Bubbling in the cauldron: Is Twitter a sign?

“Double, double toil and trouble; Fire burn, and cauldron bubble,” chanted the witches of Shakespeare’s Macbeth, cooking up trouble. Similarly, are the VCs of Silicon Valley cooking up trouble by helping to fuel a new bubble?

Valuations for venture backed companies are certainly higher than they’ve been in a long time but are we in a bubble?

The answer seems to be no. At least, not yet.

I spoke with veteran VC Bill Davidow: “When I look at companies such as Facebook, Zynga etc, I see high valuations but at least these companies have business models with proven revenues. Whether they can keep up their growth rate is another question. But these are not the same type of companies that we had in the dotcom boom where investments were made in companies that had no revenues. It feels very different to 2000.”

Over on VentureBeat, Riley McDermind spoke with Phil Black, co-founder of True Ventures VC firm: “We need to worry about a bubble when there are businesses being valued at sky high prices with no underlying fundamentals,” he said. “Currently, any type of sky-high, bubble valuation dynamic is the exception and not the rule in the venture market.”

At Y Combinator Paul Graham, a veteran investor in early-stage companies, says there is no bubble: “What’s happening now is a lot more localised. A few professional investors are paying higher valuations for startups than they were a few years ago. But the number of participants and the amounts of money moving around are both very small compared to the 90s.” … In the 90s, it was the dumb leading the dumb…

I went to see PayPal alumni Peter Theil and Max Levchin speak recently. Both are very active investors and both agreed that were was no bubble in tech. Peter Thiel: “There is no bubble in tech. This is not like 1999. But valuations are all over the map.”

Olivia Oran on TheStreet.com yesterday wrote an article headlined: “Tech Market: Frothy, but no Bubble.”
“Whether or not you believe it’s excessive to price Facebook at $65 billion or Groupon at $6 billion, there are trends and revenues to price those valuations,” said Jeff Clavier, a prominent Silicon Valley angel investor and managing partner at SoftTech VC.
However, Therese Poletti, over at MarketWatch did find Kathy Smith, principal at Renaissance, in an article on 2011 Tech IPOs: “It’s not a bubble,” Smith said of tech IPOs. “Where the bubble is happening is in Silicon Valley in pre-IPO valuations.”

I agree that there is no bubble. At least not yet. But our understanding of a bubble is very extreme. In Silicon Valley, a bubble is only a bubble when large numbers of investors are funding companies with little or no revenues. That’s clearly not the case. High valuations set high expectations and the investment risk is far higher than a year or two ago. And there is lots of money around looking for high returns. The valuations in the top tier of pre-IPO companies show no signs of slowing and that could hurt the return of a strong tech IPO market.

Silicon Valley needs good exits to pump money back into the system and nurture the next generation of startups. With high valuations, the IPOs of companies such as Facebook, Zynga, Twitter, etc, could fall flat because all of the upside has been locked in by earlier investors. That could hurt the prospects for other tech IPOs. While the top-tier venture backed companies such as Facebook, Groupon, Zynga, etc all have very strong revenues, most in the billions of dollars, there is one standout that has relatively tiny revenues (US$45-million estimate for 2010) and a sky high US$4.2-billion valuation, that’s 100 times revenue.

Will Twitter become the poster child of the next bubble? The Wall Street Journal thinks so, calling it a “tech bubble barometer.” (Via Andy Beal.)