Living in Silicon Valley, I get the feeling that “private market tech valuations are out of control” is a much bigger cultural phenomenon in my corner of the world than it is outside the bubble that is Silicon Valley. Still, it can feel like an all-consuming conversation at times, to the point that I feel the desire to add my thoughts to a debate that is going on at least a dozen years now. As the debate over the influx of capital into early-stage, venture-scale companies prepares for its bat mitzvah, it feels like anyone who has ever heard of a startup is raising a rolling fund or joining a venture firm. The same set of traditional LPs (endowment funds, pension funds, etc.) chase the same funds from the same limited universe of consistently high -performing firms, but suddenly anyone with a Clubhouse account and an AngelList page is deploying $100k checks into their friends’ startups. Packy McCormick captured the market’s frothiness perfectly with this incredible substack post detailing Ramp’s recent fundraise - I am a huge fan of Ramp, but you can see in the article that timelines have been compressed in an insane way by market heat. The SPAC mania has been particularly absurd, but changes have impacted the landscape across the spectrum of startup lifecycles and I’d like to explore the arguments around the future of this ecosystem.
The beautiful thing about debates about overheating of venture and the Silicon Valley ecosystem is that, ultimately, we’re all playing a positive-sum game. Winners and losers emerge, but progress is a constant and the world is better off for the stuff that happens here. As a college student growing up in Silicon Valley, it seems anecdotally like everyone and their mother wants to go start or join a fast-growing startup. It’s hard for me to see how this could be anything but a fantastic sign for the future of the world’s innovation and I think it largely owes to both the influx of capital and the “celebrification” of great startup founders. I often like to say that, as long as we continue down this path, the future is brighter than ever.
A Brief History of Exploding Valuations
There has undoubtedly been a massive influx of capital into the venture capital asset class/ecosystem that has accelerated over the last year. In Q1 2021, according to Crunchbase data , global venture investments reached $125 Billion, representing a 94% increase YoY and a single quarter record. It was the first time VC funding in a single quarter even topped $100 Billion - the second highest quarter on record was Q4 2020, at $92 Billion. According to Crunchbase data , there are now 770 unicorns (private companies valued >=$1B) and at least 30 decacorns (private companies valued >=$10B.) I’m old enough to remember when there were barely even 30 unicorns, and I am all of nineteen years old. This past quarter alone minted 112 new unicorns - it felt crazy when 159 companies joined the unicorn ranks in all of 2020. One consequence is the the term unicorn should probably be redefined - when Aileen Lee coined the term unicorn in 2013, it was an exclusive club of 39 companies (she included recent IPOs as well, since they simply hadn’t been private when the moniker was created.) In some sense, the decacorn is the new unicorn and a unicorn is more “promising, mid-stage private company” than “world-changing future master of the universe.”
Stakeholders in the Silicon Valley ecosystem have been complaining about explosive growth in early-stage valuations constantly since Marc Andreessen and Ben Horowitz set out to disrupt the venture industry in 2009 with their eponymous firm. In 2016, the WSJ famously published an article “exposing” the lackluster returns of a16z’s early funds, citing the complaint that “some investors say the firm has often overbid for stakes in hot companies, driving up valuations more broadly.” How has that turned out for a16z? The same funds whose mark-to-market returns were derided in that article were invested in $100B+ mega-unicorns Coinbase and Airbnb. The reporters who “exposed” a16z’s lackluster early returns fundamentally misunderstood the concept of the “J-curve” in venture investing. The nature of high-risk, high-reward, highly-illiquid investment strategies is that the failures expose themselves before the successes. In the early days of a venture fund, companies will take down rounds or die out well before you see meaningful exits for the top performers who will “return the fund.” If you looked at nearly any venture fund shortly after they finished deploying capital, you would leave unimpressed by their weak IRR (Famous exceptions would be the Sequoia fund which invested in WhatsApp or the Sequoia and Benchmark funds which invested in Instagram, both of whom saw massive, very early exits.) The nature of an asset class governed by compounding growth and power laws. What matters in venture capital is not the high-profile failures but the massive successes, and just how big those successes can be. If startup exits topped out at $1B instead of $100B, early stage investors would need ~7 (assuming ~15% ownership) of these $1B exits just to return LP capital for a $1B fund (a pretty normal size fund these days for top-tier venture firms.) These top-tier firms aim to return at least 3x investors’ capital, preferably much more than that. Twenty unicorns aren’t easy to find in one fund - for these returns to be feasible for a fund of the magnitude at which they’re currently being raised, VC firms need to find at least a few $10B-$20B exits, with a special place in their hearts for the $100B exit. You can’t talk about the proliferation of capital in venture without spending a minute on the increasing size of startup exits.
Capital is flowing into venture because winners can and will be bigger than ever, but also because of a massive systemic increase in the universe of venture-scale tech and tech-enabled businesses. It is easier to build a software company than at any other point in history. Founders can take a lot of features “off the shelf” with APIs that previously you would have built yourself, significantly compressing development timelines. Instead of driving to Fry’s Electronics in Palo Alto to buy physical servers to host your website, anyone with a credit card can sign up for Amazon Web Services in seconds and they’re ready to go. Between the lowered costs of software development and hosting costs, barriers to entry in software + e-commerce markets have decreased exponentially over the last couple decades. Additionally, the digitization of every market means that categories which never would have made sense for VC previously, like insurance or real estate, are suddenly massive opportunities to deploy capital. Everything is tech-enabled today, and tech is no longer just enabling industries, tech is the industry itself. As software eats the world , every industry becomes disruptable and venture-backable.
A decade ago no one in their right mind was thinking about $100 Billion exits. People simply weren’t modeling the possibility of opportunities for even the most promising startups approaching that scale pre-IPO. But the reality is that the early 2010s was when Doordash/Airbnb/Stripe/Coinbase were all coming through famed startup accelerator Y Combinator and getting funded by top VCs Sequoia and a16z, among others. When Stripe raised $18M at a $100M valuation in their Series B in 2012, folks in Silicon Valley called it “off the charts” and wondered how high startup valuations could go. When Stripe goes public that will likely become one of the most lucrative B rounds in the history of venture investing.
The lessons are clear:
• If people in 2012 realized that $100B exits would be possible by the time Stripe matured to IPO, that would have been a multi-billion dollar valuation even at such an early stage
• “Overpaying” for the absolute best startups has, historically, made a lot of people look really smart
• By the way, in 1999 people thought the world was going to end when Kleiner Perkins’ John Doerr paid $25M for a 33% stake in a new company called “google.com.” In his pre-dotcom-crash book The New New Thing, legendary writer Michael Lewis (The Big Short, Moneyball) thought this exorbitant price was evidence that Kleiner Perkins was feeling the pressure of Benchmark Capital’s rise and wrote that Google “consisted of a pair of Stanford graduate students who had a piece of software that might or might not make it easier to search the Internet.” I guess that’s one way to describe Larry and Sergey and the greatest company in modern history. Sub-lesson: it’s easy to sit on the sidelines and criticize startups/investments that won’t work - statistically, you’ll be right a lot! But every once in a while you will be very, hilariously wrong.
As Haystack’s Semil Shah (also a Lightspeed “venture partner”) said in this excellent interview , the consensus a decade ago was that “venture didn’t scale” - that you couldn’t drive returns with funds above a certain size without hitting on a Facebook-level outlier. But, as Shah says, “the truth verifiably now is that the size of the end markets for cloud software are significantly bigger than even the biggest bulls believed them to be,” meaning that “the terminal value of an investment position can be orders of magnitude larger than what most traditionalists (like my old self) thought.” When you realize that the exits, and the end markets, are bigger than anyone thought previously, you have to recalibrate your mental models for valuing early-stage startups - more on that later.
Side note: Semil’s interview was released when I was about halfway done with this piece, and I was a little annoyed by the timing because it so perfectly captured a lot of what I was trying to say here. The flip side of that is that it served as nice confirmation from an industry insider that I was on the right track here. I highly suggest checking it out.
Around that time and over the succeeding decade, another entrance changed the landscape of venture - the “crossover” fund. Crossover investors are public market investors who raise venture capital funds and invest in private companies. Firms like Tiger Global , Coatue and Altimeter have made headlines recently with what appears to be, essentially, a “spray and pray” strategy on a massive scale. Crossover investors started by investing in easily underwritten, private equity-type business models like a mature pre-IPO software company. These companies have (relatively) predictable business models based on recurring revenue and they aren’t difficult for a finance-focused person/firm to understand and value. This is a stark contrast to early stage deals for which constructing a discounted cash flow model is about as predictive as reading tarot cards for the founders. Still, these crossover investors continually moved up the stack - these days it almost feels like Tiger Global is in one out of every three Series A rounds in The Valley. When will they build an index-type portfolio of pre-seed rounds? If nobody stops Chase Coleman III (Tiger Global founder + in my opinion the coolest “tiger cub1”) then “raising venture dollars” will eventually just become a euphemism for negotiating with Tiger for your term sheet. The major difference between early- and late-stage investing is that late-stage capital is, essentially, a commodity whereas early-stage venture is about partnerships. Early-stage investors can provide a massive value-add in helping founders achieve their goals - because of that value, plus the “signaling” value from having a tier one firm lead your Series A, investors compete on much more than just price. At early stages Sequoia/Benchmark/other tier 1 firms (and some impressive individual investors like Mickey Malka for fintech or David Sacks for SaaS) have some power to keep prices from spiraling out of control because the value of partnering with these investors, and the signal of having them lead your round, is tremendously valuable to founders. Some founders surely pass on these investors for a pure auction-style price-maximizing, dilution-minimizing round from a less-well-known investor, but prices don’t rise ad infinitum because of the value add of many investors. Practically, this means that a dilutive term sheet from Sequoia will often beat out a number of less-dilutive term sheets at crazy valuations from less-impressive investors. At the later stages, fundraising is more about capital than partnerships (not to discount the value of certain growth investors) - because the capital is commoditized, a crossover fund without startup expertise can compete with entrenched venture firms as long as the return profiles on their investments clear their threshold. Coatue can beat out inferior term sheets from Mary Meeker at Bond Capital or from Meritech, despite less history/expertise in late-stage investing, because at that stage the priority is the valuation. As they have moved into earlier stages, crossover funds have built out some VC-esque teams, but they still have a distinct New York flavor. I laughed when I read that Tiger Global, for example, hires Bain & Co consultants to advise portfolio companies on product roadmaps and go to market strategies.
Eight years after Andreessen Horowitz set out to change the venture landscape, Masayoshi Son created a whole new game. The legendary SoftBank founder/CEO, infamous for having, at one point, lost more money than anyone in history, knows how to make an entrance. After having spent years making investments off SoftBank’s balance sheet, including an investment in Alibaba that is considered among the best venture investments of all time, Masa decided to raise an unprecedented $100 Billion fund which he titled his “Vision Fund.” Wooing sovereign investors like Saudi Arabia’s Public Investment Fund with his grandiose vision of investing for the next few centuries, Masa suddenly possessed more “dry powder” and wider latitude with which to deploy it than any investor in history. Given his propensity for identifying and encouraging maximum insanity, the results were consistently entertaining. WeWork’s IPO meltdown is the most famous of these public disasters, but investments like Wag (dog hotels) and Zume Pizza (robot pizza trucks) have been similarly maligned in the media and in tech circles. I think people can sometimes miss the point with criticism of the Vision Fund - Masa decided that he wanted to make late-stage investing look more like early-stage investing, with high failure rates and massive wins to “return the fund” and drive portfolio-level returns. To do so with mature companies who already possess high valuations at the scale at which he wanted to, you have to bet big and fail bigger. It’s too early to write off the Vision Fund, and recent wins with Doordash and Coupang suggest that its performance may look very different in a few years, but there’s no denying its effect on the ecosystem. Pumping unprecedented levels of capital into the least cash-efficient industries in The Valley helped to accelerate a culture of burning cash to chase massive wins, and pushed startup valuations to the stratosphere. Ultimately, SoftBank seems to have missed a lot of the recent winners, but their mere presence likely drove up late-stage valuations for companies like Airbnb and Roblox who never took SoftBank money. There is surely some amount of adverse selection at play here - some in Silicon Valley feel an anti-SoftBank bias where other stakeholders in the ecosystem may not want SoftBank flooding their companies/investments with capital and telling them that, however crazy their ambitions, they “need to be crazier.” It’s certainly easier to make a case against inundating ambitious late-stage private companies with capital and pushing them to pursue increasingly wild dreams than it is to make a case against a16z’s (pretty effective) strategies, but I’m still not convinced that SoftBank-related “runaway valuations” were necessarily out of control.
A few more years after SoftBank’s eyebrow-raising fund hit Silicon Valley like a money cyclone, a new fundraising innovation pushed the boundaries of accepted valuation - the SPAC. SPAC stands for Special Purpose Acquisition Company - SPACs are essentially pools of cash that IPO with no operating business and seek to execute a “reverse merger,” or “de-SPAC,” in which they combine with a private company. After the completion of that merger, the company gets access to the pool of cash and the SPAC shareholders receive shares in the newly public company. Before about 2019, SPACs had existed for decades as a strange form of financial engineering mostly utilized by “boiler room” types in Wolf of Wall Street-esque, semi-fraudulent deals which served as wealth transfers from uninformed retail investors to unscrupulous financiers. Over the last few years, Chamath Palihapitiya (Social Capital, ex-Facebook) has led the charge in the rise of the mainstream SPAC.
SPACs accelerated the traditional startup timeline by a couple of years, often serving as replacements for a Series C or Series D, occasionally bringing pre-revenue companies to the public markets. I certainly have concerns about fairy-tale projections of massive 2025 revenues in SPAC prospectuses, and I hope the SEC adjusts their forward-looking statement rules2 to account for the new paradigm in the world of reverse mergers, but, for now, SPACs are the 1,000 pound gorilla in the room. The public markets have been rewarding speculative companies (especially electric vehicles/autonomous driving tech) with rich valuations as though they had already completed their ambitious missions, even though they have barely started. That will likely end poorly for retail investors, but it presents a strange set of incentives for VCs. No longer does an investment need to reach IPO-scale for a public market exit - there are about $100B worth of SPAC dollars and they will all be competing over the same set of mediocre companies for the next 18-24 months. As SPACs compete with private market investors, and each other, they have acted as another catalyst for rapidly increasing private company valuations. Because it is an ongoing phenomenon I won’t speculate too much on the future direction of the SPAC boom, but it is certainly a driver of some wild valuations in the most highly-speculative markets.
Valuation Math
This recalibration isn’t just a result of the increasing size of the ceiling of startup exits - the entire landscape is changing. A decade ago, founders/investors in SaaS companies were often hoping for a $50M-$100M acquisition, with potential for killer execution and a great product that led to a billion-dollar result. Based on the size of end markets for software at the time, many felt like these companies had a ceiling of $1B-$2B. Yammer CEO (+ PayPal COO + VC) David Sacks talks about how, when he accepted a $1.2B acquisition offer from Microsoft for his Slack predecessor, it felt like there wasn’t an opportunity to get much bigger than that. His feeling was that, if they killed execution and kept building for years, they may get to $2B, but the market for bottom-up SaaS products wasn’t big enough to support more than that - he said that at the time he thought $1B-$2B was “the upper bound of what a SaaS exit could look like.” Slack was acquired by Salesforce for $27.7B - that’s a lot more than anyone thought these things could be worth a decade ago. The end markets for software aren’t just massive, they continue to grow at incredible rates which suggest that exits could, again, look absolutely ridiculous in a decade. Companies like Okta, DocuSign and Twilio are other examples - before everyone realized how big these markets would get, they may have been $500M acquisitions - a nice exit. Today, Okta is worth $30B, DocuSign is worth $40B and Twilio is worth $60B. Sacks highlights the scale and continuing growth of the three major cloud computing services - Amazon Web Services, Microsoft Azure and Google Cloud Platform - as evidence of the shocking size and remaining potential of software markets.
It’s a new world for startup exits and, as crazy as early-stage valuations look, I’m not sure they have gone far enough. According to Pitchbook data, in 2010 exits for venture-backed companies totaled $43 billion. In 2020, during the pandemic, exits for venture-backed companies totaled $290 billion. When payoffs are growing 7x over a ten year period, a CAGR (compound annual growth rate) of ~21%, early-stage valuations are going to grow at a pace that looks similarly insane. Also according to Pitchbook data, average early-stage deal size is up just 3x in the last decade. In later stages, once clear winners begin to emerge, deal size is up 5x. The insane exits we are already seeing are one thing, but as the emerging world continues to develop and join the global digital economy, I expect these markets to continue to grow at a pace few are expecting. Incredible products and world-class teams will continue to dominate, economies of scale in ultra-high-margin businesses will win out and the biggest and best startups will continue to see astronomical exits that drive outsized returns for the top venture firms who are able to get allocation in these rounds. When you look at it like that, I think the prices we’re seeing in the hottest early-stage deals are still absurdly attractive for their venture investors.
Explosion of Venture-Backable Startups
Will software markets keep growing? India is poised to see the same explosion of their economic middle class that China saw over the last few years, and they have even more citizens. The push to bring the developing world online is progressing fantastically, but only about 35% of the developing world currently has broadband access. The development of SpaceX’s Starlink and initiatives like Reliance Jio’s plan to provide nearly-free internet for all of India will continue to provide internet for the global masses and continue to massively “increase the GDP of the internet,” as Stripe likes to say. Compared to the “internet pioneer” nations, the developing world will catch up at hyper speed. Technology infrastructure is in place and the roadmap is set to develop a burgeoning online economy in any nation around the world. As this happens, software markets (+e-commerce markets) are going to be unfathomably massive - everyone needs to “adjust their models” accordingly. This leads to ridiculous potential exits and absolutely insane valuations for the most promising early-stage companies and founders. When you realize that markets are way bigger than we ever previously thought - and this is very clearly true of, broadly, “the internet”- you need to completely recalibrate your mental models for valuing startups at every stage.
Every industry and every market is disruptable and tech-friendly in a global, digital world - the universe of venture-scale startups is expanding at an insane pace. Big winners keep getting bigger and there is space for an increasing number of these winners. We are also seeing an incredible increase in the number of experienced operators who have seen the inside of blitzscaling companies and know what is necessary to kick off and support hypergrowth in promising markets. The universe of high-quality founders with inspiring missions chasing fast-growing markets is expanding rapidly and I am really excited that venture capital as an industry and asset class is growing alongside it - even if it is a little tough to slow down and make sure the growth in valuations is proportional to the growth in potential exits.
Conclusion
Of course, these aren’t the only reasons valuations are increasing. There is a ton of money flowing into private markets and the pressure to deploy unprecedented levels of capital is going to push valuations through the roof and continue to make rounds significantly more expensive. We see the same thing with expedited rounds. Anecdotally, it seems that due diligence is at an all-time low, or at least the lowest it’s been since the Dotcom bubble burst. The pressure to deploy LP capital, combined with the explosion in both quantity and size of the $billion+ exits, along with the FOMO across private and public markets, created a perfect storm for the 5x+ increase in startup valuations we’re seeing today. But I am not sure this is wrong, exactly. It is commonly written that venture is historically a poorly-performing asset class and this is likely to be true for the foreseeable future, outside of the top funds. Tier 1 firms will continue to generate massive returns regardless of the explosion in entry prices and tier 3 firms will continue to struggle to generate returns, and often struggle to even return LP capital. But the great thing about venture is that it’s not a zero-sum game. When more money flows into early-stage venture funding, it serves as an incentive for more incredible founders to go start promising companies, and it gives more founders the opportunity to scale their companies and partner with incredible investors. This increases not only the quantity and quality of fund-returning exits, but it also increases the levels of innovation in the American economy. Fund-level returns may become a bit more rare with larger funds but world-changing companies become more common. In short, anyone invested in VC funds who cannot access the top-tier deals should be wary of the explosion of entry prices in the startup world, but if you’re a stakeholder in a top firm, or just a stakeholder in the global economy, you should be really excited by the opportunities presented by the inflows of capital into venture. When asked about overflowing capital in venture in a recent episode of Harry Stebbings’ excellent 20 Minute VC podcast, Benchmark partner Peter Fenton explained that he thinks more capital in venture is a good thing because it increases “entropy” in the system. As more ideas and companies are funded, there are more opportunities for the types of “mutations” that create the world’s great innovations, great products and great companies - especially the kind that no one saw coming..
The New York Times’ Shira Ovide recently wrote about her take that tech bubbles aren’t exactly a bad thing, in the same way that, say, a housing bubble would be. Bursting bubbles are never a good thing, but the great thing about historical tech bubbles is that they leave tremendous innovation, infrastructure and technological progress in their wake. The great thing about the tech industry is that it is constantly a positive-sum game - everywhere you look, people are leaving the world better than they found it. I would say there is a massive, insane bubble in electric vehicles and autonomous driving technology right now, largely driven by the SPAC mania and hilariously starry-eyed financial projections. That’s not good, and a lot of retail investors will be hurt, but the end result will be a widespread acceleration of the development of sustainable cars and self-driving technology. Even when things get out of control, the answer is pretty much always that more innovation is good, and we should stuff as much capital into innovation as possible for the long-term development of our country and our planet.
“Tiger Cub” is a moniker given to hedge fund managers who apprenticed under Julian Robertson at the legendary Tiger Management. Tiger Cubs are the “PayPal Mafia” of the finance world. Coatue founder/fellow VC disrupter Philippe Laffont is another Tiger Cub. Tiger Cub Bill Hwang has been in the news lately for the spectacular disaster involving his family office, Archegos Capital Management.
Acting SEC corporate finance director John Coates released a statement highlighting his concerns with forward-looking statements in de-SPAC prospectuses and suggested that he is focused on aligning these with traditional IPO prospectuses.