Tech’s Hidden Bubbles

I’ve been dismayed by the situation unfolding over the past week in response to Susan Fowler’s incendiary blog post. If you haven’t read the post, you should, but if you haven’t, it’s helpful to know that Susan was an engineer at Uber from late 2015 through the end of 2016. Susan contends that Uber not only turned a blind eye to a repeated sexual offender but that the company actively rewards those who exhibit Machiavellian behavior to the detriment of other coworkers.

Much has been written about the idea that private tech is in a bubble, and I won’t try to dispute or buttress that idea. There are many bright minds all over that have tackled the topic, with varying conclusions and levels of certainty. Bill Gurley wrote a seminal piece on the risks of high startup valuations in 2016, and I think reading it should be all the time and worry you spend on the subject. The fact is, we rarely know we are in a bubble until years after (the Economist has a great article on that subject).

I do, however, contend that rapidly rising startup valuations bring with them a large number of issues besides the risk of failing business models. Without sounding dramatic, the current (rightfully justified) noise around Uber could be just the start of a broad reckoning around private tech companies.

A Primer

A ‘bubble’ is just an instance where there is a mismatch between expectations and reality for an extended time. The bubble is created when demand for an asset outpaces the asset’s fundamentals. Bubbles come about in a number of ways, but mostly because people use incorrect assumptions to create flawed models of future performance. These incorrect assumptions occur on both the demand and supply side – it takes two to tango.

With that in mind, it is important to note that the bubble can pop because of a resetting in either supply or demand. There are two ways to look at the supply and demand of a theoretical private tech bubble:

1. Supply is a steady stream of innovative new companies and demand is capital waiting in earnest to invest at the slightest mention of an exciting new platform business
2. Supply is a stream of money from VC and non-traditional backers and demand is the need of private companies to continue to raise new capital

I prefer the latter; it paints an interesting picture of capital as a drug, with private tech companies as addicts needing a hit to prolong the time before a positive exit or a painful withdrawal period.

Days of Reckoning

In the mental model we established above, private tech companies demand a steady supply of capital from venture capitalists and alternative sources. The supply continues as long as money is available and the demand side (tech companies) are able to show some semblance of product-market fit.  However, most of the chatter I read around the existence of bubbles is woefully ignorant of a simple fact: businesses fail for reasons other than not making enough money.

Modern corporations are intricate ecosystems of dispersed business units, and defining a common shared goal can be extremely difficult. Many private VC-backed companies today are public companies in all but name. Private companies can raise many rounds of capital in forms often only available to public firms, and these funds are used to support complex operations in all regions of the globe. The only characteristic separating public and private firms is the floating of equity on a public exchange. Large private companies increasingly have to operate at the size, scale, and sophistication of their public counterparts – without the scrutiny that comes with being traded in the public markets.

Uber is currently valued close to $70 billion dollars. As of 2/27, there were 112 companies listed on the NASDAQ and NYSE with market capitalizations above $70 billion. However, I would bet that Uber attracts a greater concentration of talent than many or all of those 112 companies. Becuase while Uber is worth ~$70B today, it could (and is expected to) be worth many times that amount in the future. The prospect of future gains attracts the best and brightest wanting to work in the most mentally challenging environments. It also attracts a set of people who care only about making money (and I admit that there isn’t anything inherently wrong with that notion). The latter of these two groups of employees will invariably contain more than a few bad apples.

When a startup is under 100 people, it is very easy to control for culture and fit. When that company grows from 100 to 1,000, the task is more difficult, but still doable. When that company grows into multiples of thousands of employees, the culture and fit that were championed early on are all but distant memories. Think of employee growth like successive generations of a family – in the first 50, a couple recruiters might handle all new hires (the first generation). In the first 500, the recruiters and hiring managers might be recent hires themselves (second and third generations). As the company grows beyond that level, the people doing the hiring and vetting might be four or five generations removed from the first employees of the company. If the company has not made an effort to adhere to specific goals and values, it may become a tangled web of allegiances, factions, and hierarchies.

It’s obvious that businesses can stray from their original missions as they grow. With success comes people who wouldn’t have been hired had the startup still been in its seed stage. We are increasingly seeing that many of the companies who have been rocket ships in the past few years have glaring holes in their corporate structures that will lead to similar casualties as a hypothetical and oft-mentioned tech bubble. These holes could come in many forms – lack of proper HR controls, shady accounting practices, or just a general absence of morality.

Isolated or Uberiquitous

I want to make it explicitly clear that I think accusations without concrete proof or evidence should always be taken with a grain of salt. I think it is extremely dangerous to immediately treat such accusations as fact. Uber has also achieved success on levels that most companies will only ever dream of. That said, Fowler’s comments suggest that Uber’s skyrocketing valuation has attracted sketchy characters like gnats to a light. We also got further evidence when an anonymous Medium article was published that detailed similar transgressions. While Uber has much to be proud of, it also clearly has many entrenched issues it must deal with.

It’s not Uber’s fault that is has attracted these types of people. By the laws of large numbers, there are bound to be a few bad folks in companies of this size. What is concerning is that it seems Uber didn’t have many of the protections and protocols in place to handle these awful situations.

Sarah Lacy at Pando has a good article chronicling similarly troubling issues at other private tech companies. It’s important to note that none of the companies she discusses are anywhere near Uber’s size or scope. That said, I think we are just beginning to see some of the other issues that come with building companies at such a large scale. CB Insights regularly updates a list of recent startup failures. A quick run-through of the list shows that most startups fail because they aren’t able to generate enough revenue to attract continued venture funding. However, if the recent (warranted) backlash against Uber is any indication, sky-high valuations are no barometer of operational excellence.

Final Thoughts

It’s completely naive to say that public companies don’t suffer through many of the same scandals that I mention above. Public companies, however, are held accountable by the ever-watching gaze of public market investors.

Private companies are increasingly able to operate as pseudo-public corporations, but this rapid growth and sophistication might outpace the framework necessary for full accountability. A lack of proper HR controls, accounting practices, and general morality are tough to get back once they are lost. The backlash against Uber should serve as a warning sign/wake-up call for all companies that have pursued rapid growth at the expense of the quality of the people they hire.

 

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Notes:

1. Susan Fowler: Reflecting on One Very Very Strange Year at Uber
2. Bill Gurley: On the Road to Recap
3. Economist: Bubbles are Rarer Than You Think
4. Jay Ritter: Internet and Tech IPOs
5. Andreessen: The Only Thing that Matters
6. Economist: Uber, from zero to seventy (billion)
7. Medium: I am an Uber Survivor
8. Pando: VC and The Silicon Valley Asshole Game
9. CB Insights: Startup Post-Mortems