Private tech companies valued over $1 billion were once nicknamed unicorns for their rarity and mythical status. They were seen as potentially being the next Facebook Inc (FB) or Google Inc (GOOG). But as of June 2015, there are now 111 privately-held tech companies valued over $1 billion. And they can’t all be the next Google. Are tech startups once again drastically overvalued?
A Herd of Unicorns Gathers
According to CB Insights, a venture capital database, the total valuation of these 111 tech unicorns is over $404 billion. Among the most highly valued are companies aiming to disrupt entire industries. Uber, the on-demand car service company, took on the taxi industry and is now valued at $50 billion as of May 2015. Vacation and short-term real estate rental company Airbnb took on the entire hotel industry and was valued at $20 billion as of February 2015. (Read more in Winners And Losers In The Sharing Economy)
Tech companies are also reaching billion-dollar valuations at an astonishing speed. Slack, a team communication tool launched in August 2013, inked a deal with investors in March 2015 that values the company at $2.7 billion. Not bad for a company less than two years old.
Fears Over a Second Tech Bubble
The skyrocketing valuations have led some analysts to question if we are in the middle of a tech bubble like the one that burst in 2000. Since companies like Uber remain private, it's impossible to know with any degree of certainty whether their massive valuations are justified.
Critics fear that revenue isn't growing fast enough to keep up with the rate at which the companies burn through cash. Defenders of the valuations argue that the companies have real revenues and proven business models. (See also Market Crashes: The Dotcom Crash)
Low Interest Rates Fueling Startup Investment
Thanks in part to historically low interest rates, tech companies have managed to raise large sums from a variety of investors including hedge funds and mutual funds looking for higher returns. The investing climate is likely to change soon though, when central banks begin to raise interest rates. Some analysts expect the Fed to push for higher rates as early as the end of 2015. When higher interest rates take effect, money will flow less freely and investing in risky tech startups will become less attractive.
It's not just the privately held tech companies that have seen their valuations soar. In 2015, the tech-heavy NASDAQ index breached 5,000 for the first time in 15 years. Among the important differences to note between the NASDAQ values of 2000 and the NASDAQ of 2015 are dramatically lower price-to-earnings ratios and also a lower percentage of components in the technology sector. This means more diversity in the index and lower risk.
A number of distinguished voices have raised concerns over current market valuations. In May 2015, at a meeting with International Monetary Fund Director Christine Lagarde, Federal Reserve Chair Janet Yellen stated that equity market valuations are quite high and potential dangers exist.
Mary Meeker of venture capital firm Kleiner Perkins Caufield Byers warned in her 2015 annual Internet trends report that Internet and mobile user growth is slowing, which could have an adverse effect on a wide range of tech startups.
In March 2015, entrepreneur Mark Cuban wrote a blog post titled, "Why This Tech Bubble Is Worse Than the Tech Bubble of 2000." Cuban, who sold Broadcast.com in 1999 for more than $5 billion, argued that the current overvaluation is mostly in private companies. He stressed that angel investors have no means to liquidate their investments when things turn sour, stating; "The only thing worse than a market with collapsing valuations is a market with no valuations and no liquidity."
Bill Gurley, a general partner at venture capital firm Benchmark, responsible for the early stage funding of startups including Twitter and Uber, sees trouble in the near future. Speaking at a South by Southwest keynote in March of 2015, Gurley said, "I do think you'll see some dead unicorns this year."
The Bottom Line
Looking at today's publicly traded tech stocks, there is clearly not the level of overvaluation that existed in 2000. In contrast, the enormous run up of investment in privately held tech companies is unprecedented. Due to the lack of transparency inherent in privately-held companies, it is hard to judge whether these companies are overvalued. However, we do know that the Federal Reserve has signaled their readiness to raise interest rates and that this will change the economic landscape and make it much harder for startups to access easy capital. This in turn will likely reveal which companies were reasonably valued and which were built on a house of cards.