JENNA WORTHAM and EVELYN M. RUSLI, On Monday December 6, 2010, 7:20 am EST
In a memorable scene in the "The Social Network," the actor Justin Timberlake, who portrays the Silicon Valley investor Sean Parker in the movie, leans over the table and tells the founders of Facebook in a conspiratorial tone: "A million dollars isn't cool. You know what's cool? A billion dollars."
These days in Silicon Valley, a billion dollars seems downright quaint. The enthusiasm for social networking and mobile apps has venture capitalists clamoring to give money to young companies.
The exuberance has given rise to an elite club of start-ups - all younger than seven years and all worth billions. Successive investments in Twitter have reportedly increased its value 33 percent, to $4 billion, while Zynga, creator of the popular Facebook game FarmVille, is worth more than $5 billion.
Google was willing to pay $6 billon for Groupon, an online coupon company that was valued at $1.35 billion only eight months ago. And Groupon was willing to reject the bid on Friday evening, presumably because it could sell for even more money later.
Less than a decade after the dot-com bust taught Wall Street and Silicon Valley investors that what goes up does not keep going up forever, a growing number of entrepreneurs and a few venture capitalists are beginning to wonder if investments in technology start-ups are headed toward another big bust.
The chief evidence, according to industry experts and analysts, is the way venture capitalists and established companies are clamoring to give money to young companies, including those with only a shred of an idea. They are piling into me-too start-ups that imitate popular Web companies that already received financing.
Companies that involve social shopping, mobile photo sharing and new social networking are finding it easy to attract investors because no one wants to miss the next big thing.
Yammer, a system for sending Twitter-like messages inside businesses, recently raised $25 million, while investors reportedly signed a check for close to $30 million for a niche blogging site called Tumblr. GroupMe, a new group messaging app for cellphones, raised $9 million. Path, an iPhone app for sharing only photos on a social network limited to just 50 people, received $2.5 million. Its competitor, Picplz, scored $5 million. And those are just within the last few weeks.
It has some venture capitalists scratching their heads.
"I'm not saying Quora, Foursquare, Square aren't eventually worth a lot of money, but the price to pay to get into those games is kind of amazing - $50 to $80 million?" said Dave McClure, founding partner of 500 Startups, a technology incubator in Silicon Valley. "These companies are in big markets with proven founders, so maybe not absolutely crazy but certainly eyebrow-raising."
Fred Wilson, a prominent venture capitalist, said he had watched the trend accelerate over the last six to nine months. "I am seeing many more unnatural acts from investors happening," he said in a recent blog post. He attributes it to competition among investors eager to participate in popular young start-ups. And he notes, "I have never seen phases like this end nicely."
No one really knows if there is a bubble until after one pops. Nevertheless, there are many signs of froth. For example, enthusiasm for closely held Facebook shares has run so high that private investors are trading derivatives of it.
"I always get a little nervous about bubbles when five different angel investors ask me to join their brand new angel funds" in one week, said Alex Gould, leadership scholar of the Stanford Institute for Economic Policy Research. And although the rapid-fire pace of investment in popular Web companies feels reminiscent of the investing craze that led to the dot-com bust a decade ago, there are a few significant differences.
For starters, this is not a stock market bubble. None of the companies are publicly traded.
Mr. Gould said that while "bubble behavior doesn't change," the culture of high-flying start-ups like Flooz.com, Pets.com and theGlobe.com making initial public offerings is largely nonexistent. Those did not fare well, though companies like Amazon have continued to prosper.
Instead, entrepreneurs are increasingly looking to large technology companies like Microsoft, Apple or Google with mountains of cash, not the stock market.
Those three companies have about $90 billion in cash on their books. McKinsey & Company calculates that the largest software and hardware companies have enough excess cash on hand to buy nearly all of the tech industry's midsize companies.
Although the volume of deals is expected to swell, financiers are much more conservative in the amounts they are investing in each company.
"Back in the '90s, companies got funded for five times the amount that Tumblr raised and didn't have anything close to a business model," said Roger Ehrenberg, founder and managing partner of IA Ventures. "People were getting $50 to $200 million a pop and it brought down an entire industry."
The frenzy is as much the result of simple laws of supply and demand as the herd mentality. Thanks to the constantly falling cost of computing power, a start-up needs less money to get off the ground.
Meanwhile, more wealthy people are viewing investing in technology as a hobby, which has increased the competition.
"Investing in technology has become fashionable," Mr. Ehrenberg said. "It used to be that angel investing was the province of wealthy men. Now its become the province of everyone."
Some venture capitalists -- hungry for growth and troubled by weak returns -- have moved toward smaller investments, hoping to catch the next Facebook in its infancy.
"I think at the high end, it's not that frothy, but there's a lot of exuberance in the early-stage stuff," said Chris Sacca, an angel investor who has decided to temporarily hold off on new investments until valuations drift lower. "A lot of the valuations there don't make a lot of sense."
Most Silicon Valley investors still see no signs of gloom and doom. Ron Conway, a San Francisco financier who has invested in more than 500 companies, including Facebook, Zappos, Google and Twitter, says he does not think there is any bubble.
"All the start-ups today have business models and business cases that make them viable," he said in an e-mail. "In 1999 when the bubble happened many companies did not have business models and advertising on the Web was very immature."
Jeff Clavier, managing partner at SoftTech VC and a well-known Silicon Valley angel investor who has financed companies like Mint and Ustream, said that over the next 12 to 18 months the real challenge for start-ups flush with venture cash would be proving they were worth the investment or risk having to fold their companies.
"There may not be a big implosion, but down the road there will be a bunch of blood and tears," he said.
"The music is going to stop and people will realize there aren't enough chairs for companies to get the next round of financing."