The Great Bubble Debate

The WSJ hosts a debate between two venture cap­it­al­ists on whether we’re in a Web 2.0 bubble. The par­ti­cipants are Todd Dagres, founder and general partner of Spark Capital in Boston and David Hornik, a general partner with August Capital in Menlo Park. Don’t expect to come away from the article with a strong opinion one way or another, but do expect to feel a lot better informed. The par­ti­cipants reach some con­sensus on the idea that, “great entre­pren­eurs are the key to building valuable companies.”

Mr. Dagres begins: Web 2.0 is a bubble for 3 reasons: 1) There is far too much money chasing Web 2.0 deals. Too much money means too many com­panies getting funded at higher valu­ations. 2) There are vir­tu­ally no barriers to entry in Web 2.0 and there­fore the ability to develop a unique solution and sustain a com­pet­itive advantage is vir­tu­ally nil. Therefore, it’s dif­fi­cult for Web 2.0 com­panies to build long term value. 3) There is very little liquidity in the market for Web 2.0 com­panies. The Dow was recently at a high and still no liquidity. Without liquidity, Web 2.0 com­panies must rely on acquis­i­tions to achieve liquidity and this will put a lid on the poten­tial exit options and ultimate valu­ations of these com­panies. In short, they will be playing a musical chairs game in which there are far too many players and too few chairs.

There are some sim­il­ar­ities between the current “bubble” and the last one that burst in 2000: Lots of incom­plete and under-​​experienced teams, business models based more on eyeballs than cash flow, and a rash of incre­mental and “me too” deals.

Mr. Hornik responds: I do not believe that the exist­ence of too much venture capital money chasing too few inter­esting ideas con­sti­tutes a bubble. The Web 1.0 bubble inflated because the public markets were willing to bet on unproven ideas. Public markets are ill suited to eval­u­ating such risks. On the other hand, the venture capital com­munity exists pre­cisely to take on that risk. While many Web 2.0 com­panies will fail, they will not likely fail in sig­ni­fic­antly greater pro­por­tions than has been the case with other venture invest­ments his­tor­ic­ally. So it is hard to imagine how this so-​​called bubble will over-​​inflate. Venture cap­it­al­ists will ration­ally stop investing in ideas that don’t bear fruit. Those that do bear fruit will gain traction and either be acquired or go public. Those are the traits of a rational market in my mind.

[…]

Mr. Dagres: I agree that there will be inter­esting com­panies coming out of the Web 2.0 wave. Every wave has its winners and losers. The notion of a bubble, however, is that a par­tic­ular market gets overdone, i.e. over-​​hyped, over-​​invested, and ulti­mately exper­i­ences a high mor­tality rate. I think the Web 2.0 space will have a higher mor­tality rate than other segments of the overall media and tech­no­logy indus­tries. There are far too many MySpace and YouTube genet­ic­ally chal­lenged clones. All but a few will fail. The winners are gen­er­ally the ones that get in early and out before the bubble bursts. There are rare examples of bubble com­panies making it through the bust and going on to become suc­cessful and valuable com­panies. By the way, the combined cash flow of Spot Runner, LinkedIn and Facebook is less than that of one Costco store.

The debate con­tinues here…

Also note the fol­lowing table from the TNL.net blog which shows that while there have been some enormous deals (MySpace, YouTube), the average Web 2.0 acquis­i­tion is somewhat more modest.

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