
Internet start-ups: Another bubble? - obilgic
http://www.economist.com/node/17733145?story_id=17733145&fsrc=rss&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+economist%2Ffull_print_edition+%28The+Economist%3A+Full+print+edition%29
======
3pt14159
The graph on the article is misleading. Show me trending for the last 5 or 10
years. The number of exits over the past two is a completely irrelevant metric
because all sorts of investors were squeezed shortly after the recession
started.

Calling internet startups a bubble in the same breath as the housing market
bubble is doing a disservice to the readers. Every single American was seeing
housing prices soar. All sorts of people were borrowing 100k against their new
found home equity to "invest" in their home, despite the fact that homes have
no revenue, while the majority internet companies do.

Most people running startups in the community I'm most active in (Toronto)
_have revenue_. For example: dateideas.ca is only 6 months old and they have
revenue, guestlistapp.com has been out of beta for about half a year (launched
a year before that) and they have fairly substantial traction, then you have
the bulk-ward of the Toronto tech scene, freshbooks.com, with over 2 million
users and a solid business model. Just look at their hiring page, 22 positions
listed for a 50 person company.

There is a huge difference between building valuations based on a solid
business model and changing public trends (ie, more people getting on/trusting
the internet), and building valuations on selling ponzi scheme debt that
overvalue non-revenue generating assets like housing. The same article could
have been written about clothing manufacturing in England just after the
industrial revolution started.

~~~
jsvaughan
bubble or not, I can't help point out that it's profit not revenue that is
important - it is the easiest thing in the world to make loss making sales.

~~~
tybris
Unless you give dividends, profit is mostly just money you forgot to invest in
your business. A successful business is about sustained growth with a balanced
budget.

~~~
helmut_hed
In accounting terms, an "investment", at the time you make it, does not change
your profitability. This is because you are assumed to have received in return
an asset of equal value. For example, the purchase of equipment results in a
decrease of your cash balance, but an increase in your fixed assets of the
same amount. An "expense", on the other hand, does reduce your profitability.
So profits are not a sign of a lack of investment, but of revenue that exceeds
your expenses, which seems pretty desirable to me.

~~~
Bricejm
Accounting: Assets = Liabilities + Capital. This deals with the Balance Sheet.
Expenses/Revenues are reported on the Income Statement. Two completely
different things. An income statement basically explains how well you're using
the items on your balance sheet.

------
swombat
_The emergence of an active secondary market in shares of start-ups yet to go
public has allowed founders and early investors in firms such as Facebook and
Twitter to bank fortunes without waiting for a traditional exit by IPO or
acquisition. These secondary-market prices feed hype about what these firms
might be worth, were they to list on the stockmarket. Not many shares are
available; many punters are chasing them. And those punters tend to be
outsiders, such as fund managers and private-equity firms, who may not
understand the tech business as well as insiders do._

Wait a minute. There's an unregulated secondary market where pension fund
managers and other non-tech people invest other people's money into stuff they
don't understand?

Previously the argument was that only wealthy people will lose out on their
risk money if this is a new bubble, but if large investors like pensions and
the like are also feeding this bubble than maybe we do have a new equity
bubble on the way - except this one is happening on unregulated markets and so
perhaps even more dangerous.

~~~
roc
It seems to me that bubbles _only_ form to catastrophic sizes around the
unregulated edges of markets.

e.g. If not for the ineffectual IPO regulation, the dot-com boom couldn't have
built so much irrational exuberance. Similarly with nonexistent regulation of
derivatives and the ratings thereof during the real-estate bubble. And also
with Savings & Loans being deregulated in the late 80s, leading directly to
that real estate disaster.

~~~
yummyfajitas
I'm not sure how you can possibly characterize the housing bubble as occurring
in the "unregulated edges" of markets.

Banks purchased AAA rated MBS because they were legally obligated to own AAA
securities (by Basel I and II) [1]. The securities underlying an MBS are
heavily subsidized and regulated by the government, and several major players
in the market were backed by the government [2].

Derivatives are a sideshow. The speculative bubble was created by banks and
real estate speculators ("homeowners", as politicians call them, even though
most of them only own highly leveraged call options on a house), with the
strong encouragement of the government.

[1] You can satisfy capitalization requirements by purchasing AAA bonds from
another party.

[2] In spite of assorted claims that they had nothing to do with the crisis,
the GSEs seem to require the biggest bailouts.

~~~
roc
The ratings were obviously unregulated. The oversight committees that received
reports that agencies were slapping AAA on garbage outright ignored those
complaints.

The unregulated derivatives were a necessary instrument to obscure the risk of
the underlying assets. I don't know how you could imagine institutional
investors being conned into thinking trash tranches of subprime mortgages were
safe investments without derivatives obscuring their contents and ratings
agencies blessing garbage as AAA.

If the bubble only wiped out speculators, _it_ would have been the sideshow.
The money that chases high risk is a rounding error compared to the money that
can only chase 'safe' investments.

Without derivatives and fraudulent ratings the bubble couldn't have ensnared
nearly as much money, the banks couldn't have become so precariously leveraged
and the system itself wouldn't have been on the brink.

~~~
yummyfajitas
Let me get this straight. The government requires banks and other financial
institutions to purchase securities rated AAA by one of five ratings agencies.
As of 2006, the ratings agencies could even be subject to some penalties if
they screw up the ratings in certain ways. The ratings agencies are all
selected by the SEC. The downside risk is bounded below by the implicit
guarantee of a government bailout, and again the biggest players in the market
are government sponsored entities.

I think we have a very different definition of "unregulated".

Also, I don't know where you get the idea that the crash of the housing bubble
was somehow based on people being conned into buying securities that were too
complex to understand. An MBS is a fairly simple security, and so far MBS's
have done exactly what they are supposed to do: allow you to take exposure to
a long position on housing.

~~~
roc
> _"I think we have a very different definition of "unregulated"."_

Yes. I recognize unenforced regulation as not being regulation.

Also, the implicit guarantee of a bailout wasn't a known or accepted feature
of our financial system prior to TARP.

> _"I don't know where you get the idea that the crash of the housing bubble
> was somehow based on people being conned into buying securities that were
> too complex to understand"_

The _crash_ wasn't. But the feature of the situation that put our entire
financial system on the brink were the securities.

Again: if high-risk crap wasn't rated AAA and being sold to institutional
investors, then much less of it would exist, exposing the banks to much less
risk. More of what they could sell would be properly rated, meaning there
would be enough reserves and insurance to cover the expected losses. There
still would have been a bubble and crash, but it would have been more on the
order of the Dot Com cycle, than what we just experienced.

When dot coms bottomed, investors were wiped out, but the banks themselves
were fine. When the properties behind the securities bottomed, the banks were
obligated to continue making payments. Payments they couldn't possibly make,
because they didn't have enough reserves or insurance to cover the spread
between the risk they _said_ they had and the risk they were actually exposed
to.

~~~
yummyfajitas
_Yes. I recognize unenforced regulation as not being regulation._

If regulations were unenforced, why were banks bothering to meet
capitalization requirements at all? Why invest in MBS at all rather than
something with higher returns? And if capitalization regulations were
unenforced, why bother selling your own loans and purchasing an MBS of loans
from some other bank (paying a chunk to loan packagers in the process)? And
why bother buying wasting money getting a AAA rating from the government
specified ratings agency?

What regulation do you believe was not enforced?

 _Also, the implicit guarantee of a bailout wasn't a known or accepted feature
of our financial system prior to TARP._

You have no idea what you are talking about.

<http://en.wikipedia.org/wiki/Savings_and_loan_crisis>

[http://en.wikipedia.org/wiki/Long-
Term_Capital_Management#19...](http://en.wikipedia.org/wiki/Long-
Term_Capital_Management#1998_bailout)

[http://en.wikipedia.org/wiki/Government-
sponsored_enterprise...](http://en.wikipedia.org/wiki/Government-
sponsored_enterprise#Ownership_and_implicit_guarantee)

 _Again: if high-risk crap wasn't rated AAA and being sold to institutional
investors, then much less of it would exist, exposing the banks to much less
risk._

This is not in dispute. Also not in dispute: if regulations didn't demand that
banks own lots of AAA rated securities, they wouldn't have bought as much.

You may be able to, with the benefit of hindsight, pinpoint some specific
regulation that might have prevented the bubble. But lack of that particular
regulation is not the same thing as an unregulated market.

~~~
borism
Interesting that you waste so much "productive time" that you claim you value
so much arguing about those things on HN. It's not like HN exactly attracts
the crowd that will write next banking regulations, is it? Then what's the
point of having these arguments here? If it's about getting more karma, then
it's obvious you'll get plenty from extremely libertarian tech crowd here, but
it's not like your 12000 karma is convertible into real dollars?

Another observation is that many times you come in with an argument you seem
to purposefully derail it into something that more suits you. The original
argument was:

 _Similarly with nonexistent regulation of derivatives and the ratings thereof
during the real-estate bubble._

instead of addressing those two issues you go into government involvement in
housing market and Basel requirements. Those are important issues not
unrelated to housing bubble, but that wasn't original point!

Of course housing market was heavily regulated and influenced by government.
But market for housing securities wasn't! It is basic knowledge now that
pretty much everyone could structure, rate, insure and sell pretty much
anything to pretty much everyone. I don't understand how you could argue with
that?

And finally, back to the topic, is it not indicative of something that
SecondMarket is now the marketplace for both the toxic housing junk and hi-fly
tech start-ups?

------
jdp23
"For the first time since 2000, internet and technology entrepreneurs can
raise seed capital with little more than a half-formed idea and a dozen
PowerPoint slides."

Really?

~~~
dabent
When did YC start? I'm pretty sure they've been funding ideas for a few years
now. I think one of them turned out to be Reddit.

~~~
jdp23
The ideas that YC funds are much more than half baked, and it's not just a
"few powerpoint slides".

~~~
dabent
I didn't mean that as an insult to YC companies, or YC, but when YC started
they were literally funding teams with ideas. In Reddit's case, YC convinced
the team to do a different idea than what they had presented.

I'm thinking YC now funds more mature companies, but that probably is a sign
that there is less of a "bubble" now than there was before.

~~~
jdp23
Interesting point ... I don't know much about YC back in the early days.

Don't get me wrong, I think the right idea _should_ be fundable based on a few
PowerPoint slides. I just don't see it happening very often at all.

------
aristidb
It says that founders are less technical, and more likely to be based in NYC
not SV.

But YC, the poster-child of the new wave, is totally "technical founder", and
I also read that the share of VC investments in California vs Rest Of The
World has risen from 47% in ~2000 to over 50% now.

Discrepancy?

~~~
nostrademons
I think the Economist is describing a different wave than YC. The poster child
for its wave is Groupon, which has lately stole the press cycle by turning
down the $6B acquisition offer from Google. (Which was a masterful PR move,
BTW - we don't even know if there _was_ an acquisition offer, yet by leaking
that they turned it down, Groupon has become the new hotness in every media
outlet's eyes.)

YC seems to invest much more in B2SmallB startups, which are less visible from
a media perspective and require more technical savvy. Reddit's their most
famous success because it was one of the few that is purely consumer web, but
their other investments have included Wufoo, Heroku, ClickFacts, Auctomactic,
FrogMetrics, and RescueTime, all of which are aimed at small businesses.

------
w1ntermute
I love reading about world affairs in The Economist, but seeing how poorly
they covered this topic is making me take a second look at my preferred
magazine.

~~~
chopsueyar
I read a copy last week that I grabbed while in an airport. It had some good
articles on China and its military capabilities, but then had a horribly
written, pompous article about Google with factually incorrect information and
exaggerations.

Very disappointing. What is happening to the Economist?

~~~
spamizbad
> Very disappointing. What is happening to the Economist?

Nothing - it's the same magazine it always was. Only this time it's covering a
topic for which you have a large degree of expertise. I imagine someone with
vast knowledge of China and its military capabilities is shaking their head at
the article you just lauded.

~~~
T_S_
You nailed it. Journalism will always seem "challenged" on a topic on which
you are an expert. If they don't completely screw it up with factual errors,
give them an A+ and take everything else with a grain of salt.

I worked on a biofuels startup for 2 years, focused on a lesser known crop.
During that time I did not read a single article on our sector which did not
contain major factual errors.

------
diziet
I think this article fails to understand a fundamental trend that has been
going on from 2000 to 2010 and wasn't going on in 1998. Increased market
penetration of web based devices. Having a business in 1999, when the
potential population of internet users is roughly 1/10th what it is now, when
you do not have such a large population of non-tech people using very
sophisticated devices and the web constantly. Of course, even in such a
favorable environment, it is possible to have a bubble, however the numbers
even they themselves use are both statistically insignificant and not telling
the whole story.

------
jacquesm
The secondary market is an excellent place to get burned big time.

~~~
gyardley
No one gets burned without a burner.

The secondary market is therefore also an excellent place to burn someone big
time.

~~~
chopsueyar
"Fear and greed, mofo."

------
revorad
<http://redeye.firstround.com/2007/10/this-year-i-mea.html>

------
JimboOmega
I've used up my 5 free views on the economist... anybody have a link that
avoids that problem?

~~~
drpancake
<http://www.economist.com/products/subscribe>

~~~
JimboOmega
My SO bought the economist groupon for me yesterday, so I have a new print
subscription, but the details are still on their way.

------
palewery
Is there going to be a time in the next 5 years where most people change their
views about the [usefulness/profitability] of [investing/creating/buying]
[housing/start-ups/restaurants]?

If your answer is yes then there is currently a bubble.

~~~
nostrademons
Only if the change is negative. If the change is positive, then you have a
trend.

------
tybris
Yes, except for the ones that aren't...

------
radioactive21
jesus what's with this new trend of calling everything a bubble?

~~~
ScottBurson
It's a bubble bubble! (Sorry, couldn't resist)

------
sabat
Why are they calling overvaluation by private investors a stock market bubble?
I know -- they didn't say "stock market", but that's what "bubble" refers to.
It's a word that conjures up images of the the dot-bomb era with a crashing
stock market and thousands out of work. Having a few startups overvalued by
some private investors is not going to create the same effect.

Why is it that the media can't go for more than two years without making a big
fuss about tech bubbles? There is no bubble. We're in a financial downturn --
a bad one.

------
maxawaytoolong
A big reason the dot-com bubble was bad was because normal people with more to
lose were depleting their retirement savings buying stock in stupid companies
that recently went public. There are no more IPOs. The public at large cannot
participate in this bubble. This financial part of this bubble involves a
bunch of rich guys and even richer investment firms. Who cares if these people
lose .001% of their net worth betting on startups?

~~~
jwh
The problem is the 'rich guys' are using the average Joes money, often lent
to/invested with them by banks and pensions funds to try and secure the
largest return possible.

Even if they're using their own money, the cynic inside me predicts that
if/when the house of cards comes crashing down, Mr and Mrs Taxpayer will be
asked to 'stabilise' the industry in the interests of national economic
security.

