VC Firms Drive Bubble 2.0

By Davis Freeberg

There is little doubt that the late 90’s was a pretty spectacular time for the tech markets. Fueled by the introduction of the internet we saw valuations surge and innovation flourish. Some companies saw widespread adoption of their products while others learned some pretty harsh realities about trying to run a business with negative cash flow. After we hit the bottom of the market in 2002, we saw an impressive run up in 03′, but over the last two years the markets have been tame to say the least. There are a lot of people who think that the markets will continue this way for sometime. Forbes published some thoughts on how they see the markets developing for 2006 earlier this morning. They seem to feel that the markets will stagnate for at least a little while longer.

We continue to stand by this “trading range” scenario, even if the narrowness of the range is far smaller than we had envisioned. It’s just too soon after the last roaring bull market for another to start now. Given the fact that after the huge bull markets of the 1920s and the 1960s, the market stagnated for 25 years and 16 years, respectively, we would not expect to see another super-bull market in stocks until sometime in the next decade. This should mean that trading rather than “buy-and-hold” will be the better strategy.

While I would probably agree with Forbes that the general public is still in no mood to assume massive amounts of risk, beneath the surface, Bubble 2.0 may finally be starting to materialize. Over the last year we’ve seen some pretty impressive technologies be born or acquired. Companies like Delicious, Flickr, & Upcoming.org have all flourished with the backing of venture capital dollars and have managed to sell themselves at a pretty penny. It could be the success of these types of investments that is driving today’s VC investments or it could be the explosion of hedge funds, who are given more flexibility in the investments that they make, but there is clearly a great deal of interest in private companies right now.

Yesterday, Pure Networks received a second round of VC funding for $12.5 million dollars. Pure Networks makes a product called Network Magic that simplifies the process of setting up a home network. When I look at this company it’s hard for me to get very excited about their prospects. Sure CNET gave them a next big thing award at CES 2005 and PC Magazine has written positively about their software, but lets be realistic for a second. The company doesn’t sell routers or hubs, it sells software that allows you to network computers together. Where is the value? If I remember correctly I never had to buy any additional software to get my PC hooked up to my Xbox, just a router from Cisco. With TiVo unveiling their Series 3 and Microsoft coming out with Media Center Vista at the end of this year, it’s hard from me to believe that this company will have compelling software to sell by the end of 2006.

Of course Pure Networks isn’t the only one to receive funding this week. We also saw Play First, the maker of the popular game diner dash raise another $5 million in funding, Small Bones Innovations Inc. received a staggering $42.2 million in series B financing, and Guild.com received $7 million to accelerate the sales of Art and Jewelry over the internet. Riya also recently received $15 million.

Now I’m not saying that I think all of these investments will necessarily fail. In fact some of these companies have had some success and it will be interesting to see what they do with the capital, but it seems that while the public might not be driving up the market right now, there is certainly a lot of private equity deals that are taking place. It remains to be seen if we will see Bubble 2.0 pop, but VC & Hedge funds certainly represent a different type of investor then the baby boomers that drove the last bubble. They typically do more due diligence and have a greater appetite for risk, but when things turn ugly, it’s anyone’s guess on how they’ll respond.

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One Comment

  1. Jeff Clavier says:

    Even if there are a few deals that seem large or overpriced, I don’t see a bubble at this point – merely quite a bit of froth.
    Until the door to the public market or large scale M&A; opens in a significant way, VCs know that only a few companies will be able to generate the kinds of returns that are required to make a firm successful.
    Investment metrics show a sustained activity with valuations and terms improving favorably for entrepreneurs – but still within reason.