Why We Are (and Are Not) in a Startup Bubble

I’m old enough to remember the first internet bubble and lately I’ve been having a feeling of déjà vu. While most entrepreneurs and investors seem more disciplined this time around, there are some worrying signs. They include:

Billion Dollar Exits. The sale of Instagram to Facebook for a billion dollars when it had no revenue is being cited as a sign that we are again in a bubble. Others say it that Facebook paid only 1% of its market cap to take out a growing competitor. Either way, the deal has changed the expectation of what a great exit looks like.

Pet Hotels, Car Washes and Grilled Cheese. What do these things have in common? If you said that they are all the basis of a recent startup you’d be right. It’s concerning when even crazy ideas get funded. Digiscents—technology that attempted to make the internet odoriferous—was a good example of this last time.

Celebrity. Movies, TV shows and web sites today are obsessed with entrepreneurs. Gossipy “business” web sites build up entrepreneurs and their companies only to tear them down. It makes dot com-era publications like the Silicon Alley Reporter seem quaint by comparison.

Also, once again, the Hollywood elite are investing in startups. And then there are the regular VC’s that are trying to become celebrities themselves. Last year, First Round Capital and Foundry Group self produced music videos that may someday serve as examples of the silliness of this era.

Huge Early Stage Rounds. Remember when Color, the photo sharing web site, raised $41 million dollars last year and then released a product that flopped? Or when AdKeeper raised $42 million so that people could save ads for later? These large, early stage rounds create sky-high valuations that make it difficult for anyone to make money. Last week Peer39 was sold for half as much money as it raised.

Journalist Entrepreneurs. When the most skeptical of our citizens—journalists—catch the startup bug it’s time to worry. Some former Tech Crunch writers have recently been given venture capital to try their hand at being entrepreneurs, including Paul Carr who wrote about his entrepreneurial failures during the last boom in his book “Bringing Nothing to the Party.”

On the other hand, compared to fifteen years ago, the startup world has changed for the better. Here are some reasons to believe we may avoid another crash:

Technology is Real. In the dot com days many of the businesses failed because technology and consumer behavior wasn’t in place yet to support them. Back then, people got online via dialup modems with computers that had hard drives that were smaller than today’s removable USB drives. Today, high-speed wireless is the norm and mobile has finally arrived.

Companies are Making Money. It’s remarkable how many startups, especially media and ad tech companies, are making $10 million dollars or more in revenue each year. A number have revenue in excess of $100 million. It’s become so common, in fact, that some of these businesses are getting very tame valuations. Back in the dot com days, companies like US Web would roll up digital agencies at 2.1 times their trailing annual revenues and other companies would go public with little revenue at all.

B2B is Hot. Despite the hoopla surrounding Facebook’s upcoming IPO, the most successful initial public offerings over the past year have been from quieter companies that are focused on the serious work of building solutions for business. LinkedIn, Jive Software and Splunk are all examples of companies that are focused on making business and the economy more efficient.

People Remember. The best way to protect from irrational exuberance is to remember how it could all go wrong again. Most veteran entrepreneurs and venture capitalists seem to remember the mistakes they made a decade ago.

How will this economic cycle end? Will we inflate another internet bubble or is everyone still sufficiently chastened from the last go around to keep things in check?

We’ll find out soon enough.