Silicon valley is abuzz with bubble talk.
It’s the VC conversation starter of choice these days. Frequently, the topic segues into unease about the increasing competition for deals from Valley newcomers. The argument goes that the new investors are inflating a bubble in the venture asset class by bidding up valuations. Often there is nostalgia for the days when investment in the best private growth companies was essentially a private matter involving only a small group of bankers and venture capitalists.
I can say from experience that bubbles are indeed something to fear. They are not just scary for the direct participants, but destructive to the innovation economy generally. As valuations tumble and investors flee to less volatile securities, good companies can’t find capital. Typically, years can pass before a healthy capital market restores itself in the wake of a burst bubble. In the meantime, the primary driver of U.S. economic growth struggles without adequate growth capital.
What I believe often gets missed in these conversations, though, is that greater liquidity and transparency are among the best ways to avoid bubbles.
Consider why venture is so susceptible to bubbles.
Bubbles thrive in illiquid and opaque markets. Venture is an extreme example of both. Private companies do not publicly publish their financial data. Nor do they publish valuations from primary financings or secondary transactions. Secondary selling in these companies is constrained for several reasons, not the least of which is the difficulty just in finding a buyer. When investment can only flow into (not out of) a company and valuation information is infrequently available, it’s easy for investors to “overshoot” intrinsic value.
George Soros once said, “Stock market bubbles don’t grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception.” Combining the natural enthusiasm for the world’s most exciting companies with the lack of transparency and liquidity traditionally associated with this asset class makes it easy for bubble-inflating misconceptions to occur.
Understanding the cause makes it clear that the solution is not to circle the wagons against new sources of capital seeking access to the asset class. I believe the solution is to go the other direction - to increase transparency and liquidity. Doing so won’t eliminate fluctuations in value or turns in the market. However, it should go a long way to replacing the mayhem of bubbles bursting with something more like orderly corrections.
This does not mean private companies should embrace the same degree of liquidity and transparency as public companies. Private companies are now staying private for a reason. They want shareholders that are supportive of the long-term building of value and to ensure that sensitive information is not disclosed to competitors. But these needs can be met while still creating a much more efficient market.
It’s also important to recognize that unicorns such as Uber, Flipkart, Airbnb among others, are a new breed within the venture asset class.
Many private companies are going to continue to stay private longer and so more and more of them will likely become much larger than the largest, venture-backed, private companies of a decade ago. This structural shift in the capital market divide between public and private seems irreversible at this point and it’s accelerating.
The number of unicorns, their value, the capital they are raising, the amount of secondary liquidity and the efficiency of the market generally are all plainly increasing at a rapid pace.
Given their size and the number of them (over 100 at last count), unicorns need something far more robust and efficient in the way of capital markets support than what worked in the past. The venture world’s reliance on personal relationships will continue to be central. However, the asset class is now so large and the number of unicorns and the number of primary and secondary share transactions has grown so rapidly that it’s outpaced the ability of Sand Hill Road to organize all of the activity. What is needed is a deeper, more efficient, more liquid capital market.
In my view, the largest part of the innovation economy now lives in the private market.
That’s not to be feared. However, being private need not and should not mean closed, illiquid or opaque. What’s healthiest for the venture asset class and for the overall U.S. economy is for all investors to have access to the potential growth returns to be found in the private market. We need new solutions to efficiently channel capital from a broader spectrum of investors and into the asset.
The venture community should embrace this change and evolve for the good of all of its constituents.
Greg Brogger is Founder and CEO of SharesPost, Inc., the parent of SP Investment Management, investment advisor to the SharesPost 100 Fund, and SharesPost Financial Corporation, member FINRA/SIPC, facilitates access to investments in late-stage, ventured-backed companies.
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