Tech Bubble? Not Anymore

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Illustration by Oliver Munday for Newsweek (source photo) Jonathan Alcorn / Bloomberg-Getty Images

“That sound you just heard was the IPO window slamming shut.” That was the gloomy message tweeted by one Silicon Valley venture capitalist on Aug. 8 as the stock market continued its free fall. Indeed, with stock prices collapsing, all those “hot” tech startups, many of them profitless, suddenly don’t seem so hot anymore. Earlier this summer everything seemed promising in Silicon Valley. Real estate was going nuts. Exotic cars were popping up in parking lots. Now, in the Valley like everywhere else, the party could finally be over.

Groupon, which has filed for an initial public offering, may have to settle for raising less money than its owners once expected. Some companies may just sit on the sidelines and wait for the markets to bounce back.

That’s a tough break for the irrationally exuberant venture capitalists who have been paying crazy prices for stakes in tech startups, believing they would soon be able to flog off those companies to bigger fools in the public markets. Even for those who weren’t looking for a quick flip, the melting market makes life difficult. Some, like Facebook and Twitter backer Marc Andreessen, insist these companies are actually undervalued. Now all VCs, from the scheming to the well-meaning, will need to wait a little longer, or maybe a lot longer, to get a return on their investments.

Or maybe they will never get a return, because in some cases it is going to be hard to persuade investors in public markets to match the prices that VCs have been paying. Twitter, a five-year-old company that barely generates revenue, let alone profits, last December raised venture funding at a valuation of $3.7 billion, and by August it was raising money again, only now at an incredible valuation of $8 billion.

Twitter is a wonderful service with lots of avid users—but $8 billion? If it were public and trading at 15 times earnings, as Apple (the gold standard) does, it would need to generate net profit of more than $500 million a year to carry an $8 billion market value. To generate that much profit, Twitter would need to be doing $1.5 billion in revenue. In fact, this year the microblogging site will generate only $150 million, and will lose money.

Dropbox, a cool online storage service that did about $100 million in revenue last year, is reportedly raising a new venture round at a valuation of $10 billion. Will Dropbox one day generate enough profit to be worth that much money? Maybe, but it’s worth noting that in its current funding round, some of the money isn’t being put into the company; rather, it’s being used to buy shares from early investors and employees. The same thing took place in Twitter’s latest round. In both cases, and in others as well, insiders have been racing to cash out now rather than wait for an IPO. Does that tell you anything?

In every bubble, someone gets left holding the bag. Last time it was the poor suckers in the public market. This time it could be the venture capitalists. There might be some justice in that.

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