Every decade, there is a theme that captures the zeitgeist and expresses itself as investment mania. It was gold in the 1970s, Japan in the 1980s, Nasdaq in the 1990s, and China and commodities in the 2000s. As more investors are lured in by the big gains, a classic bubble forms and ultimately pops.

Nothing captured the investment zeitgeist of the 2010s better than venture capitalist Marc Andreessen’s prescient 2011 article, “Software is Eating the World.” Andreesen foresaw a dramatic and broad technological and economic shift in which software companies were poised to take over large swathes of the economy. As he put it:

Six decades into the computer revolution, four decades since the invention of the microprocessor, and two decades into the rise of the modern Internet, all of the technology required to transform industries through software finally works and can be widely delivered at global scale. More and more major businesses and industries are being run on software and delivered as online services—from movies to agriculture to national defense. 

Over the next ten years, I expect many more industries to be disrupted by software, with new world-beating Silicon Valley companies doing the disruption in more cases than not. The battles between incumbents and software-powered insurgents will be epic. I’m privileged to work with some of the best of the new breed of software companies, and I can tell you they are going to be highly valuable cornerstone companies in the global economy, eating markets far larger than the technology industry has historically been able to pursue. 

Software-as-a-service (SaaS) companies took advantage of the growth in cloud computing and the scalability of subscription-based software. According to Gartner, the worldwide cloud-services market grew from $12 billion in 2011 to a staggering $332 billion in 2021. 

Since Bessemer Venture Partners created the BVP Cloud Index of publicly traded companies in August 2013, the basket is up 900 percent, almost triple the gains in the Nasdaq and five times better than the performance of the S&P 500. 

In February 2021, the total value of Bessemer’s index hit a record $2.2 trillion, up from $1 trillion pre-pandemic and $100 billion in 2011. Its five top companies are Adobe, Salesforce, PayPal, ServiceNow and Shopify.

Source: Bessemer Venture Partners

The year 2021 was a record year for VC fundraising in the US, double 2019 levels and 40 percent higher than 2020. Funds are being deployed faster, rounds are being closed at record speed, and startups are being valued higher than ever. Cloud startups are fetching a 34x revenue multiple compared to 9x in 2016. 

According to Pitchbook, US venture dealmaking hit a record $330 billion last year, and global venture capital financings reached a new high of $621 billion, more than double the $294 billion recorded in 2020. Each working day two or three unicorns sprung up in 2021, with the global tally reaching 1,000 unicorns and a total value of $3.4 trillion. 

As unicorns became paradoxically ubiquitous, “dragons” emerged to refer to private companies valued at $12 billion or more. There are 35 dragons, including Stripe, SpaceX, Instacart, Epic Games, Databricks, Chime, Plaid, OpenSea, Miro and Grammarly.

Tiger Global took the crown as 2021’s top investor with 335 deals (1.3 deals per business day) despite telling investors that it “strived to remain disciplined, passing on opportunities we deemed good in favor of executing on great ones.” Then in late December, Tiger told clients they could put money into its hedge and long-only funds “because the opportunity set seems asymmetric.”

Source: CB Insights 

According to Fred Wilson of Union Square Ventures, the venture capital industry is moving at “a blistering pace,” the fastest he’s seen in 35 years, including the dotcom boom. “It is exhausting,” admits Wilson, “the VC business has turned into a sprint. And you can’t sprint forever.” He’s particularly concerned about the growing number of seed rounds at valuations of $100 million or more. 

Seed stage is when a company has a good team, a good idea, but has not yet proven product market fit or a go-to market model, and has not yet demonstrated a sustainable business model. These investments have a high failure rate and there is a lot of dilution from the seed round to the exit. 

So, in a world where we are seeing more and more $100 million valued seed rounds, one has to ask the question what are the investors expecting? A $100 billion outcome? Doubtful. Less dilution, maybe. A different power law distribution? Don’t count on it. 

I think they are being delusional, comforted by the likelihood that someone will come along and pay a higher price in the next round. But it seems that person may also be delusional. Because when you model things out, the numbers just don’t add up. 

Given a power law distribution, a $100 million seed fund that makes all its investments at $100 million post-money will barely return the fund. And that number is gross, before fees and carry. 

In another cautionary sign, last year a new show debuted on Amazon Prime called “Unicorn Hunters.” Startups faced a panel of investors, including Apple co-founder Steve Wozniak, who interrogated them about their businesses before deciding whether to invest. Part of the show’s pitch is “democratizing wealth creation” by allowing people at home to also invest in those private companies.

Source: Fortune

The best decision an investor can make is to avoid the popular zeitgeist when a new one begins. This is hard since it requires going against a pattern of behavior that has proven to be rewarding. 

Gold did terrible in the 1980s, Japan kept sliding through the 1990s, tech was weak in the 2000s, and China and commodities were a disaster from 2010 onwards. Now it’s software’s turn. 

Last fall we identified that the global race to zero emissions is going to be the investment zeitgeist for this decade. We should have gone even further and advised against investing in software stocks. The BVP Cloud Index reached its peak in November 2021 and has since dropped 43 percent. 

Cloud stocks were trading at an average of 16 times forward revenue at the top. They’re now at 10 times, which is still above the peak in previous cycles over the past twenty years. 

The BVP Cloud Index has fallen 20 percent in the last year, while the Nasdaq and S&P 500 have gained 2 percent and 10 percent, respectively. It’s a sure sign that the zeitgeist has shifted when the leaders start to lag.

Source: Bessemer Venture Partners

In 1933, Aldous Huxley wrote that the zeitgeist “is a most dismal animal and I wish to heaven one could escape from its clutches.” Most people are unable to do so. They’re desperately trying to ride its crest. 

In January 1980, gold prices reached an all-time high of $850 per ounce before plummeting 63 percent by July 1982. Following that, gold rallied 57 percent in six months to $500 per ounce, giving hope that the bull market had resumed. It wasn’t to be. Gold dropped another 43 percent to $287 by February 1985.  

Japan’s Nikkei index peaked in December 1989. In 1992, there was still hope that the bull market would return in good time. It did not. Instead, the Nikkei plunged another 40 percent in six months, then languished sideways for eight years (still 40 percent below the all-time high), before dropping 60 percent during the 2000—03 bear market. 

The Nasdaq index peaked at 5,132 in March 2000, then dropped 40 percent to 3,042 by May. In just two months, the index rallied by 40 percent to 4,289. Then, by the end of the year, it had plunged another 43 percent to 2,436. Wall Street strategists forecast an 18 percent gain for 2001, on average. 

Some strategists who were conservative, such as Christine Callies of Merrill Lynch, expected a big catch-up rally. “The bulk of the correction is behind us,” she wrote, “so now is the time to be offensive, not defensive.” In the first nine months of 2001, the Nasdaq fell another 43 percent. 

The CRB commodity index peaked in 2008 with a secondary lower peak in 2011. Because of inflationary embers, most people didn’t give up on the bull market until 2015 when the bottom fell out. 

We see this pattern repeating. Byron Deeter of Bessemer Ventures argues that software businesses remain “the drivers of the new economy” and that “all of those trends that people were excited about in the 2020 market, when this basket returned almost 100 percent, those remain today.” There is a reluctance to accept that times have changed.

Of course, we are still in the early stages of the “softwarization” of the global economy and many industries are yet to be disrupted. SaaS companies are growing fast, and it’s hard to envision that arc ending abruptly. Even in the face of a slowing economy, we expect strong revenue growth. However, Deeter overlooks the fact that software valuations face a steep contraction.

Between 2004 and 2014, Cisco more than doubled its earnings, yet the stock was trading at the same level as it did in 2004. This is because the price-to-earnings multiple halved from 33 in 2004 to 16 in 2014. Even if investors seem to have forgotten prior lessons, valuations matter.  

This decade, stay away from software stocks. A new zeitgeist is starting to blow through.