Global stock markets have reacted with shock to bad economic news from China. In the tech world this has led to more comment about a possible bubble in startup valuations. And the risk of a bust. Yet tough economic times could make startups more attractive not less. High growth and possible high returns will be even more rare. The real test will come if there is a liquidity crisis.
Growth And Returns Look Even More Attractive
The recent falls in US Stockmarkets have restarted the bubble debate. Triggered by the far heavier losses in China, things look bad. Lots of focus has fallen on those companies which are post IPO. That is their shares are exposed to the challenges of the market. As those prices drop, fears that the current investment boom may be about to end resurface.
China is a big risk factor. The data is hard to read. But some of the signals could mean damage to the economic prospects for every major economy. Startup and Tech investment is at an all time high. The logic follows that an unexpected hit to the wider economy will trigger a correction.
I have no doubt that the current investment cycle will end. I also know that I don’t have the gift to predict when this will happen. Yet there are reasons why the bust could happen later rather than sooner.
1. When the economy is in recession businesses and the media will scream about cost cutting. But the real problem is always loss of revenue. Anything that offers prospects of growth becomes super attractive. Right now startups are the best bet.
2. The flow of money into startups is also driven by historic poor returns. Traditional investment vehicles have struggled since 2008. This is pulling in cash from institutional and more conservative investors. Stock market losses make the alternatives to startup investment look even worse.
3. Lower prices in stock markets will make an IPO an even less tempting option for Unicorns than it is today. Private rounds remain the only way for investors to get a piece of Uber, AirBnB and many others.
There are still risks on the downside. But like many other factors, stock market indices do not play the role today that they did in the dotcom crash. It looks horrible for Twitter and LInkedIn. There are limits to any contagion.
Liquidity Is The Big Startup Risk
Could some other global event prove the trigger? Predictions as they say are hard. Especially when the concern the future. I venture one point though. All the concern about a bubble points at the sheer volume of funds. And at valuations. These may well be the biggest source of pain when the cycle ends.
But I believe the trigger will be liquidity. Anything that causes a cash crisis will be nasty for big startup investors. Getting money out of Uber right now is much harder than putting it in. On a macro scale nothing is on the horizon. There will be an internal liquidity issue in China. It becomes a global issue only if China stops buying US Treasuries.
It has been clear for a while that smart leaders in tech should prepare for a day when investment is harder to find. This has not changed. But startups should be confident about the virtues they offer. Strong growth. And the potential of high returns….if an exit can be achieved.
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Kenny Fraser is the Director of Sunstone Communication and a personal investor in startups.