Bubble or bust? Only the unicorns know

Worried about high valuations and the explosion in late-stage VC funding? Don't be: We're actually in the middle of a tech bust

Bubble or bust? Only the unicorns know
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Forgot all that talk about tech bubbles inflated by overvalued unicorns. What if instead of a tech bubble, we're actually in the middle of a tech bust?

This week noted venture capitalists Sam Altman and Marc Andreessen argued exactly that.

Andreesen, co-founder of investment firm Andreessen Horowitz, has long been bullish on the tech sector and dismissive of concerns about bubbles. "I don't think we're in a bubble. I think we're in a bust," he said this week at the Fortune Global Forum in San Francisco. "Tech has been undervalued ever since 2000 and is still undervalued."

In particular, Andreessen believes that tech unicorns are undervalued. "You need a couple to take off, and it will become really clear in retrospect, clear the basket [of unicorns] is undervalued."

Contradicting that bullishness, investment firm Battery Ventures this week released an analysis of valuations for U.S.-based technology companies that have gone public since 2011 compared to the valuations of their last pre-IPO financing rounds. Battery found that "stock performance for investors in late-stage rounds completed since 2010 has decreased every year, likely because valuations for private financing rounds have gone up in this period."

There were some big winners, notably Fitbit, GrubHub, and Zendesk, but roughly 40 percent of unicorn IPOs are now flat or trading below their private market valuations. "While there have been some massive companies built and grown in the public markets since 2011, investors need to be cautious of the growing disconnect between public and private market valuations," Battery cautioned.

But are high pre-IPO valuations proof of another bubble?

Altman, president of the startup accelerator Y Combinator, notes that 2015 has had the lowest level of tech IPOs in seven years, as a percentage of all IPOs. What's more, the S&P price-to-earnings ratio for valuing tech companies was lower than the overall S&P P/E. "Neither of these facts seems suggestive of a tech bubble," Altman said.

In fact, Altman is so tired of bubble talk that earlier this year he put up a $100,000 "no bubble" bet, predicting that the five most valuable unicorns will be worth more than $200 billion by 2020.

If pre-IPO valuations seem too high -- particularly in late-stage funding rounds that investors like Bill Gurley have been so critical of -- it's because they aren't valuations at all, Altman argues. "Perhaps the answer is that these [late-stage] 'investments' aren't really equity -- they're much more like debt."

When investors structure funding deals so that they get 2x liquidation preference with a 3x liquid cap, they are buying debt but dressing it up as venture capital, he says. "There is a massive disconnect in late-stage preferred stock, because if you're using it to synthesize debt, it doesn't matter what the price is."

(BusinessInsider has an excellent primer on these kinds of funding deals structured with preferred stock -- and how startup employees with common stock will get screwed.)

It's inevitable that some of those loans-dressed-as-investment deals will wind up being bad debt -- and some unicorns will fail. But "that doesn't make it a tech bubble," Altman says. "It'd be more accurate to say it's a tech bubble if no unicorns die in the next couple of years."