Last month in our article “The Good, The Bad, and The Money” we analyzed whether another bubble is around the corner for U.S. financial markets. Building on our analysis, we now take a look at key data to understand whether a tech bubble is going to burst anytime soon.
Quarterly VC investment activity in the United States.
Looking at quarterly investment activity data published by PWC Moneytree, we see that investment activity of VC firms is at an all-time high of $23bn vs. $4.5bn in Q1 2002. We also see that the amount invested into each startup has risen to $16mn on average, with over 1,400 startups funded compared to roughly $10mn from 2002 to 2005, when only ~400 startups were funded each quarter.
The question you might be pondering now is: “So what if VC investment activity is at an all-time high, does this indicate anything?” To answer this question, let’s go back in time to the pre-2002 period, more commonly known as the dot-com bubble era. We will also look at the evolution of deal values in internet startups, which were considered the prime cause of the dot-com bubble.
Data from 2000 to 2001 indicates quarterly VC investment activity at the time of the dot-com bubble was just above $30mn, with about 2,300 startups receiving funding per quarter. Recently released data from CB Insights shows that we are once again very close to reaching that level, as investment activity in Q3 2018 grew to $27.5bn. This is clearly a sign that it may not be long before another dot-com bubble hits us.
An analysis of investment activity in internet startups points us to the same conclusion. For internet startups, average investment value has risen to $14.5mn today compared to $8mn in the beginning of 2002. Separately, healthcare focused startups, where total VC investment activity is only second to the internet sector, shows an even higher rise, with startups raising $24.5mn today vs. $11mn in the beginning of 2002.
The buildup to the dot-com bubble and the subsequent burst was mirrored by the Nasdaq composite index in 2000 to 2001. Recently, the Nasdaq has experienced an all-time high of over 8,100, and the index has slowly declined to a current index value of 7,497. If the previous mirroring of the Nasdaq to the VC investment activity was not a mere coincidence, this is yet another sign pointing to the same conclusion. Furthermore, the U.S. housing market has experienced a slowdown as of August 2018 based on recently released data by the U.S. Census Bureau and Department of Housing and Urban Development.
To rule out any further doubts, let’s look at average investment values at the different stages of the startup life cycle. Only 58 startups secured seed or early stage funding back in Q1 2002. Today, this figure stands at 678, a whopping 12x increase. On the contrary, 481 startups received funding during expansion or a later stage in Q2 2018, depicting only a 3x increase vs. Q1 2002. The average investment value for early stage startups has also increased from $8mn in 2002 to $13mn in 2018 after hitting a bottom of $5mn during the post global financial crisis period of 2009 to 2010.
As we all know, since early stage investments are riskier and there is greater uncertainty around the life of the startup, we should be asking ourselves: “Why are VC’s investing more and more in riskier ventures?” Do early stage companies have more historic financial data to prove revenue growth is guaranteed, or are they now run by highly educated and more experienced founders? We haven’t found evidence to support a viable answer to these questions. What we do find from Statista, however, is that 40% of VC investors in the United States have a degree from either Harvard or Stanford. So presumably, they know what they are doing. But this is not enough to rule out the risks, as all other analysis points to the conclusion that another dot-com bubble is just around the corner.
You ask when? We say soon!
P.S. To gain a better understanding of the actual timing, it would be wise to closely monitor the trend in successful startup exits.