Don’t Blow It! New York Tech’s Top Investors Have Bubble Trouble on the Brain

roger ehrenberg photo Don’t Blow It! New York Tech’s Top Investors Have Bubble Trouble on the BrainIs the tech industry in a bubble? Influential and well-informed leaders in the field have started to worry, and are speaking out unequivocally about reckless investors, rising valuations and the misuse of technical talent resulting from the abundance of eager, loaded tech hobbyists who are throwing money at bad ideas.

“We’re in a boom right now, and there will be a bust at some point that will come on the back of this boom,” said Fred Wilson, a managing partner at Union Square Ventures, in an interview last Wednesday. “Some people will lose money and some companies will go out of business and some people will get hurt financially, and there will be a hangover associated with the party. I think that’s inevitable.”

Two days later, Mr. Wilson wrote on his widely read blog that he was seeing “storm clouds” in the air–that the pursuit of “hot” deals was making investors behave irrationally and impulsively. “I have never seen phases like this end nicely,” Mr. Wilson wrote.

Mr. Wilson is not the only investor in New York who is starting to get nervous.

“There’s been some talk of this, you know, for the last six to nine months, but it has increased in a nonlinear way,” said Roger Ehrenberg, the founder and managing partner of IA Ventures. “It really is going parabolic now: the fear of froth.”

Part of the reason for this, Mr. Ehrenberg told The Observer on Monday, is the large amount of “dumb money” being thrown at entrepreneurs by inexperienced angel investors who have jumped into the tech sector because it is fashionable to do so.

“Right now, being called an angel investor seems to be like having ‘dot-com’ at the end of your name,” Mr. Ehrenberg said. “At the golf club now, there is a badge of honor in saying, ‘Yeah, I funded 10 start-ups!’ And I’ll tell you, when I started angel-investing in early 2004, believe me, nobody in New York was saying that.”

Some angels are well-intentioned entrepreneurs who have sold companies and are now putting money back into the ecosystem. Others are retired executives who made millions on Wall Street, in real estate or in the media business.

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“Invariably, they overvalue their investment acumen, as most people do,” Mr. Ehrenberg said. “It’s a form of gambling. And, I mean, it’s a new form of engagement and involvement that’s kind of cool. If you’re gonna throw 10 grand right here, 15 here, 20 here– let’s say you put a quarter of a million, half a million dollars out, who cares? It’s fun! You get invited to cool parties, you get to talk about it, it’s kind of exciting. This whole thing is happening and you’re part of it!”

But it’s not just the growing number of angel investors at the table that’s driving valuations up, though. In fact, most of that work is being done by venture capital firms with an appetite for making early stage investments.

“I do not think the bubble is largely driven by hobbyists,” Mr. Ehrenberg said. “I think it is driven by investors with limited partner capital making undisciplined, ‘follow the crowd’ decisions. The rise of hobbyists is a symptom and not a cause of bubblicious behavior.”

He added: “There are plenty of dumb VCs driving out smart, and disciplined, VCs in times of market frenzy. Angels are merely the icing on the cake. But with institutional pools of capital now actively investing at the seed stage, the opportunity for bubbles… to form is greater than ever.”

Often these people invest without any apparent strategy in mind, putting small amounts of capital into a wide range of early-stage companies. Unlike Mr. Wilson and Mr. Ehrenberg, both of whom are experts on particular areas of the industry –the former specializes in social Web services, the latter in big data–these more promiscuous investors are generalists, and they build portfolios that don’t seem to reflect any firmly held belief about the future of technology.

For all their enthusiasm, these kinds of investors can be bad for entrepreneurs, Mr. Ehrenberg and Mr. Wilson argue.

“Once we make an investment, we’re going to do as much as we possibly can for as long as is prudent, in some cases longer, to try to make the company successful,” said Mr. Wilson. “There are a bunch of investors who are like us and that’s good–but there are also people who are trying to sprinkle the money around and get into every good deal and just kind of have a piece of the action. And that’s a little bit more of a casino type of model, and I think that’s problematic.”

One of the ways in which it’s problematic has to do with the intense competition for technical talent in New York (and everywhere else, for that matter). If you’re a hacker right now, you’re getting emails every day from entrepreneurs who want to hire you, and the fact that it’s so easy to get a start-up funded right at the moment makes the competition even more intense.

“They consume resources,” Mr. Ehrenberg said. “When crappy companies get funded, it hurts people’s really good companies because it just makes the talent squeeze much worse. If some companies die, they die. But the amount of quality engineers being consumed by these companies during the time that they’re limping around, when they could be doing better things, is really frustrating.”

Mr. Wilson, for his part, is trying to prepare his portfolio companies for harder times.

“We are telling them constantly that this period of easy money will not last forever, and that they should take advantage of it, get some funding, put it in the bank, build a real business, get profitable,” Mr. Wilson told The Observer. “It’s not that we’re running around saying, ‘The sky is falling! It’s gonna be horrible! Cut your burn rate!’ We’re just saying, ‘Hey, everybody, let’s be honest with ourselves.'”

But being honest with oneself under these circumstances is not always easy, particularly since it’s usually in the interest of everyone involved–including the press–to say everything is going great.

“It’s not all going great,” Mr. Wilson told The Observer. “You know, companies are failing. A couple of high-flying entrepreneurs came crashing to the ground recently. Justin Shaffer of Hot Potato and Sam Lessin of Drop.io–both of those companies essentially failed. Both of them ended up ‘selling’ their businesses to Facebook, but those were really just–Facebook wanted to hire those people, and they wrapped it up in a ‘sale.’ But those companies were unsuccessful. They failed. So there is failure out there–like, right in front of us. We can see it.” (Hot Potato’s former lead web engineer Matt Langer responded, “Maybe Fred and I have different definitions of ‘failure.’ Justin and Sam both built companies that Facebook considered valuable properties … when the single most important company on the Web considers it worth their while to acquire the product you’re building and the people you’re working alongside the absolute last word that comes to mind is ‘failure’.”)

Mr. Wilson said that while valuations and salaries for technical talent are rising at a pace that makes him anxious, he does not believe that we are already in a full-blown bubble. “We are not there yet,” he said. “Not in the Bay Area and certainly not in NYC.”

That distinction between the Bay Area and New York is not trivial: There are those who believe that the tech scene here is not as overheated as the one in Silicon Valley, and that it’s not as vulnerable to a crash.

Mr. Ehrenberg is among them. He thinks bubbles happen when investors run in herds, pursuing deals without doing due diligence just because a bunch of others are doing it. The fact that, proportionally, more investors in New York are specialists in one kind of company or another, he said, means there are fewer herds.

“In the Valley, there’s a very pronounced echo chamber,” Mr. Ehrenberg said. “Everyone is talking to the same people. All the same deals are rattling around and this is what’s generating the friction–this is what’s generating the heat … and creating this frenzy.”

Furthermore, Mr. Ehrenberg added, “Companies in New York tend to be more focused on actual business problems: There tends to be more of a commerce mind-set early in the game. That leads to a discipline around valuation, funding and growth that has rendered New York less bubblicious than the Valley.”

Mr. Wilson said he doesn’t “totally” agree. “It is happening in NYC but it is not as serious as what is happening in the Bay Area,” he said. “But there are signs out there. I don’t want to name names.”

Mr. Wilson added: “I don’t think [the bust] will be anywhere as big as what happened in the late ’90s. … I think that now the start-up economy is 15 years old, and if we went through a similar kind of thing … the pain would be much less. That’s my view.”

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lneyfakh@observer.com