Are we in midst of a startup bubble?
We are experiencing a startup boom. Every day, new startups are raising millions of dollars at astronomical valuations. This situation is even more extreme in India. In the first 4 months of 2021, more Indian companies became unicorns (startups with at least $1 Bn valuations) than the entire 2020. India is no exception. More and more startups are becoming unicorns all over the world.
How can we explain this sudden rush of capital to startups?
The Covid upended the business models all over the world. It accelerated the technology adoption that has been going on for decades. As traditional businesses (both manufacturing and services) struggled to survive, technology companies including startups picked up the slack. Their revenues soared.
This lead to a massive inflow of venture capital (VC) into startups. VC investments were between $100 Bn and $180 Bn between 2017 and 2020 (calculated for every half-year – H1 and H2). It touched an all-time high in H2 2018. After H2 2018, the investments declined over the next 3 periods before rebounding in H2 2020. This rebound was quite expected because the first wave of pandemics had ended. Investors were back looking for good deals. This was a pent up demand. But VC investments went berserk in 2021. The first half of 2021 saw $290 Bn investments, a 61% increase over the H2 2020 which anyways was an all-time high.
How can we explain this sudden rush of venture capital? I have 2 competing theories.
1. Global investors have realised startups are the future. They know most of the future growth will come from startups. Thus, they are reducing their investments in other assets (real estate, private equity, bonds, listed securities, etc.) and investing more in startups. It sounds logical. But the data doesn't support this hypothesis.
2. We are witnessing a global economic bubble. Central banks are printing more money than ever to help economies recover from Covid. This is leading to global asset inflation. All investments including VC have increased exponentially. There is more money chasing fewer assets. Startups are not an exception.
Even though I believe startups are the future growth drivers, I think we are in midst of a global economic bubble. Maybe it's still early days, and the asset prices will cool down as the money supply dries up. Or the valuations for all assets including startups will keep exploding until we see a collapse.
We don't know what will happen. But the signs are ominous. If I were a VC, I would stay away from this FOMO on so-called amazing deals and try to find some good reasonably priced startups. But it's easier said than done.