What a tech bubble deflation and the recent financial crisis would have in common

With all this tech bubble talk, I’ve been thinking about the last financial crisis and whether there are any commonalities. There’s one big difference– a tech bubble deflation wouldn’t be the main event. Something else will be and that will be the catalyst for a sustained tech deflation.

For example, the Bernie Madoff scandal, which happened during the crisis, wasn’t the main event. It was the bigger financial crisis that hit Madoff’s inflows that uncovered his house of cards. Ponzi schemes break when inflows < outflows (I’m not insinuating that VC is a Ponzi scheme!).  For tech, something would have to impact the inflows into venture funds or exit opportunities significantly to cause a sustained deflation. Relevant questions should be “What would cause the Nasdaq to decline sharply?” or “What would make LPs stop investing in venture funds?”.

A tech deflation that happens in containment (no systemic risk/contagion) is a feature, not a bug, of the early stage tech industry. Startups are high risk/high reward. There’s alignment among parties involved that these investments are supposed to be risky. High variance is built into financial expectations. I’m not saying this won’t be a painful process, but it’s part of the process.

The SEC said the Bernie Madoff scandal was $64B theft. Most of that were fake markups that he created for his clients (sound familiar? i.e. unicorns). This event caused a lot of pain for high net worth investors but it feels mostly contained compared to the larger financial crisis.

On a related note: Lack of debt in tech makes a huge difference. We’re not playing with borrowed money. The reason why the recent financial crisis was so painful and hard to recover from is that it largely centered around debt. Debt is more tightly coupled and it’s expected to be a lot less risky. When these stable investment products become even a little unstable, it has huge impact because there’s not a lot of slack provided for variance.

 

 

 

Posted by John Ryu, Partner at Scout Ventures

What a tech bubble deflation and the recent financial crisis would have in common

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