis departments. This was done in order to prevent the abuse that had occurred from the pressure investment bankers placed on their analysts to provide falsified favorable portfolio results.

#6: What Is a Startup?
The Business Model

A startup is the term given to a newly created company that is in a rapid process of development, research, innovation and scalability. Modern startups are typically characterized by their low bootstrap costs, dependency on private equity, and high rate for potential return on investment while having a relatively small rate of success. Examples of modern day successful startups range from the popular and well-know, such as Uber and Pinterest, to the obscure yet massively profitable, like Palantir Technologies, a software company that specializes in data analysis and has even had clients like the CIA and FBI. This type of business model has bled into the corporate culture, instilling a casual attitude that promotes efficiency by removing environmental stressors in the office setting. Companies such as Google have deliberately cultivated a relaxed and enriched work environment in order to attract the best and brightest talent from startups. There is no set date at which point a company ceases to be labeled a ‘startup’, but most these businesses end their startup phase when they reach milestones such as an acquisition by a larger firm, a large employee base, considerable revenue or an IPO.

#5: Who Invests in Startups?
The VCs

Startups can find funding from multiple sources, including venture capital firms, angel investors, seed funds and crowdfunding. These sources of funding are important at different levels of the startup growth phase. At the beginning it is typically angel investors, seed funds, or crowdfunding websites that provide the initial funding. Companies such as Y Combinator are known to fund hundreds of startups by providing seed money that amounts to about $120 000 in total. This is known as the seed round. Once a company has gained traction and is generating revenue, it begins its Series A round, a more aggressive route of funding whereby venture firms may provide significant funding in the range of $2-$10 million in exchange for a portion of the company. This leads to Series B, C and D rounds of funding before the company eventually launches the IPO.

#4: What Is an IPO?
The Investment

The acronym IPO stands for the term ‘initial public offering’, a process by which a private company becomes public by issuing shares of stock in their company to institutional investors, which in turn are sold to the general public for the first time. The first recorded modern IPO occurred in March 1602, when the Dutch East India Company offered its shares to the public. An IPO can be a huge asset to a company, as it can generate a massive influx of revenue, give easier access to capital and increase exposure and brand. By contrast, an IPO can lead to an increase in marketing, accounting and legal costs and an overall loss of control due to new shareholders. It would also allow the public and competitors to gain access of company financials and policy. The current IPO process in the United States is overseen by the U.S. and Exchange Commission, and in the United Kingdom, it is regulated by the UK Listing Authority.

#3: How Are Startups Valued?
The Future Profit

A valuation of a startup’s worth is extremely important as it will dictate the level of funding an angel investor or venture capital firm is willing to invest in a company. Valuations are notoriously hard to calculate as most startups have little history, revenue or earnings. This leads prospective investors to calculate valuations based on similar industry valuations and the level of competition for startup investment based on the economy. In booming economic times, there will be larger company valuations as competition to invest in the best startups is higher. For example in 2013, there were only 38 tech startups valued at over $1 billion, also known as unicorns, yet as of May 2015, there were over 100. Not to mention over a handful of decacorns, companies that are valued at over $10 billion, such as Uber, Dropbox, Xiaomi and Airbnb.

#2: Are Startups Being Overvalued?
The Question

As company valuations continue to grow at a staggering pace, many in the industry fear that they’re being pushed by external factors such as low interest rates, an investor’s fear of missing out, and a need for higher returns. As of mid May 2015, Uber, an American international transportation network company, is pushing for another round of funding in the territory of $2 billion. Expectations are that this round would push the company to a valuation of more than $50 billion, which would make it the highest valued venture-backed startup in history. That being said, there are many industry investors and experts who believe that startups are not overvalued. According to Sam Altman, president of Y Combinator, startups are not currently overvalued but that being given easier access to a large cash flow can kill a good company.

#1: Is There Another Tech Bubble Brewing?
The Future

The question of whether there is another tech bubble brewing is a touchy one, as the 2000 dot-com bubble still weighs heavily on investors’ minds. Thanks to the dot-com bubble, there are stricter regulations governing IPOs and investments, making it harder for shabbily constructed companies to go public. However, according to entrepreneur Mark Cuban, an American investor and owner of the NBA’s Dallas Mavericks, we are in a bubble and actually headed towards its imminent burst. While stock markets may be affected, unlike the 2000 dot-com bubble, he argues that angel investments also will be, which is an even bigger problem. Yet, as startup valuations and tech industry employment rates continue to grow, only time will tell if the world actually really is in another tech bubble.

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