A month ago, a Finnish newspaper interviewed me and asked are we living a bubble due to the high valuations of startups. Back then, I said no. Today, I'm not so sure anymore. My statement in that interview still stands true though on one part - there's no bubble in Northern Europe for sure, but I can't fully agree with regards to the US anymore. First, let me define a bubble in this case by stating it's an economic cycle where companies' valuations are highly inflated compared to a situation when calculated by business potential and metrics at large.
The reason that got me thinking about all this was the recent round a company creating a photograph application got. A company called Color (app by the same name) announced today that they received $41 million for their photo sharing app from Sequoia Capital, Bain Capital, and Silicon Valley Bank. No small names either.
I may be completely wrong here, but when equipped with so much rocket fuel - you run into a danger of blowing up. A $41 million valuation would have already been relatively high for such an app, that just launched its product along with the announcement, but most likely the valuation is somewhere well north of $100 million.
How did the launch of Color go then? Scoble doesn't like it at all. Listen to him rant about it. He gets very passionate about it, but then again - he raises some very valid points in doing so. I tried it out and had the exact same experience. Didn't impress me all that much. An app that raises $41 million - should impress you a lot.
Om Malik, one of the writers I really look up to in the tech industry, wasn't really impressed by the Color app either. He posted a tweet where he states that Color getting more money than Google isn't necessarily good. The reason Google became GOOG (ie. went public), was because they had to work their way into making money. Furthermore, he praises Instagram over Color in another tweet.
I'm not saying Color doesn't have potential - all I'm saying is that when you give a company $41 million in its first round they won't be as hungry to search for profitability or sustainable growth compared to a company which has to break it or make it with a few million dollars only.
As you can probably see, I'm not a huge fan of companies simply growing huge user bases and trying to monetise on that later. Facebook has shown its capability in monetising its platform with their ads. However, Twitter for example, hasn't shown a lot of willingness to on this front. Venture capital isn't a business model.
I then ran into this other article about Flipboard raising another round at a $200 million valuation in All Things Digital. The app is useful and has received a lot of positive reviews. But the problem to me here is, is that it's free. If you would have charged for the app and received the same traction - that would have been awesome. Just look at Rovio and Angry Birds.
Finally, another sign that there's a clear bubble emerging (if it's not there already) is the fact that WSJ has quoted a source saying the following about the latest Y-Combinator startups:
One investor who has spoken to companies in this Y Combinator group and who didn’t want to be identified said he estimates that the pre-money valuations on this batch will average $10 million. That would have been a startling figure just last year but now seems not too surprising to many involved in these deals.
$10 million in pre-money valuations? This is almost as scary as Finland taking in 32,5 billion euros in national debt during the next four years if it doesn't change course. But seriously speaking - these companies have very little traction at this moment in general and just valuing them based on their acceptance into Y-Combinator is scary. Paul Graham and his team are doing a fantastic job with Y-Combinator (and I personally think it's one of the best startup programs out there), but valuing companies solely on these factors does not make business sense.
There is something good in all this for Northern European startups as well. Now would be a good time to get acquired by a competitor or a larger company in the US. The valuations are clearly higher compared to a few years back, and not that much has changed to be honest.
Image by Joey Lim.