Startups are beginning to run out of money and investors are becoming more discerning. How does this compare to the time leading up to the dotcom crash?

This article is more than 3 years old

This article is more than 3 years old

If you were looking for an apartment in the Bay Area 18 months ago, realtors recommended you took your checkbook to viewings and were prepared to fork out for the deposit and first month’s rent – that’s $8,000 to $10,000 for a two-bedroom place in San Francisco – on the spot.

“There was no negotiation because there were 10 people behind you saying, ‘We’ll take it’,” said Ron Stern, CEO of housing relocation service Bay Rentals.

Today, rents are still expensive, but the market has plateaued after years of painful increases. It’s part of a broader trend in the Bay Area: Silicon Valley’s technology bubble has had some of its wind knocked out – not bursting, but fizzling – with VCs making fewer investments, startup valuations falling, and recruitment slowing.

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“We’re starting to get a lot of résumés from [software engineers at] companies where the business model isn’t working and they can’t get funding, so they are closing down or cutting back,” said Mark Dinan, a software recruiter based in the Bay Area, who keeps track of companies’ hirings and firings.

These startups are running out of money because VCs are being more discerning about where they place their money, making fewer, bigger bets.

“The number of investments [in the private market] has fallen by about a third, but the amount of capital is around the same,” said Tomasz Tunguz, a venture capitalist at Redpoint, adding that some of the “fast money” from hedge funds and mutual funds had shifted away from the sector.

“It’s been happening for a couple of years. It’s not as easy to raise capital and VCs are demanding better terms,” added Aswath Damodaran, a professor of finance at the Stern School of Business.

This is partly because of a slowdown in companies going public. Last year was the slowest for US IPOs since the recession, with the amount raised by technology companies falling 60% from 2015, according to Bloomberg News.

“Silicon Valley has not had a major success in terms of IPO before Snap for years – and Snap is in LA,” Dinan said.

A stream of “down rounds” – when a company raises funds by selling shares that are valued lower than the last time they raised funds, leading its overall valuation to fall – has led investors to be more discerning. CB Insights has tracked more than 100 of these down rounds and exits since 2015, including software company Zenefits, mobile app Foursquare and online music streaming service Rdio.

“It used to be that 95% of [investment] rounds were up, now 20% are down,” Tunguz said.

Then there are the so-called “decacorns” – unicorn startups valued at tens of billions of dollars – such as Airbnb, Uber and Palantir – which some believe are overvalued, but it’s hard to tell until they go public and are forced to reveal details of their underlying finances.

Ride-sharing app Uber, for example, has raised more than $16bn and is valued at more than $69bn. That’s more than automotive giants such as General Motors and Ford, despite the company losing $2.2bn last year.

“The interesting question with Uber is how long they can keep as a private company. They are raising capital like a public company without any of the disclosure and consequences of being a public company,” said Damodaran, who believes the company’s value is overinflated and it’s really worth $23bn.

How does this moment compare with the time leading up to the dotcom crash?

“I got here in 97 and it was like it is now – incredibly packed, impossible to commute, high apartment costs,” Dinan said.

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“We’re seeing overvalued companies, funded based on hopes and dreams and aspirations and not good business models. Companies counting users and eyeballs rather than profits. There are a lot of similarities.”

Another echo of the dotcom era is what Dinan calls “bad habits” such as the allegations of sexual harassment at Uber and human resources startup Zenefits cheating on mandatory compliance training.

“There was a lot of crazy behaviour in the late 1990s, including sexual harassment. It’s a result of there not being discipline,” Dinan said.

However, Dinan said that his view is clouded by his personal experience of the dotcom crash. “I probably have some scar tissue. When you’ve seen your income go down by 80% as a recruiter, I could be seeing things that aren’t there.”

The critical difference now is that it’s not a universal tech slowdown. There are now large established technology companies such as Google, Oracle, Facebook, Apple and Salesforce trading on public markets that can bring stability to the region.

“We still think of tech and high growth as interchangeable,” Damodaran said. “But there’s old tech and new tech. It’s new tech that’s overpriced.”

That correction could lead to job losses and single- rather than double-digit millionaire founders but is unlikely to lead to a dotcom-style crash.

“The [dotcom crash] happened very suddenly and without any warning,” Damodaran said. “When it does happen everyone says they saw it coming. If you saw it coming then why didn’t you get out of it?”

“If it were possible to forecast collapses we could get incredibly rich.”