Should Silicon Valley Be Nervous About Another Tech Bubble?

Reports have said a second bubble is looming in the tech sector, but experts are divided as to whether it will signal impending doom or a new opportunity for savvy business people.

by / January 25, 2016

Along the California coastline, spotting a mounting storm is fairly simple. The skies darken, the waves swell to double and triple their normal size, and the tourists clear the beaches to head toward shelter as the rain and wind come ashore. 

But in Silicon Valley, spotting the signs of a financial tempest is not so simple. When the dot-com bubble burst in 2000, even many investors who felt the charged air of an approaching storm lost their shirts in the gale that followed. This time around, the situation is markedly different, but that doesn’t mean there won’t be some amount of suffering if things go wrong.

Depending on whom you ask, you’ll get varied perspectives. Is there an impending cataclysm bound for the tech sector? Some will tell you the water is fine – if not a little choppy. Others will tell you to batten down the hatches and brace for heavy surf. 

If many of the headlines are right, we should all be stocking up on canned goods and bottled water for a real doozy. But for those on the ground in the valley, there is a strange sense of optimism, like the lurking clouds might hold a silver lining.

From the perspective of Garage Technology Ventures (GTV), the doom and gloom in the media is measured against the time-tested rules of economics: What goes up must (eventually) come down. While some in the space scream in terror and shovel their life savings under their mattresses, Bill Reichert, managing director at GTV, sees both the signs of trouble and opportunity.

Reichert said the rush of money into the space in recent years has certainly created a bubble within the technology sector, but he isn’t quick to jump into the financial doomsday predictions. He sees more potential for a pullback rather than an impending cataclysm.

“I think pretty much everyone would agree that we are in a bubble of some sort. For the last roughly year, everyone here in the valley has been aware of the fact that at some level, we’re experiencing a bubble, but the challenge is how is that bubble going to play out, where is the primary source of the challenge and what does that mean for various sectors of innovation?” he said. “Yes, there is a concern that too much money came in too fast and created a bunch of overvaluations in the market, but the flipside of it is that there are some massive underlying forces that will sustain the need and opportunity for innovation.”

The venture capitalist is quick to point out the differences between this presumed bubble and the one almost 16 years ago. For one thing, the investor-driven frenzy of today has been largely relegated to private investments, not the public market, he said. In 2000, overvaluation and unsustainable growth in the public market eventually folded and left those with their money riding on hopes and dreams holding the proverbial bag.

Reichert also said that today investors may very well lose big money, but it won’t be to the same scale as it was when the dot-com situation went sideways. Though he said there are “striking similarities” with the past, he said the situation is the inverse of what happened back then. 

“The last bubble tech basically brought down everyone," he said. "Tech was the reason the market crashed. This bubble is in the private side and so the extent to which the bubble corrects, it’s not really a public market correction, so it’s less damaging to the system, I would say this time around.”

On the positive side of a potential slowdown, Reichert said a pullback of currently available capital would quickly weed out the weak companies, who have not made their bones in the marketplace. He jokes that a combination of greed and opportunism on the part of the market would help to drive things forward if all else fails.

“As an investor, the way is looking at the picture is on the one hand I’ve got my current investments and I want to make sure those guys are well positioned to be survivors in a downturn. From that point of view, which is more or less the entrepreneur point of view, it’s an opportunity if you have a position of strength and have control of your destiny, in other words you’re not going to run out of cash, then a downturn can be a great time to win market dominance …,” he said. “The other half of my investor perspective is, ‘OK, I’ve got some dry powder, where am I going to invest it going forward?’ I think increasingly, all investors are going to be focused on these fundamentally novel technologies that have a clear, objective long-term value proposition and have a sustainable competitive advantage.”

While he doesn’t see many positive signs for consumer convenience startups, like food delivery apps, should things go south, Reichert said innovation and fundamentally useful technologies will likely continue to see growth in areas like manufacturing, agriculture, the financial sectors and data centers.

Ron Bouganim, a venture capital investor and founder of the Govtech Fund, has a slightly different view of the situation. His fund, which is not associated with Government Technology, provides startup capital to companies focused on public-sector innovation.

From his point of view, the activity in the space is not indicative of a 2000-style bubble, but rather a natural market repricing and rebalancing due to a wider set of global factors, like geopolitical conflicts and instability in the Chinese markets. 

He describes the back and forth of the market as “froth” rather than a bubble and said it pales in comparison to the “mania” surrounding the 2000 market crash. 

“What I would say in the last couple years, broadly in technology, is there has been a move to investing in technology and a lot more capital chasing technology investments, specifically private investments. That is a function of just a low interest rate environment frankly, where capital is just searching for some yield,” Bouganim said. “I think in the public markets, it would be fair to say that a lot of those people are nervous. As a result of that nervousness, I think you’re seeing price adjustments on the downside. You’re seeing bearish market sentiments and bearish trading activity certainly from the beginning of this year, but I think arguably through Q4 of last year … I think you’re seeing all of that putting downward pressure on the public markets.”

Bouganim said the froth is resulting in investors looking toward more mature, late-stage companies and avoiding the longer-shot, high-risk/high-reward investments.

“On the ground, the reaction and the impact from all this is more reasonable valuations at the higher end and late-stage companies, you will probably see less unicorns – billion-dollar-plus valuations – but some more reasonable valuation going on, more reasonable terms at the angel level …,” Bouganim said. “I don’t think that’s cratering. I think that’s just a natural repricing of marketplaces.”

The investor said a slowdown wouldn’t neither cripple innovative new technologies, nor derail areas like the software-as-a-service sector. In fact, from where he is sitting, “scrappy” companies willing to get their hands dirty and with a measurable value proposition shouldn’t have any trouble finding cash – even if the rest of the tech world is struggling.  

“Good entrepreneurs are going to find opportunities in marketplaces,” he said. “I would venture to say that if you asked a lot of VC investors in the software-as-a-service space, more broadly not just govtech, my sense and my hope for them is that if their companies are growing and doing well, that they should be able to more easily attract capital now because they look like solid businesses.”

At the Brookings Institution, Darrell West, vice president and director of Governance Studies, says there is rational concern surrounding the perception of another bubble in the technology marketplace. The flood of investment dollars looking for a return in the tech space does draw a parallel to the dot-com fiasco of yesteryear. 

“It’s a rational concern, we’ve seen it already once in recent memory and people need to remain vigilant about the possibility of it happening again,” he said. “You had huge increases in valuations of companies that had not established much of a revenue stream, you had a number of [initial public offerings] that came on to the market, so eventually it reached a point where the bubble burst and everything came crashing down.”

As for moving forward, West said the overall environment is well positioned to grow. Larger companies, like Apple, Microsoft and Oracle, will likely remain unaffected should all fears be realized. It’s the little guys, with a year into the mix and no returns to show for it, who will be in trouble.

“It’s hard to know when bubbles will actually burst. The technology sector is clearly very well positioned for long-term growth, so some of the valuations we see are pretty reasonable given the right prospects for the industry as a whole," he said. "I think the key thing to watch is just making sure companies that don’t have much of a revenue stream have valuations that are reasonable given their situation."

Eyragon Eidam Web Editor

Eyragon Eidam is the Web editor for Government Technology magazine, after previously serving as  assistant news editor and covering such topics as legislation, social media and public safety. He can be reached at eeidam@erepublic.com.