Silicon Valley's Hottest Innovations 2016

"When Money looks easy, it brings out the worst entrepreneur"

Bill Gurley of Benchmark Capital on how excess capital continues to distort valuations in Silicon Valley

Published 4 years ago on Jan 03, 2017 7 minutes Read

Bill Gurley has been the voice of reason in the Silicon Valley for the past couple of years with his relentless warnings of a technology bubble and unsustainable businesses being built on excessive capital. As one of the top technology dealmakers in the Valley, Gurley has spent over a decade as a general partner at Benchmark Capital, the VC firm behind companies such as Snapchat, Twitter and Uber, which is the most highly valued private company at $62.5 billion. A regular on the Forbes Midas Touch list, Gurley spoke to Outlook Business at the sidelines of WSJ.D Live conference on how unprecedented low global interest rates and the steady trickle of money are ensuring that Silicon Valley is seeing a slowdown, rather than a crash last seen in 2000 and 2009. He, however, warns that when the interest rate cycle reverses, investors and start-ups will have to pay for being indiscriminate with capital.

 >> You haven’t been afraid to call out startups with uneconomic business models and have also been equally critical of investors funding them. While there is a slowdown, not many are too alarmed with the situation today. Why? 

Some of the startups have recapitalised because of the amount of money that is still coming in. Hence, you are not seeing a cataclysmic fall and only some companies are failing to be relevant. But you are seeing an increase in layoffs and some startups shutting down, but it isn’t spooking people as much as it should. Most of the venture returns are still on paper because of the low liquidity, given the lack of IPOs, and excessive valuations which are making companies too expensive to be acquired. The excess capital has allowed companies to stay private longer than usual and that is probably the worst thing that could have happened to them. Going public is not only the true measure of a company’s valuation, but also brings in the much-needed discipline. Unfortunately, a low interest rate over a long period has created asset bubbles across industries, including real estate and venture capital. 

Bill Gurley on 'How Excess Capital Continues to Distort Valuation'>> Are you seeing signs of sanity returning to the market and valuations turning more realistic?
There’s lesser money out there and, as a result, a lot of seed money is stranded. What happens when things go the other way, that is, when the late-stage investors start using the Series A and B investors as proxy for quality, it results in a shrinking downstream impact. Growth capital becomes more selective and that is a positive for investors like me. You know things are starting to get difficult in the US, in the Series As and Bs, as tough questions are now being asked. You had a peak in 2015 where no one was asking you what the growth margin was and the focus, instead, was on grabbing market share rather than profits. It was definitely not a sustainable affair. Investors are now slowly getting a bit smarter. You are beginning to see entrepreneurs take a knock on the asking price during fund raising. Investors have finally started realising the actual risks of being highly illiquid. One of things that is already happening is the realisation that unit economics matter and the need to delineate what’s unreasonable. But we still have a long way to go. 

>> So, who is to blame for the indiscipline in the way some of the businesses were built? The entrepreneurs or the investors? How difficult is it going to be to bring the attention back to unit economics? 
Both, nobody’s free from blame. The access to excess capital meant we saw some ridiculous burn rates and uneconomic business models getting funded. The continuous flow of money has ensured that companies not only stay private longer, but also meant they operate recklessly because they don’t have to play by the rules. It is going to be difficult for companies to get back on the path of profitability because they are not really prepared for it. But some of them would have no choice as funding dries up.

>> Valuation concerns aside, where would you invest in today’s markets?
Security is on fire. There’re so many problems globally and many companies which are working on it. In the security space, we have a startup called HackerOne that helps companies identify system vulnerabilities, and it is really doing well. Besides, there are so many things we can do with the smartphone. In future, we should be able to navigate through a hospital or hotel just by using our phone, without human intervention. Like when you walk into a hotel which you have booked, there is a pop-up which tells you where your room is and the phone opens the door. You don’t have to watch this person key in all your details. A similar experience is possible in hospitals where you can avoid lengthy registration process. There is still so much to do. 

>> The talk around artificial intelligence (AI) is relentless. Everyone, be it the start-ups or investors, seem to be gung-ho about the possibilities around AI. Are you buying into that story? 
I worry about any venture category where everyone gets excited before it happens. I tend to be less enthusiastic. We’re seeing situations where people are using applied data science to win. For instance, I’m on the board of a company called Stitch Fix, which is attacking the women’s fashion market and knows everything about each of its customers, and uses that to make better recommendations. It’s not clear to me that the tools are going to be easily saleable because Amazon and Google have already declared that they’re going to be in that business. So, if the tools aren’t saleable, the only way to make money, from my point of view, is when its applied.

>> How are you vetting investments right now? Are you still getting pitches by the dozen or is there a slowdown? 
We’ve calmed down now. Last year was worse because when money looks super easy it brings out the worst entrepreneur and your deal flow goes out of the way. So, your quality drops. When things get harder, it improves the quality as bad entrepreneurs are weeded out. The best entrepreneurs can raise money in any environment. So when capital is scarce, it works to their advantage and, hence, they are unaffected. In fact, when there is excess capital, it puts the best entrepreneurs at a disadvantage because there is reckless behaviour all around – it allows weaker players to compete indiscriminately. As a result, it brings down the overall returns for everyone.

Bill Gurley on Sillicon Valley in 2017>> Which is the one sector that you won’t touch right now? 
The over-choreographed sectors are always scary. I would say fintech. In a world where there’s so much money available, it is really scary when you start shifting money around. You have no idea what’s real and that’s [fintech] a super scary segment with tonnes of money going around. 

 >> So how is 2017 going to look like for Silicon Valley? 
If you were to tell me that there were a bunch of initial public offerings and things are looking a little better, I’d believe that. Even if you told me that everything is shutting down, I know that’s possible. They are usually resets like the one we had seen in 2001 and 2009. Seven years in, a lot of really stupid things are happening because there is money flowing in. I’ve never seen a world with infinite low interest rates and then there’s all this foreign money. There is high net worth money in China that is afraid of both a slowdown in the local economy and the fact that the government might one day take away their money. They want to move it offshore. Then there’s money in the Middle East and Russia that is fearful of oil running out one day. Though they want to buy income-producing assets, they’re indiscriminately spending as the money just wants to get out. Its scary and crazy. When that starts to correct, things will begin to get really tough.


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