I’ve just found time to read Bill Gurley’s On The Road To Recap. I won’t add to the volume of good posts saying that he’s right to point out that the unicorn financing market is entering a dangerous period where all manner of pressures and biases will cause people to behave badly and mistakenly put off adjusting to the new reality in late stage funding.
Instead I’m going to highlight his warning about what happens when markets get over-funded:
Loose capital allows the less qualified to participate in each market. This less qualified player brings more reckless execution which drags even the best entrepreneur onto an especially sloppy playing field. This threatens returns for all involved.
In 2014-2015 the unicorn market was over-funded, sparking intense competition, high burn rates, and as we are starting to see now, ultimately damaging returns.
This is a movie we’ve seen many times before, although it is usually an industry sector that gets over-funded rather than a stage of investing.
I first noticed it in late 2000 when the fund I was working for was invested in one of six high profile and highly funded enterprise portal businesses. It seems crazy now to think that software for enterprises to build intranets (remember them) was such a big deal, but we all piled into these companies giving acquirers multiple options to acquire similar businesses and driving M&A valuations down for everyone. I think one of the companies made it to IPO but even they struggled when IBM and other large tech players bought their competitors.
Other examples include mobile games, DVD rentals, and cloud storage. It’s likely to happen in bots and AR/VR next.
The most commonly repeated pattern is for VCs to over-invest in sectors that are obviously going to be big. It’s most egregious when there’s a long period of elapsed time between when it’s obvious a market will be big and the market actually takes off. Most everything that moved from the internet to mobile looked like this, and was hard to make money from as a result.
The lesson here is to not invest in the obvious stuff, either by investing before it’s obvious (but remember that being too early is as bad as being too late) or by giving it a miss altogether. Instead it’s better to look for less popular areas that you understand well, that are growing, and where the fundamentals are strong. That takes the courage to be different and the confidence to hold your nerve, but if you’re short in these areas maybe investing isn’t the best career for you anyway.