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Are We In A Bubble?

This is a chart of the median pre-money valuation of companies raising a Series A or Series B in the last ten years, compiled from Pitchbook. There’s a somewhat linear increase of on average 16% every year until 2020. Then in 2021, it skyrockets from $30.78M to $50M, an increase of over 60%.

Something is clearly going on here. A lot of people think we’re in a bubble, similar to the dot-com bubble that burst in 2001. Here’s a Wall Street investor saying we’re in the “biggest bubble of [his] career.” He’s talking about publicly traded companies, but the same things apply to early-stage startups. The implication is that these valuations do not reflect reality - that these companies are not worth the valuations that they are commanding. In the late 90’s, the joke was that anyone could form a Delaware C-corp with an associated .com domain and automatically get a multimillion dollar valuation. Is the same thing happening today, only with “fintech” or “crypto” or “future of work” instead of .com?

I think there’s another possibility - the jump in valuations reflect investors starting to realize the true value of these companies. In 2012, where the chart above starts, there were between 5-10 unicorn companies (depending on how you count IPOs, from this CBInsights article). According to that same data, there have been over 360 unicorns minted in 2021 alone, and we’re only in September. Even accounting for 11% inflation over those ten years, that’s a huge increase of >36x. And in fact, the number of unicorns are up 43% this year compared to the same period in 2019 (we’ll disregard 2020 for obvious reasons).

Now a 60% increase in early-stage valuations is starting to make a little more sense. If the rate at which valuable companies are being created is increasing, then rational investors should be more willing to pay a premium for hot early-stage deals - the risk is lower. If you’re a VC investing in the late 2000’s, you would have had to invest in one of about ten companies each year that would turn out to be a home run (i.e. would become a unicorn in a few years). Contrast that with a VC a decade later, who has to invest in one of several hundred companies each year that could carry the fund. It’s no wonder that there is more capital in early-stage markets - it’s easier than ever before to find a future billion-dollar company. In fact, until valuations today are 36x what they were in 2012, investors should count themselves lucky at getting such a great deal!

When the dot-com bubble burst in 2000, a lot of companies went out of business, and a lot of investors lost money. But as much as investors were irrationally investing in worthless companies, there was a core of real value. There really was a revolution in the late 90s, where the advent of the Internet was suddenly making a whole new world open up, for consumers as well as businesses. And I think there is a parallel to today, where we are creating new technology at a breakneck pace, and for every Greensill and NFT scam, there are companies creating real, tangible value to their customers. That’s hopefully the kind of company that can weather any kind of change in market conditions, even a market correction or a bubble burst.

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