Will Facebook's IPO Mark The Beginning Of The End? ~ MAKE MONEY BLOG$

Guest Post Written by Dave Whorton

Dave Whorton is the founder of Tugboat Ventures, a Silicon Valley venture-capital firm.

Dave Whorton: The bubble will burst.

Remember when Netscape went public in 1995, kicking off a torrent of investment in new Internet companies that lasted for five years? Well, now we’re waiting for another Netscape-caliber IPO

: the first public stock offering by Facebook, which is expected to come sometime next year. The deal will no doubt value the company at tens of billions of dollars, or more, and make many, many people into multi-millionaires, if not billionaires.

Except this IPO will spell the end of the party, not the beginning. I’m convinced that the frothiness we’re seeing right now in Silicon Valley cannot last. And it won’t last, I believe, past the point at which Facebook finally sells shares to the public.

Why? One would have to be blind, or have no friends in New York, London or Shanghai, to not realize that Silicon Valley is currently operating in a different reality. In Silicon Valley, office space is scarce, engineering graduates are commanding record salaries and homes are being purchased before the “For Sale” sign has even gone up. The number of startups formed in the last two years dwarfs the company formation pace of the late 1990s. And high-growth companies are receiving private financings at valuations – many over $1 billion – that could only have been achieved a decade ago by going public and beating Wall Street’s estimates over several years.,

But here’s the disconnect, which is obvious to everyone: We are in midst of the Great Recession, with 9% U.S. unemployment, European default risk, growth in China slowing and state governments on the brink of bankruptcy. Yet young technology companies with unproven management teams and business models are commanding nosebleed valuations. The most recent example is blogging startup Tumblr, which raised money valuing it, reportedly, at $800 million. This despite the fact that the company doesn’t have its business model figured out yet. Many of these investments are being justified by the anticipation of some highly lucrative, initial-public offerings for tech companies in the coming 12 months. If standouts like Facebook,Zynga, Groupon and Twitter are going to go public for tens of billions of dollars, the argument goes, surely lesser tech stars can command a premium in their financings as well.

Some would argue that this investment frenzy is not irrational. The explosion of smartphones, social media and location-based services could fundamentally transform not only Silicon Valley industries but many others. I couldn’t agree more with Netscape founder Marc Andreessen’s “software will eat the world” argument, having invested under that premise since I was an associate at Kleiner, Perkins Caufield & Byers in the late 1990s and helped KP back companies including Google, Autotrader, BlueNile, Drugstore.com and Good Technology. Those firms have transformed industries and created billions in value for investors along the way. But transforming industries takes time, and often the disrupter gets disrupted again by a new entrant – or the incumbent proves to be more deft at responding than it was in prior years. For every business that has become a long-term market leader like Amazon.com, there are a hundred companies of significant potential that simply don’t make it.

We are seeing glimpses of how hard it is to build long-term, market-leading ventures as the current “dream team” of consumer-Internet IPO candidates starts to stumble. Groupon’s IPO appears to be in real trouble, with the company slashing its reported revenue in half and grappling with the departure of its No. 2 executive. (This after Groupon was forced to drop from its regulatory filings a ridiculous, self-invented measure of profit called “adjusted consolidated segment operating income.” It conveniently excluded expenses like marketing and subscriber acquisition.) Twitter is trying to find a business model that matches the largeness of its most recent valuation. Similarly, Zynga’s revenue growth slowed over the summer, according to the company’s just-amended SEC filings, as R&D expenses in the first half of this year nearly tripled as the company invested in its next set of games to re-ignite revenue growth.

The only reason we haven’t seen a slowdown in startup funding already, or a downtick in the lofty valuations being ascribed to small tech companies, is because of the broader, global economic reality driving the Silicon Valley froth. In short, it’s the quest by global investors – big institutions and hedge funds in New York, London and Dubai – for above-average investment returns. Right now, most of these investors are desperate for such returns and will go anywhere to chase them. There’s tremendous excess liquidity in the market, but returns on bonds are middling and commercial real estate in the dumps. Ben Bernanke’s recent proclamation that the Fed will keep interest rates near zero for two years just reinforces the problem. So when those big investors hear about Twitter raising funding at a $8 billion valuation, file-sharing service Dropbox at $4 billion or Facebook potentially being worth $100 billion, they want in.

With all that cash sloshing around chasing growth, local Silicon Valley investors continue pumping money into unproven growth companies likeAirBnB and Tumblr, among others. There’s even a startup touting a new way to sell grilled-cheese sandwiches, called “The Melt”. And, because the valuations for growth companies are shooting up so quickly, everyone seems to be a seed investor today. Even traditional, prominent VC firms are getting into the act. A recent VentureWire story detailed how prominent venture capitalists are pouring $100,000 to $500,000 of cash into dozens and dozens of seed-stage deals with virtually no due diligence, and often with the signoff of only a single partner—all to keep up with all their new, angel-like competitors chasing the “mobile-social-local” Holy Trinity. The more of this low-commitment money that is invested with little research, the higher the risk for entrepreneurs that they will be left at the altar if their venture doesn’t gain significant traction in short order.

On the plus side, hard-working entrepreneurs in the Valley have, in aggregate, built dozens of good companies over the past decade that have enough revenue growth to feed at least some of the current investor demand. But the question, of course, is, at what price?

I predict that Facebook, a well-managed company that has become indispensible in the lives of hundreds of millions of users and found a powerful business model, will stage a very successful IPO. But many of its much-hyped brethren will not. And once that becomes clear, the funding frenzy we’ve seen in the Valley will slow down.

Will that deter high-potential companies on the order of Google and Amazon.com that are undoubtedly being built in garages today? Absolutely not. Innovation, and talented entrepreneurs, will move forward. But maybe a few grilled-cheese startups will not.

My advice: If you are the next Jeff Bezos or Steve Jobs, keep your feet firmly on the ground, your eye sharply focused on delighting your customers, and your energy on building a highly effective core team, including patient board members focused on the long term and fair, aligned investors. That’s the enduring Silicon Valley formula for success. And it always has been, through decades of market booms and busts.

source: forbes.com

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