Nov 16, 2015 · 6 minutes

Lately I’ve had two different – but mirrored – conversations in Silicon Valley about this bust/correction/deflating [CIRCLE ONE] that no one can stop talking (and writing) about.

The first is that the tech industry is actually showing maturity and restraint. The second is that it’s arbitrarily talked itself into a contraction.

The evidence for either argument is the same.

I’ve spoken with a dozen or so sources – everyone from seed investors to late stage investors to people who control platforms like AngelList – who believe the “peak” of this late-stage, high-priced deal-making frenzy was some six months ago or so. The decrease in the number of deals – even as absolute dollars has increased – the weak IPO market, the mutual fund write downs… this is all evidence of the market sorting itself out after that peak. Or starting to.

Even bulls like Andreessen Horowitz – who love to mock the very idea of a bubble – have begun advising their portfolio companies that a funding winter could be coming, according to reports from their portfolio meeting [Disclosure: Mark Andreessen is an investor in Pando]. I’ve spoken with several VCs who’ve pulled back activity, some because they aren’t seeing companies they are excited about, and others because they expect VCs at all the other stages will do the same and they want to protect themselves.

But here’s what’s befuddling to many: There was no single catalyst that seems to have started this reigning in. No widely circulated “Good Times RIP” memo that caught everyone off guard. No massive explosion of a top brand unicorn. Sure, there’s the overall crappy IPO market but thanks to the Jobs Act, the public doesn’t know how many or who may have filed and pulled due to lack of interest.

This may be why the press – but don’t just blame them, because there were a metric shitload of VCs and entrepreneurs Tweeting about it too – obsessed last week over Fidelity’s mark downs of several prominent startups including Snapchat, Blue Bottle, and Zenefits.

The Information quoted entrepreneurs saying it was like going public “without even knowing it.”  Fortune said it was “about to have some big unintended consequences for all involved.“

Indeed, it was one thing when it was Dropbox being written down. Many had viewed that company as one of the wobblier deca-corns. Snapchat is another story.

There’s a lot of speculation about what these markdowns really mean. Mutual funds are required to do this every quarter – VCs regularly revalue their portfolios too, they just aren’t required to publicly disclose it. This is a big reason VCs stopped taking money from public pension funds more than a decade ago, once news outlets started filing FOIA requests to get the underlying data. VCs have long argued that the entire reason for being private is to keep this kind of stuff private.

What’s causing so much angst about Fidelity’s write downs is that without any more information, the press, other investors and the employees of the companies in question are all left to wonder what it means. Is it simply due to the increased liquidity constraints with a near-dead IPO market? Or something about these companies in particular, that we don’t know?

It’s new for the ecosystem, because we’ve never before traded IPOs for these kinds of late stage deals on such a mass scale, funded largely by mutual funds and other groups that have to make such disclosures.

One thing is for sure: “The tourists” are getting restless.

...But so is nearly everyone else.

This week the chatter will turn from Fidelity to Square. Dozens of industry insiders have described the pending Square IPO as just the catalyst they’ve been waiting for. Something to justify the much-anticipated, even lusted-after deflation of capital and valuations.

Consider that Square:

  • was an early unicorn, back when that was hard
  • is lead by one of the most iconic founders of this entire wave: Jack Dorsey
  • demonstrates the kind of hubris that people love to see the entrepreneurs suffer for. Despite Square’s problems – say, its much-hyped Starbucks deal and iPhone app were both total busts – and despite that it’ll be lucky to price at some $2 billion less than its last private round, Square’s road show is being done by a founder/CEO who has never done this before and is trying to save Twitter at the same time. Not only that: Twitter’s stock falls nearly every time Dorsey addresses investors.

Square is a company that absolutely revolutionized payments and the way small businesses operate. It’s the sort of hack that makes the Valley what it is. The reason companies have non-sensical valuations. Square’s prices were based on a premium for a founder and a great narrative about helping an artist take payments.

But it never delivered the second punch – the killer business model – to back that valuation up. Forbes explained it well:

The core of Square’s business is credit card processing, which has always been somewhat problematic from an economic perspective. Like many other card processors, Square takes a percentage of the overall transaction amount in the form of a fee. This fee, however, has to be shared with banks, credit card companies, and others. Early on, Square actually lost money on each transaction it processed, though their economics improved over time. Still, this model effectively forces Square to play the volume game to generate sufficient revenue to justify its valuation. The trouble is that to do this, Square would have to effectively dominate the entire market. As a result, Square has to seek out diverse revenue opportunities that are non-core to their main business, leading to a trial-and-error that stretches resources thin and confuses the overall strategy. To pursue all of these opportunities, Square has had to raise more and more capital, perpetuating the cycle.

Square was priced for perfection, and it’s execution hasn’t delivered that. That’s not necessarily the fault of Square, but it’s the reason people have been nervous about valuations: Things just don’t go perfectly for most startups.

If Square prices in the expected $11-$13 range this week, it’s 30% lower than the last round and certainly not a deal to feel great about. But most VCs feel like unicorns are over-valued and are going to have to take a haircut in their next pricing. The usual suspects will point out that $4 billion is still a remarkable exit, and most investors will still make money since Square has raised less than $600 million in capital to date, and the late-stage investors had ratchets to protect them in the event of a disappointing IPO.

With all eyes on this IPO as some sort of Rorschach ink blot, that’s not only the best case scenario for Square and Dorsey, but for startups hoping we are in the middle of a slight deflation of the markets and nothing more.

There’s another reason this week’s anticipated Square IPO matters for those “tourists” like Fidelity. If a lousy Square debut depresses the IPO market further, IPOs may become such better bargains that the late-stage private market dries up even quicker than startups hope.