Easy money is making it harder for ‘winning’ startups, investors say

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Silicon Valley is still debating whether it’s in a bubble again. But one thing some investors can agree on is that too much money flowing into too many shaky startups is making it harder for the real winners to succeed.

This week, two well-known venture capitals voiced similar concerns on the topic. Their message, admittedly a bit self-serving, is that other investors are spoiling the party. Presumably, they’ve picked the winners.

Chamath Palihapitiya, an early Facebook employee and co-founder of VC firm Social+Capital, warned on Wednesday that there will be only a few winners despite the explosion in investment dollars flowing into the tech industry. “You get impostor companies that get funded,” he said of the many me-too startups. “You are feeding capital to companies who shouldn’t be there.”

The real problem, according to Palihapitiya, is that this extra competition forces the true winners, if you will, to raise more money to compete. Companies must spend more on employees — higher salaries, more perks, more office snacks — and to squash their rivals.

The influx of capital into the technology industry is real. Last year, venture capital reached its highest level in a decade with more than $48 billion dollars invested, according to a report by the National Venture Capital Association and PricewaterhouseCoopers.

Earlier in the week, Benchmark Capital general partner Bill Gurley, made similar remarks. Gurley has been warning of a “tech bubble” and of the imminent death of some “unicorns” — startups valued at more than $1 billion — for quite some time, and he finally explained his reasons:

“The reason I speak out is because I don’t like these environments. I think that really great entrepreneurs can raise money in any environment, so, on a relative basis, they’re disadvantaged in these environments because lower-quality people can raise money and enter their field and bring this kind of unsustainable competition.”

Investors’ priorities are partly to blame for this, according to Gurley. Over the past four years, they’ve favored growth over profitability.

“What happens is that you have some of the very best companies, these chosen unicorns, taking on hundreds of million of dollars of capital as a private company,” he said. “And the only way you can spend that money is to take on these huge burn rates.”

Much of these big burn rates, or how much a company is spending beyond what it’s making, goes to what Palihapitiya calls “window dressings:” fancy offices, employee perks, skyrocketing salaries, and other frivolous spending.

With that said, Gurley does believe that trend will reverse and that profitability — a better metric of true success — will return to its rightful place as the prime consideration for investors.

A small shakeout is already in progress. This week, Soothe, an online service for booking massages as quickly as within an hour, acquired UnwindMe, one of its smaller competitors. Also, valet parking service Vatler shut down while a similar service, Caarbon, said a few weeks ago that it would shift its business after it struggled to find a competitor to acquire it (if you haven’t been following, there are many startups in this space).

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