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Archive for November 3rd, 2014

What Bubble? Silicon Valley’s Younger Set Exhibits Optimism
By CHRISTOPHER MIMS CONNECT
Nov. 2, 2014 5:59 p.m. ET

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‘Have profitability in grasp,’ says Y-Combinator President Sam Altman. Gary Fong for The Wall Street Journal
There’s a generation gap in Silicon Valley, and it’s over a great deal more than who is using Snapchat versus who is still sending emails. In tech, the psychological dividing line is whether you were in the game the last time it all came crashing down.

“I remember the bubble bursting, but only just; I was 14,” says Sam Altman, president of Y-Combinator. Mr. Altman may have yet to see his 30th birthday, but as the head of the most-influential incubator of startups in Silicon Valley, he is among the most well-connected people in tech.

Everyone from Facebook FB +1.19% co-founder Dustin Moskovitz to YahooYHOO +0.92% Chief Executive Marissa Mayer guest-lectures in the course on startups Mr. Altman teaches at Stanford University. Companies that graduated from Y-Combinator include Airbnb and Dropbox.

“People have been calling the next bubble [in tech] since 2008, and it’s like they want it to crash,” says Mr. Altman, referring to recent talk about how overheated are the valuations of early stage startups. I admit I’ve been among those folks, calling Uber Technologies’ $18.2 billion valuation a “head scratcher,” given the competition it faces now and in the future.

Talking to Mr. Altman brings to mind another generation gap—between those who lived through the Great Depression and their children. Major economic crises can scar even the most resilient among us. The question about what’s currently going on in tech is whether it’s different this time.

I realize that is almost always a rhetorical question, but here’s how Mr. Altman—and to be fair, many others—frame it: In the 2008-2009 stock market crash, many tech companies that had little or no revenue were vaporized. Plenty of those kinds of companies still exist. Some may even be in the list of 49 privately held companies currently valued at $1 billion or more.

The good news is that since these companies remain private, public markets aren’t directly exposed to them. Companies waiting to go public until they mature a bit is perhaps the one lesson that everyone learned from the last bubble.

My own perspective is that of those 49 companies, there is no way to know how many could weather the kind of macroeconomic shock that is inevitable in our cyclical economy. Perhaps most of them learned from the last crash, or maybe none of them did, in which case a bunch of venture capitalists—and more important, their investors, known as limited partners—could take an epic bath.

For the average investor, that would be fine if LPs were just a bunch of hedge funds and wealthy individuals, but public pension funds are the largest single source of money for venture-capital funds, representing 20% in 2014. And, of course, there always is the danger that high-profile failures of big startups, which some VCs have said are inevitable, would spook the wider markets.

Mr. Altman says companies that come out of Y-Combinator are prepared for anything. “One of the things we urge Y-Combinator companies to do is to have profitability in grasp” he says. “If you need to get profitable before your A round of money, you ought to be able to do that.”

Whether or not companies that can make money when consumers are feeling confident can continue to make money when they are queasy about spending is a separate issue. And here’s where Mr. Altman’s optimism really comes in.

He allows that “there is too much capital available right now, and there are too many startups. It’s a little crazy right now.” But he also says that “I believe in the future, and to be a good investor you have to believe in the future.”

Thus, the 10,000 applications that Y-Combinator received for its last class of startups, in the summer of 2014, represent for Mr. Altman not the cresting of a great wave of entrepreneurial hype, but the logical result of Y-Combinator’s ability to concentrate power and influence in the valley through its alumni network, in which companies that graduate are made available to advise new recruits.

Also fueling record interest in Y-Combinator and other startup incubators is the increasingly global nature of tech. Forty percent of this year’s Y-Combinator applicant pool came from outside the U.S., says Mr. Altman.

A recent report by London-based venture-capital firm Atomico found that the number of billion-dollar companies formed outside Silicon Valley is growing at a faster rate than the number formed within it. More than ever, entrepreneurs are coming to the valley to learn its ways, then returning to their respective countries and creating their own startup ecosystems, says Mr. Altman.

All of this is good for tech. But is it good for those investing in tech, many of whom are propping up the valuations of big public companies whose taste for pricey acquisitions is fueling record acquisition prices?

This is where I, as a card-carrying member of Generation X, must part ways with Mr. Altman.

Economists say I’m a member of the first generation since the Depression to do worse than its parents. I graduated into the abysmal job market that followed the last tech bubble, and I survived the downturn that vaporized my own tiny startup in 2009.

The nature of capitalist Darwinism is that markets crash and companies die. It’s a necessary thinning of the herd, and it frees up resources for the fittest companies: engineers, office space, attention, everything that is scarce in our age of cheap capital.

The process is good for tech, and it’s good for some kinds of investors—those with foresight or just luck. But does it mean there isn’t a reckoning coming, even if it’s different than the last one?

Even someone who lacks the muscle memory for coping with economic free fall wouldn’t say that. Of today’s startups signing 10-year leases on lavish offices, piling on employee perks and generally spending like it’s 1999, Mr. Altman says, “If you are dependent on raising money, you will die.”

—Follow Christopher Mims on Twitter @Mims; write to him at christopher.mims@wsj.com.

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