IMM (In Mike's Mind)
There is a storm coming!

I spent the last few days in Switzerland, visiting family and friends as well as networking with old colleagues from work. I am leaving Switzerland with a very distinct feeling in the pitt of my stomach. There is a storm coming! We are very close to a significant economic shift that will particularly affect the funding climate of small technology based startups. Time predictions are always hard. I can not tell you if it will take another 2 months or another 18, but the writing on the wall is fairly visible by now. The possibility of a drastic reduction of the funding market is now very real. 

My prediction is based on two pillars. The macro-economic circumstances in the economic and financial world of Europe and the U.S. as well as the over-saturation of startups in the  technology sector.


Micro-economic

On the micro-economic level I am particularly concerned about the over-saturation of startups, the overlap of ideas and therefore the hyper competition in too many niche markets. In countless discussions with professionals in the tech and finance world in Switzerland two things became crystal clear.

  • Everybody who read halfway through Eric Ries “The lean startup” or 37 Signals “Rework”, thinks they can start a company.
  • They actually find investors for it.
I am used to high funding rates from the Valley, but I did not expect this amount of risk taking from the fairly conservative Swiss. After closer evaluation it turns out that many run often with identical ideas, concepts, market analysis even site designs of existing companies. I can not tell you how many Groupon competitors exist and not one of them being cash flow profitable (using standardized accounting practices). Each and everyone justifying their valuation by the IPO/acquisition price of other competitors. Meanwhile nobody seems to realize that they all compete for the same market, are feeding each others growth by swapping users and bidding up their nearly insane valuations. Let’s get this straight. Consumer facing internet startups are a hit driven business. For every one that wins, 99 companies die. It is just not realistic to believe that every single startup set out to produce daily deals will either be acquired or a sustainable long term business. But that is exactly how the Swiss entrepreneurs feel. And let’s put this further into perspective. Switzerland is financially and politically one of the most conservative nations in Europe. Women could’t work or open a bank account without the explicit permission of their husbands until 1985. In some parts they could not even vote until 1990. Now if the Swiss are startup crazy, I can guarantee you that our larger neighbors Germany, France, Italy or the Brits far up North are too. Summarized you now have perceived market valuations of small companies that exceed by far real values not just in the Valley or the US but all over  Europe as well. 


Macro-economic

On the macro-economic level my prediction is fairly pessimistic. Greece will default, will exit the Euro, so will 1 or 2 other countries. The Euro in its current shape will no longer exist after 2015. Greece as well as all other exiting countries will get their own currency back, will likely face a period of hyper-inflation, great uncertainty and lower spending by consumers and dramatically reduced investments by companies. This will have a ripple effect through the financial world on to Europe and the US. I also predict that the US will face rising inflation and interest rates with similar effects, particularly a negative effect on the nationwide still very vulnerable housing market. 3 factors here will have a negative impact on the funding environment of startups.

  • Low consumer spending and business investments will have a ripple effect through all industry branches. Ad prices in all shapes and forms from PPC, PPL to PPA will drop. Large companies as well as startups that depend on add revenue will see a revenue drop and accordingly adjust their forecasts.
  • High inflation rates increase cost and reduce the runway of startups
  • With high inflation will come with high interest rates which will further increase the opportunity costs for large pension funds and institutional investors. Why invest into a venture fund when you can make equivalent returns at the bond market at significantly lower risks.
     

Conclusion

Market corrections are natural and occur cyclical. This one is no exception. For Silicon Valley in particular the effects will be significantly smaller than the burst of the dot-com bubble. I do consider a consolidation of the funding market in Silicon Vally for tech startups by 30 - 40% as healthy and realistic.

  1. michaelkk posted this