A History of Silicon Valley

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These are excerpts from and updates to Piero Scaruffi's book
"A History of Silicon Valley"

(Copyright © 2018 Piero Scaruffi)

The Selfies (2011-18)

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The Investment Bubble of 2013

A staggering 88 of the 100 largest venture capital rounds of all times took place between 2007 and 2014. A huge amount of money was flowing towards Silicon Valley, largely attracted by stellar evaluation for high-tech startups. In 2014 Airbnb set a new record raising $500 million, while the even younger Lyft  raised $200 million. On the East Coast, a seven-year old Dropbox raised $250 million. Silicon Valley, in fact, had not started this trend: in Texas at the end of 2008, in the middle of the worst economic recession since the Great Depression, the small HomeAway had raised $250 million. The traditional venture capital firm was increasingly joined by the hedge funds, the mutual funds and private equity firms. This phenomenon was allowing startups longer incubation periods, but it was also viewed by many as an alarm bell that a new bubble was about to burst.

This was the era of the "unicorns," or billion-dollar start-ups: Square, Stripe, Airbnb, Pinterest, Uber, Dropbox, Snapchat, Palantir, GoPro, Slack, Cloudera, Eventbrite, electronic notebook Evernote (founded by Stepan Pachikov in 2008 in Sunnyvale), Stemcentrx (a biotech company founded in 2008 in South San Francisco by Stanford scientist Scott Dylla and investment banker Brian Slingerland to treat cancer under the assumption that cancer is caused by a small population of stem cells) enterprise social media platform Sprinklr (founded in 2009 in New York by Ragy Thomas), discount shopping site Jet, founded by Marc Lore, who had sold his e-commerce company Quidsi to Amazon in 2010; etc. Most of these startups generated no cash flow, i.e. were losing money. The term "unicorn" had been created by Aileen Lee of Cowboy Ventures, who in November 2013 wrote a TechCrunch article titled "Welcome To The Unicorn Club: Learning From Billion-Dollar Startups". In 2015 WhatsApp hit the one-billion user mark, but it still didn't know how to make money out of them. At the beginning of 2016 Magic Leap was valued at $4.5 billions without even having demonstrated its product. By 2015 there were 144 unicorns with a total value of $505 billion. Utah, the state with the fastest economic growth in 2014-15, had 4 unicorns (Domo. Pluralsight, Qualtrics and InsideSales).

The unicorns were also emblematic of the decline of the Initial Public Offering (IPO). Apple had gone public in 1980 with a market valuation of $1.8 billion, Microsoft was worth less than a billion dollars at its 1986 IPO, Netscape had gone public in 1995 when it was worth $2 billion, but Twitter waited until it was worth about $25 billion and Facebook until it was worth more than $100 billion. And now many of the unicorns showed no intention of going public. Part of the reason was bureaucratic. The government had reacted to the Enron scandal, revealed in October 2001, with the Sarbanes-Oxley legislation, but that legislation, meant to protect investors and consumers, ended up being a gigantic tax on small businesses because it requires fleets of lawyers and accountants. To protect smaller investors from discrimination, the government had enacted the Regulation Fair Disclosure legislation of 2000. This mandated that all publicly traded companies should disclose information to all investors at the same time. Ironically, this made it difficult for small companies to counter hostile rumors that could devastate their stock values. Generally speaking, the regulatory system began to favor big corporations and discouraged startups from going public. Venture firms such as Marc Andreessen's explicitly stated that their goal was not to take companies public.

Until 2012 the government forced companies to go public when they reached 500 shareholders. In 2011 if a company had 500 employees and each one had been paid some shares in the company, that company was required to file for an IPO. In 2012 the government passed the JOBS Act that raised the number of maximum shareholders for a startup to 2,000. This number made a big difference in the age of the slim IT company (in 2015 a $16 billion colossus like Facebook had only 12,000 employees) because most unicorns had only 100 or 200 employees and 10 or 20 external investors.

Ironically, the JOBS Act of 2012 (which actually stands for "Jumpstart Our Business Startups" act) had been enacted to facilitate IPOs for high-tech startups. Since then, instead, Silicon Valley startups were more reluctant to go public, particularly the startups in I.T. (not so much the higher-risk biotech startups). The JOBS Act indirectly encouraged massive fund-raising in private markets for I.T. firms (the cases of Airbnb, Lyft, Uber, Dropbox, etc). Capital was readily available during the 2010s (for a number of geopolitical reasons and domestic reasons) and somehow investors were willing to invest in highly-valued startups that were losing money every single month. Investors were willing to take the risk for a longer period of time, hoping that during that time the valuation of the startup would keep going up. This had a detrimental effect on the Silicon Valley ecosystem. When a money-losing startup is kept artificially alive for so long, it ends up killing the startups that are making money in the same field, the contrary of what the free market should achieve: disruption without profit. This was, after all, the business model pursued by Amazon to destroy the booksellers of the world: keep expanding despite no profit until you have killed all the incumbent retailers, even though they are making money and you are losing money; i.e. take advantage of the fact that the incumbents are under pressure to generate profits to satisfy their stockholders. The multiplication of accelerators and incubators was itself a consequence of the nonchalance with which a startup could lose money for a long time. This new modus operandi lowered the entry barriers for a start-up. Additionally, software-based startups benefited from the decline in the cost of computation (especially after the advent of cloud-computing, which was basically a new form of "time-sharing") and from the rise of open-source software. The hardware was no longer a "capital investment". It had become something that a startup could rent on demand. The low-cost infrastructure of the 2010s meant that the real cost of a startup was the salaries of the staff. And some of the trendiest startups of the era didn't pay much in salaries: Uber and Lyft relied on armies of low-paid drivers, while their technology simply combined some mapping software, some simple pricing and dispatching algorithms, and a smartphone app.

Investors displayed unlimited appetite for money-losing high-tech start-ups until, in May 2019, Uber (the one with the biggest losses) went public. The Uber IPO was as much anticipated as disappointing. It was expected to be the biggest IPO in US history. Instead, it was one of the biggest flops. Before Uber's IPO, high-tech companies since 1985 on average had risen 41% on their first day of trading. Instead Uber's stock lost 7.6%. Its valuation crashed from $120 billion (the valuation floated by investment bankers six months earlier) to $76.5 billion (after the first day of trading). Of course, there were other famous cases of high-tech startups that disappointed. Zynga and Groupon were the most famous cases of startups whose stocks crashed in the first year after the IPO; but that was 2011, at the nadir of the "Great Recession".

A staggering $66 billion was invested in unicorn startups during 2017. The startup world had boomed so much that some of the new unicorns were actually startups that provided services to other startups. For example: Brex, founded in 2017 by two Stanford dropouts from Brazil, Henrique Dubugras and Pedro Franceschi, to issue credit cards to startups; InterPrime, founded in 2018 in Menlo Park by Kanishka Maheshwari and Anish Kumar to help start-ups manage their unused cash; and Carta, founded in 2012 in Palo Alto by Manu Kumar, to digitize stock options given by startups to their employees.

In parallel to the phenomenon of unicorns, Silicon Valley experienced the rise of megafunds. For example, during 2018 Sequoia Capital raised a $12 billion global growth fund and set a minimum investment of $250 million to join such fund. At the same time, Japan's Softbank raised the $100 billion Vision Fund, largely invested in Silicon Valley. Besides its widely advertised investments in Nvidia, Uber, ARM, Slack and GM Cruise, Softbank invested huge amounts in: Menlo Park-based building construction startup Katerra, Menlo Park-based online marketplace Globality, Mountain View-based driverless delivery service Nuro, Mountain View-based Zume, a start-up that uses robots to make pizza, San Francisco-based food-delivery startup DoorDash, Palo Alto-based smartphone-camera startup Light, as well as (outside the Bay Area) New York-based real-estate startup WeWork, Los Angeles-based dog-walking service Wag, Flipkart and One97 in India and Didi Chuxing in China. Consider that, according to the National Venture Capital Association, in 2017 the entire venture capital industry of the USA invested about $80 billion. Softbank's boss Masayoshi Son, now based out of his Woodside mansion, was de facto the most powerful man in Silicon Valley. Clearly, these firms could no longer invest in early-stage firms, firms that required small investments. This new dynamics created tension within the venture capital world. At the end of 2018 the glorious firm Kleiner Perkins Caufield & Byers broke up into two separate entities, and at the beginning of 2019 Menlo Ventures launched the $500 Inflection Fund to focus on smaller deals. At the same time, the megafunds created opportunities for several micro-funds specializing in early-stage investments.

click here for the other sections of the chapter "The Selfies (2011-16)"
(Copyright © 2016 Piero Scaruffi)

Table of Contents | Timeline of Silicon Valley | A photographic tour | History pages | Editor | Correspondence