Investment Bubbles: Timeless Avoidable Traps
The 17th century Dutch tulip craze is often portrayed as a cautionary tale for both individual and institutional investors. University students learn about the “Tulip Bubble,” where tulip bulb prices in Holland outpaced demand and led to an investment bubble, leading to market collapse and the wiping out many personal fortunes along the way.
While other investment bubbles have occurred over the centuries, including many real estate bubbles, there is nothing quite like the frenzied speculation related to the bursting of a technology investment bubble, such as the Dot-Com Bubble.
Today’s “Seed-AI-Crypto-Bubble” (coined here) appears to be the most recent example of investment bubbles where prices skyrocketed, perhaps from investor fears of missing out or venture economics driving unicorn pricing, or from seed investors throwing money at companies they don’t fully understand.
The following data comes from Pitchbook’s Q2 2021 Data Pack, and it shows:
The annual seed deal counts increased from 146 in 2006 to 1,430 in 2021
The medium pre-money valuations for seed deals increased from $3.8 million in 2006 to $8 million in in 2021
The annual late-stage deal counts increased from 604 in 2006 to 1,063 in 2021
The medium pre-money valuations for late-stage deals increased from $11.9 million in 2006 to $40.6 million in 2021
One note: this data was as of 6/30/21 – reflecting just six months’ of investments!
Over the most recent 15-year period, annual seed deals and medium pre-money valuations increased substantially in the years leading up to the 22% correction in the S&P and readjustment in the funding of new ventures.
The Seed-AI-Crypto and other technology bubbles share some identifiable characteristics:
Long Development Period – From start to finish it appears to range from 13 to 17 years. The Internet bubble took 17 years; the Seed-AI-Crypto-Bubble took 15.
Ubiquitous FOMO (Fear of Missing Out) – No matter where you turn, people are talking about seed investing, AI applications, cryptocurrencies, and the infinite dependability of block chain applications. These conversations generate an intense need to get involved before it tops out.
Outsized Valuations – In the latest bubble, founders and angels drove up the price of seed companies. As a result, VCs pumped the price of post-seed / pre-IPO companies. Valuations were driven by competition, FOMO, and denying the rules of deal gravity.
Bubble Personification – During the Internet bubble, Jeff Bezos at Amazon, Pierre Omidyar at eBay, Steve Boal at Coupons.com, the sock-puppet from Pets.com, and several others served as avatars for their period of bubble intensification. Elon Musk, more than any current CEO, has personified the latest tech bubble thanks to his direct involvement with Tesla Motors, a range of cybercurrencies, SpaceX, The Boring Company, Neuralink, and OpenAI, not to mention his profligate use of, and attempt to buy, Twitter.
Prevailing Bewilderment – In the Internet bubble, investors did not understand the business models, financials, investment criteria, and disruption potential of the startups in which they were investing. Similarly, presentpday investors do not understand the financials, valuations, and disruption potential for cryptocurrencies, AI technology, and seed companies.
Investing With Blinders – Human nature prevails despite the obvious signs of a bubble and entreaties by experts for investors to do the hard work underlying disciplined investing and reasonable market valuations. As a result, due diligence, serious valuation analyses, and aggressive negotiations with seed company founders falls by the wayside.
Getting Way in Front of the Skis – Seed companies expanded like crazy, driven by excess funding.
Skills Shortcomings Become Apparent – Frenetic funding results in the reckless promotion of certain staff, team, or group leaders. Extravagant titles are given to promoted personnel. Skills shortcomings become obvious.
Bubble Addiction – Bubbles drive-up equity and private company valuations – especially in M&A situations and IPOs. Many VC surf on the top of bubbles for better portfolio IRR.
As shortsighted investors and profit takers cash out when it’s apparent that an investment bubble will burst, emotions snowball and the characteristics outlined above conspire to turn forward thinkers into conservative investors.
Some investment bubbles – the Internet Bubble, in particular – are said to be Darwinian, creating an ashen wasteland in its path wherein new life emerges. The hope is that the bursting of the “Seed-AI-Crypto-Bubble” will lead to ubiquitous adoption of these technologies … and perhaps avoid the next investment bubble.