Is There an "Innovation" Bubble?

In January 2000, our B2B e-commerce startup had its IPO (Initial Public Offering - AKA "going public") on Nasdaq. The share price closed at $52 per share on the first day. We were feeling exuberant, rich and particularly smart, as we had previously rejected a cash offer to buy out our company and opted to try our luck with the stock market (per the advice of our investment bankers). "My hard work has paid off", I praised myself. As the CTO of the startup, I owned close to half a million shares. I was all set financially for the rest of my life!

In the following days, the stock price kept rising to reach a high of $75 sometime in mid February. Then in March 2000, the stock market turned south and started to collapse. Because I was in a "lock period" (typically enforced on employees and early investors), I could not sell my shares for an extended period of time after the IPO. As I watched my paper wealth disappear day after day, I learned my first lesson on bubbles. 2000 and 2001 were particularly brutal years: the dot-com bubble, corporate scandals on wall street, and the terrorist attack on September 11 wiped out trillions of dollars of wealth, including my own. By the time I sold all my shares, my company's share price had dropped to under $1 (BTW - I sold my next startup for 100% cash in 2003 so do not feel too sorry for me :-).

The same thing happened all over again in 2007-2008, but this time it was the housing market that caused the bubble. As investment bankers and brokers sold subprime mortgage backed securities to unsuspecting investors, home owners signed up for loans they could not afford, and loan officers collected fees on selling loans to home-owners without proper documentation, house prices kept going up and up... until one day, there was no way to go but downhill.

Financial bubbles have been with us since modern economics invented the concept of "credit" - enabling banks and investors to invest in future ventures which may (or may not) yield economic value creation. History is littered with examples of financial bubbles, such as at the Mississippi bubble of 1720, which some people argue set in motion the collapse of the royal French financial empire.

During the past decade, we have witnessed the globalization of the "Silicon Valley way". In the words of Brian Yee of Sherpa Capital, Silicon Valley is no longer a geography, it is a concept. This trend is creating exciting developments across the world in innovation ecosystems. I just got back from Slush in Helsinki - a gathering of 20,000 global innovation enthusiasts from 130 countries - and I was in awe of the kind of conversations, discussions, presentations, activities and exhibits which, only a decade ago, were the exclusive realm of Bay Area entrepreneurs, thought leaders and investors. The Silicon Valley has truly gone global!

But in the midst of this wave of energy and excitment, there are a few disconcerting (and in my opinion, very unhealthy) phenomena, the patterns of which are similar to patterns that have caused previous bubbles in history: unchecked credit offerings, commission-based financial middle layers, unregulated markets, get-rich-quickly schemes, and unsophisticated first-time investors.

Here are the trends I consider to be harmful and potentially deadly:

1. The celebritization of tech entrepreneurs - Tech entrepreneurs have become local rock stars, particularly in small countries! This is both an unwanted and undeserved distraction. The most valuable asset of a tech entrepreneur is his/her time. Of course, there is no harm in accepting an award once in a while, or being part of a media story at times. But I know of many tech entrepreneurs who spend more time managing their media presence than running their startups. Worst yet, I think some tech founders are starting companies not to build businesses, but to be in the spotlight. This is not healthy.
2. The no-skin-in-the-game government schemes - As governments try to prop up their local innovation ecosystems and incentivize global entrepreneurs to move to their countries, they are hastily offering facilities and incentives that do not require much skin-in-the-game on behalf of the startup founders. These schemes attract the wrong types of entrepreneurs - from the ones who are pushed into entrepreneurship because they cannot otherwise find regular jobs to the ones that are seeking "lifestyle" entrepreneurship rather than building innovative companies and businesses. I know of people who jump from one European country incubator to another: one year they are in Switzerland attending a government-funded Swiss incubator, another year in Germany being incubated by a University affiliate, and then off to London to be part of an innovation center backed by the city of London. Maybe this is not necessarily bad if among the crowd a few serious ones will ultimately emerge, but I am not so sure.
3. The commission-based financing middle men - As rounds of financing become bigger and bigger (some series A and B rounds are now exceeding $100M!), and as more foreign money is trying to get into early stage rounds in hot innovation hubs (such as the Silicon Valley), a new layer of financing brokers has emerged. These brokers facilitate bringing investors into a syndicate round in exchange for commission fees. I have been approached by a few of those. While I am sure a few legitimately ensure that the deal is a good investment and that the investors are educated in the process, I am afraid many of these brokers only care about the transaction fees, and they care neither about the strength of the investment nor the appropriate credentials of the investors. This layer is akin to the loan officers who sold loans to unqualified home-owners and the brokers who sold low-grade securities to too-trusting investors during the housing bubble of 2007-2008.
4. The rise of innovation "advisors" - Every week I learn of a new boutique consulting firm offering innovation consulting services to government agencies and corporations. During the Gold Rush, people who made the most money were the people who sold the shovels and tools to dig for gold. But at least when you are digging for Gold, you have a pretty good idea what tools you need. But when you are in a hunt for "innovation", how do you know that the tools you are buying will lead you there? I have attended numerous presentations and pitches from so-called innovation experts that are either "recreations" of similar presentations anyone can easily find online, or generated from "textbooks" on innovation (please stop using the Kodak story!). Even worse - some of them contain outright wrong advice about how to unleash innovation in your country or company. But while you need a medical degree to practice medicine and a law license to practice law, you don't need any license or credentials to offer innovation advisory services. In many cases, it is enough to say that you are "from the Silicon Valley" (which sometimes means you spent a summer there hiking in its park), or you have been "educated" at Stanford (which sometimes means you attended an executive course at Stanford), to be labeled as an innovation expert.
5. The secondary markets - This is where I may be the most biased! Secondary markets were invented to allow founders and early investors to get some early liquidity from their hard work when exits are taking longer to achieve. Had secondary markets existed in 2000, I would have been able to receive some financial relief for my "paper stock" before our startup went public, and perhaps not suffered as much financial loss as I had. Secondary markets serve a useful role, but I believe they are being abused today. Founders and inside investors in any startup have significantly more information about the well-being of the startup and its future potential than new investors (economists call this "information asymmetry"). This is why it is dangerous to invest in any startup where the founders and early investors are not committed to staying in it and continuing to invest their sweat and money into building it. "Taking some chips off the table" to secure yourself financially has become "taking some chips off the table" to go play on another table. This is not a healthy phenomenon.
6. The explosion of tech buzzwords - In the late 90's it was the Internet. Then came Web 2.0. Then we had Mobile and Social. It was still manageable. Today, we have a plethora of buzzwords: AI, Deep Tech, VR, AR, Blockchain, Big Data, Nano, Bots, Cloud, etc. All referring to "technologies" and not necessary markets. Buzzwords are a powerful tool to attract investors, employees and media attention, but customers do not buy buzzwords, they buy solutions to their problems. The more buzzwords we chase, the harder it is to distinguish true value from hype. Our innovation economy today is more buzzword-driven that I have seen in my lifetime. I don't feel too good about that.
7. Innovation as PR - There are many corporations, government agencies and even some academic institutions getting in the "innovation game" for public relation purposes. This is especially true in developing countries. These practices are bad for innovation and bad for innovation ecosystems. The worst of these practices are "idea" competitions - which is something I have written about before.
8. The crypto world - Bitcoin, Cryptocurrencies and ICO's have all gone wild! I think they are the Dutch Tulips of our times. These "investment" vehicles are akin to a legalized global gambling cyberspace. And as in gambling, the casino always wins. In this case, the casinos are the middle brokers and the governments collecting taxes on winnings. Don't get me wrong, I do believe that blockchain is a technology with huge potential and that digital currencies are here to stay, but I doubt there will be a happy ending to the current mania, especially when we are starting to see signs of irrational behavior such as taking out home mortgages to buy bitcoins.
9. The sovereign wealth funds - Who needs an IPO when you can exit your startup to a sovereign wealth fund, or to a PE fund backed by one or many sovereign wealth funds? It used to be that you can only exit your tech venture through an IPO or an acquisition by another tech company, but it is looking more and more likely that sovereign wealth funds may be providing new exit mechanisms to both founders and early stage investors. This will continue to drive valuations higher and encourage traditional "public market" funds to enter the "private tech market" investment domains, driving more financial engineering and less true value creation. This is a very dangerous phenomenon in my opinion.

While I believe that we will face an innovation bubble bursting one day - due to the factors I mentioned above - it is hard to predict how big the bubble will continue to inflate before that happens. The truth is that there is still plenty of cash available in circulation that could continue to flow into the global innovation economy. Tech giants are flush with cash - both onshore and offshore. Corporations in traditional industries - banking, insurance, logistics, etc. are also doing well financially and are leveraging their relative financial strength to increase their footprint in the innovation ecosystem. Public stock markets are at a historical high and public companies can always use their public stock to provide healthy exits to innovation startups. Giant PE funds are being created (funded partially by sovereign wealth funds) to provide not just late-stage pre-public investments but also big exits - at least partial - to late-stage startups.

The question is: Who will be left "holding the bag" when the innovation bubble finally bursts? During the dot-com bubble it was mainly US-based retail investors who suffered the financial losses caused by the burst as they saw the company shares they bought on the public market become worthless. In the housing bubble, home-owners were left to deal with big loans on assets that were rapidly decreasing in value, and investors who bought and held subprime mortgage securities suffered major losses. It is hard to predict the "last men standing" in the upcoming innovation bubble. But the nightmare scenario is that it would be national wealth funds and financial institutions of developing countries. The tech bubble burst was brutal, but it did not bring down countries and large financial institutions. The subprime mortgage bubble did cause century-old institutions like Merrill Lynch to go bankrupt, and destabilized the financial systems in countries like Iceland and Greece, but the world managed to stabilize and recover. The "Innovation Bubble" may have much wider impact and may even affect global stability and security, at a time when we are already facing uncertainties in our global systems. Fasten your seat belts!