There Is No Bubble
A lot of smart people have recently been hinting that the current climate in the startup world (systematic increase in valuations, “hot deals” with very high valuations, increasing cost of talent, and a sharp uptick in number of startups receiving seed funding) is not rational or sustainable. People are tip-toeing around using the word bubble, but it’s insinuated that some sort of crash, or at least a decline is impending. I respectfully disagree.
The same technology and market forces that are encouraging a rise in seed incubators and seed-stage investments are driving up the valuations of the companies coming out of these programs. The fact that it is cheaper than it has ever been to start a company also means it is cheaper than it has ever been to grow a company.
In Econ 101, we learned that the cost of a barrel of oil has nothing to do with the actual cost of drilling the oil, and everything to do with what people are willing to pay for it. This is how gas can be $4.40 per gallon and Exxon makes record profits: the market price is completely de-coupled from the actual cost of production.The same thing is happening in startups today. The valuation of a startup has nothing to do with the actual cost of running the startup: the number of employees, how many years (or months) they have been in business, are irrelevant to the assigned price tag. It has everything to do with what an investor is willing to pay to be a part of the financing round. In a rational market, what an investor will pay is based on the potential size the startup could someday be, offset by the risk that the company will never achieve that size.Today, a startup can get much farther than it could just a few years ago on much, much less. A couple of talented developers can spend a quarter of a year patching together existing technologies and external APIs, put a beautiful, simple interface on it, and have a company with the same potential as one that just a few years ago it would take a dozen engineers a year to build. Social media and inbound marketing can drive significant traffic without spending a dime on direct advertising.Hence, a company coming out of an incubator program such as YCombinator with only two-three employees is getting the same valuation as one that not too long ago was several times that size and years older. Because of that, many more investors are willing to take the risk on a couple of developers, hence the spike in seed investment. (For this same reason, the labor cost of a very talented developer at a large company is also increasing.)So, there is no bubble. All that has happened is that the valuations of companies are finally starting to reflect the new norm, which is that a company can build something significant much faster, and with fewer people than has ever been possible.
The same technology and market forces that are encouraging a rise in seed incubators and seed-stage investments are driving up the valuations of the companies coming out of these programs. The fact that it is cheaper than it has ever been to start a company also means it is cheaper than it has ever been to grow a company.
In Econ 101, we learned that the cost of a barrel of oil has nothing to do with the actual cost of drilling the oil, and everything to do with what people are willing to pay for it. This is how gas can be $4.40 per gallon and Exxon makes record profits: the market price is completely de-coupled from the actual cost of production.The same thing is happening in startups today. The valuation of a startup has nothing to do with the actual cost of running the startup: the number of employees, how many years (or months) they have been in business, are irrelevant to the assigned price tag. It has everything to do with what an investor is willing to pay to be a part of the financing round. In a rational market, what an investor will pay is based on the potential size the startup could someday be, offset by the risk that the company will never achieve that size.Today, a startup can get much farther than it could just a few years ago on much, much less. A couple of talented developers can spend a quarter of a year patching together existing technologies and external APIs, put a beautiful, simple interface on it, and have a company with the same potential as one that just a few years ago it would take a dozen engineers a year to build. Social media and inbound marketing can drive significant traffic without spending a dime on direct advertising.Hence, a company coming out of an incubator program such as YCombinator with only two-three employees is getting the same valuation as one that not too long ago was several times that size and years older. Because of that, many more investors are willing to take the risk on a couple of developers, hence the spike in seed investment. (For this same reason, the labor cost of a very talented developer at a large company is also increasing.)So, there is no bubble. All that has happened is that the valuations of companies are finally starting to reflect the new norm, which is that a company can build something significant much faster, and with fewer people than has ever been possible.
