How to Recognize that You are Caught in a Bubble – And How to Leave Before it Bursts

Posted on November 3, 2010

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There is a dot.com bubble going on these days.  It has the look and feel of the late 90s, with the major difference that instead of public money it is private money that is being invested irrationally.  The problem is, of course, that you might notice this only once the bubble bursts.  And even that will be harder to notice this time around:  Anybody can see when stockmarkets crash – but nobody notices (at first) when “super angels” realize that their investments are worthless.  So this bubble will really creep up on us.

Most investors, however, already know that there is another dot.com bubble going on.  But don’t expect that they will tell you:  From an investor’s perspective there is nothing wrong with bubbles, as long as he can exit at the right moment.  A lot of people predicted that the last dot.com bubble would burst – they just didn’t know when.  The same is true for the recent credit bubble.  Everybody knew it would end – just not when.  If you are an investor you have to dance until the music stops, as the much-used Chuck Prince quote goes.

Things look different if you are an entrepreneur.  You are not diversified.  Instead you are gambling with your career. If anybody can get out at the right time, then it is your investor.  Chances that you will be able to sell your company at the exact right time are minimal.  Instead you, your co-founders and your employees will be the last ones left holding the fort.  And there will be nowhere to go at that point.  Thus, once you realize that you are caught in a bubble, there is absolutely no reason to stay even one more day.

So if you are an entrepreneur, here is how you find out whether you are caught in it; and if yes, how to get out.

How to know whether you are already caught in it

1) Your product is less valuable than a badge on foursquare

Foursquare is not a great company.  Think about it: You can check in and show your friends where you are.  You can collect badges.  Do you think in 20 years you will still check-in every time you go to your local diner? How much better off does each check-in make you?  Now compare the value of a badge to that of a newspaper.  A baker.  A machine.  A book.

But FoureSquare is arguable the hottest new tech company that came out of New York in recent years.  So what about the thousands of others that provide even less value?  Are these companies really worth the invested brainpower?  If your company provides a service that has less value than a foursquare badge, chances are you are in bubble land.

2) Your team consists of 10 or less guys/gals

Our economy is incredibly sophisticated.  The first requirement of success is a great education combined with high intelligence.  But that is not enough anymore.  You need to have a sufficiently large team of highly educated, intelligent people to come up with technology that is better than anything that exists.  Five guys’ combined brainpower is simply not enough.  Think about how sophisticated even existing technology already is.  If you only have a room full of people working on your idea, then chances are you are in fantasy land.

3) You raised money in the magnitude of $10,000 to $200,000

You somehow live the comfortable life of an employed college graduate, because angels give you just enough money to pay rent and go out on the weekend?  You think success is “not bimodal any more”? There is something wrong here.  Founding a company is an all-stakes decision.  High risk, high reward.  That means great success or ultimate failure.  There is no in-between. If you look at your lifestyle and that doesn’t ring true, then chances are you are in bubble land.

I’m caught!  How do I get out?

Getting out of this bubble is difficult, but it is easier now than once everybody wants to get out.  The short answer is: make sure you work with a big team of very smart people on a product that satisfies a human need.  But how?

1) Join a valuable company

That could be a (larger) start-up, but it doesn’t need to be.  There are thousands of companies out there that already have very smart people working for them.  Lose your disdain for “corporations” and instead make it your goal to change them.  Use the networking skills you acquired during your start-up time and use it to network your way into IBM.  Value companies by asking yourself what human need they satisfy: Scientific discovery, education, (clean) transportation, communication or health are some of the more desirable answers.

2) Merge!

Instead of working with a small team and marketing your products to other techies, merge with them, found truly great teams and market your product to the whole population!  Don’t worry if you lose all the equity in “your” company – it will be worthless anyway.  Instead convince the 20 other founders you know to all join and work on one idea.  Sticking together will be your only chance once things go down.  And, as you know, having a great team is more valuable than having a great idea.  The idea will change anyway.

3) Don’t talk to “Angels”, “Super Angels”, “Micro-VCs” and any other investor who spends most of his work-day blogging

Remember – for them it is a different game.  Their game plan is to diversify and cash out at the right time.  Most of them will lose lots of money, too.  But each one of them thinks he can beat the market.  You, however, will be “diversified away”.

Instead try to get a loan.  Banks will support small businesses, but they will be very stringent in their credit analysis.  They don’t want to lose their money, but neither do you!  If you can convince them to give you money, then your business plan is probably pretty good.

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