10:25 AM

An East Coast Fueled Bubble 2.0?

I popped into the Web 2.0 Expo and conference Monday afternoon at the cavernous Moscone West in downtown San Francisco.

I needed to get to the top floor to get my press credentials. Joining me in the elevator was Matthew, from an East Coast music startup.

We started chatting and we got onto a fascinating subject. He said hedge funds and private equity funds on the East Coast were moving into early stage funding for startups.

"The hedge funds have so much money. They're doing deals such as giving $5m for 10 per cent of the company," he said. "And they couldn't care less about board seats."

Wow. That is going to hurt the VC industry out here, I said. VCs will take as much as 60 per cent of a company in exchange for funding. Or in some cases, they take a big piece of a startup and let it use their computers, it's called "incubating."

OK, the hedge funds won't be hanging around and giving sage advice on building a company, or plotting how to evict the founders. But so what?

With that type of financing a startup can hire an experienced management team, and consultants that know how to build a business. It's a lot cheaper, the startup team gets to keep control, and they can raise more money in subsequent rounds. Sounds great.

If hedge/private equity funds get into the VC business in a big way, that will very easily generate the next bubble in Silicon Valley.

Here is a snapshot of VC investments over the dotcom-dotbomb period:


Source: PricewaterhouseCoopers Global Insights & Solutions MoneyTree™ Survey Report

In Q1 2000, the investment peak reached $28.421bn and the dotcom bubble reached its zenith. 

Some VC funds have as much as $1bn to invest. Private equity funds are larger and getting larger. A $5bn fund was considered huge a couple of years ago. Last month Goldman Sachs Groups announced plans to raise a $20bn fund.

With so much capital around, and fewer places to put it to work to get big returns, investing in Silicon Valley startups will become very attractive. We could easily see another bubble forming in the next couple of years. [I've got a killer business plan for the East coast funds...]