Why web 2.0 is a bubble, and why the deflation will be gradual

I think I went a bit too hard on Mahalo in my earlier post. Not that I take back anything I said–I can’t make any sense out of their business plan.

I’ll take a wait-and-see approach though. And if I think that taking on Google sounds grotesquely grandiose, I think the “human-powered search” idea might still carve out a profitable niche.

And singling out Mahalo doesn’t really get to the point exactly. A lot of the trendy new companies have no visible business plan. So many web 2.0 startups are flooding into the market, and though the bubble will probably get as big as the bubble 1.0 eventually it will take a long time and it won’t deflate nearly as quickly because this bubble has few companies twisting in the wind of the public markets. Most of them are owned privately and, seeing Google and Facebook as models, plan a long gestation period during which they are funded by private equity. The problem is that few of these companies will ever be profitable and eventually the people providing the funding will bail out. But these decisions will be made in boardrooms on a case by case basis, not at shareholder meetings or bankruptcy courts, so the deflation period might be so slow that one day five years from now everyone might look around and say, what happened to all those second rate startups?

Those venture capitalists on Sand Hill Road used to be seen as the colossus of the private equity market. Now the power of hedge funds and private equity buyout groups puts them in the shade–to the point that the notable startup funder of the moment isn’t even in the Silicon Valley–it’s called Union Square Ventures but it’s in New York.

So it seems to me that these private equities, flush with cash from other investments, are funding way more Internet startups–especially in social networking and search–than makes sense. But their deep pockets and lack of need to respond to shareholder demands or file quarterly reports means that a lot of these sucker’s bets won’t be called for a while.

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