VC Bill Gurley: Is Silicon Valley's Current Path Sustainable?

Not every startup can be a unicorn - and at some point, private investors need to get their money out, which means taking companies public. This suggests, as the following article explains, that putative billion dollar enterprises need that assumption tested in the public markets, however uncertain that renders their private status.JL

Rolfe Winkler reports in the Wall Street Journal:

Silicon Valley and the venture-backed businesses have moved into a world that is both speculative and unsustainable.This year, despite all these unicorns, has been one of the worst for liquidity in the venture industry. There is no M&A because the unicorns have priced themselves out of the M&A market. So it’s all on paper. It’s all a myth.

Venture capitalist Bill Gurley of Benchmark is known as one of Silicon Valley’s top technology deal makers. In recent years, Benchmark has backed many of the biggest names in tech, including Dropbox, Instagram, Snapchat and, of course, ride-hailing startup Uber Technologies, the most valuable private company in the world, at $51 billion.
Mr. Gurley sat down with Wall Street Journal reporter Rolfe Winkler to discuss today’s sky-high valuations and the importance of going public. Here are edited excerpts.
MR. WINKLER: The last time we had you onstage, we spoke in September, a year ago. You made some news by sounding the alarm on excessive risk-taking in private tech investing. Since then, valuations have continued to rise. It seems like the party’s still going. Were you wrong? MR. GURLEY: It’s my belief that Silicon Valley and the venture-backed businesses have moved into a world that is both speculative and unsustainable. And if we continue down that path, I think there’s going to be even more damage that’s caused.
I’m glad we’re at The Wall Street Journal event, so we can talk finance, as opposed to just in Silicon Valley, where they like to talk about product all the time. Valuations represent discounted future expectations. They are not a reward for what you have accomplished in the past.
When entrepreneurs raise money at really high valuations, they should be saying, “Oh [no], now I’ve got a lot to go do,” as opposed to, “Hurrah, look what we’ve accomplished.” And Silicon Valley and the press I think have both gotten that wrong for the past two or three years.
MR. WINKLER: What stops it?
MR. GURLEY: Well, I think that’s starting to happen. There have been a number of rounds in the past six weeks where an entrepreneur has gone out at a price for X and ended up at 50% of X, or something like that. I think the buy side that has been funding a lot of these rounds has finally recognized that investing in highly illiquid, immature companies is a risky proposition and not one that’s easy.
People have been acting as if it is easy, and it isn’t.
MR. WINKLER: What changed?
MR. GURLEY: Well, a couple things changed. I think things got to a point of being silly in certain places. In China, in particular, you had companies burning $100 million a month with no revenue. These are levels that we’ve never seen before.
MR. WINKLER: Talk about public markets. It seems like there’s a recognition that eventually these companies have to go public. You have to get liquid.
MR. GURLEY: I think that’s one of the biggest problems that we’ve had. There has been a mythos of stay private longer that I think is probably the worst advice that’s ever been given in Silicon Valley.
The notion was that it’s hard being public, so why not just stay private as long as you can? I think it just allowed for more promotional behavior and less discipline and less recognition that eventually you’ve got to get to a place like a public market.
Remember when you were in college and you go out on Thursday night? There’s that really old person that’s in their seventh or eighth year of undergrad? To me, that’s what this is. And everyone’s like, “What’s he doing?” If you take hundreds of millions of dollars from people, if you hire hundreds or thousands of employees and give them options, if you’re on the board of a private company even, you have fiduciary duty. It’s Delaware law to look after the best interest of that stock price. That’s what everyone’s supposed to be doing. Instead, we got into this notion that maybe you don’t ever have to go public. And I think that in order for things to get corrected, we’ve got to go back to looking at the initial public offering as the objective, as reality.
MR. WINKLER: Why is going public so important?
MR. GURLEY: Because liquidity is the only real measure. All these private valuations are fake. They’re all on paper.
But look, there’s also this other notion. If something is private, you’re supposed to apply a liquidity discount. And if you look up the definition of how you should look at a liquidity discount, it’s like, “Well, what is the health of the company? And what is the likelihood that it’ll go public?”
If the cash flows are positive, the liquidity discount should be smaller. If the negative cash flows are big, the liquidity discount should be more. If it isn’t likely to go public soon, the liquidity discount would be even bigger. So the press should be looking at these uniform valuations and applying some form of liquidity discount. We do in our own firm when we talk to our limited partners. We’ll discount our companies 40%.
MR. WINKLER: But look at a mutual fund. Typically where they’re marking this is at the price they paid for the share.
MR. GURLEY: Oh, but that’s changed in the past six weeks. And I talked to someone at one of the large mutual funds. They have a separate valuation group because their mutual funds trade all of the time. And they’re changing. They’re marking these things down and being more realistic about where they should be.

A bright spot

MR. WINKLER: There are people who advise, “Stay private because if you don’t, the media and activist investors will say, ‘Focus on the next quarter.’ You’ll be forced to take a shorter-term view, and if you stay private, you can take the longer-term view.”
MR. GURLEY: First of all, we’re confusing control with discipline. And now that so many companies have gone public with a super voting situation, that argument is off the table.
The scrutiny thing is interesting to me. I think about it in this analogy. Imagine a college quarterback is about to go out for the NFL draft. He’s No. 1, and the day before the draft he calls a news conference and he says, “You know, I just don’t think I want to stand for the draft.” And they say, “Why not?” And he goes, “Well, the scrutiny on Sunday is going to be ridiculous. I mean, they’re going to watch every play. They’re going to measure every pass. They’re going to show slow-motion replays.” And if a quarterback did that, what would happen? They would fall in the draft so fast.
MR. WINKLER: Given current market conditions, what advice would you give to seed-stage investors and entrepreneurs just starting companies?
MR. GURLEY: I think the earliest stage is probably the most insulated from all of this. My main advice would be just don’t rush yourself up to 50 employees or anything like that. If you’re starting a company today, the odds that there isn’t some type of correction before you get out are really low. So focus on your product. Focus on your customer. Focus on being small and nimble, and you’ll probably ride through all this stuff.
MR. WINKLER: A year from now, where do you think the Nasdaq is? How many unicorns (private tech companies with valuations of more than $1 billion) are on that list? Now we’ve got 125 or so.
MR. GURLEY: This year, despite all these unicorns, has been one of the worst years for liquidity in the venture industry. There is no M&A because the unicorns have priced themselves out of the M&A market. So it’s all on paper. It’s all a myth. And until we do what I talked about before, which is recognize that until you get liquid, you really haven’t accomplished anything, it’s going to be a tough time.