Sean Parker thinks Silicon Valley is in trouble

Tucson, Ariz.--Sean Parker, a big reason for Facebook's success (remember Justin Timberlake) and a now a partner with Founders Fund, thinks Silicon Valley is in big trouble. His beef: Too many angel investors are throwing way too much money--albeit in little drips--at aspiring entrepreneurs who aren't up to the task of building a company.

The subject came up during a panel Parker was on at Techonomy 2011, a conference that took place this week in Tucson, Ariz. It's a hot-button issue -every young coder in the Valley, it seems, is either doing a startup or toying with the idea.

I talked with Parker to drill down on the issue.

Q: What's the problem with the assembly line model of rapid-fire investing that's going on now?
Parker: This is a model that works well in a bubble--the model of making a large number of investments very rapidly and outsourcing your due diligence to members of your network. Obviously in a market where everything goes up, this works extremely well. And that's a bubble environment.

Q: How'd we get here?
Parker: There was a huge inefficiency in the market six or eight years ago, where there wasn't enough early stage capital. It was that opportunity that allowed Founders Fund, my venture fund, to enter the market to fill that void because angels had become very skittish and started to believe they could never get their money out.

Now we've seen this explosion in angel investing. There are lots of angels coming out of Google and Facebook investing very rapidly and wanting to be players. I think that's some of the motivation--wanting to be players, to stay close to the game and wanting to have a seat at the table.

And they're making tons of investments often in companies that aren't fully baked--either the team isn't fully baked or the product isn't fully baked or there's no conceivable revenue model.

Q: You talk a lot about the importance of the right team.
Parker: A lot of the best talent in a particular domain is not necessarily the correct talent to be starting a company. So there's a lot of fantastic engineers who really shouldn't be product people, really shouldn't be founders, and there's a lot of founder product people who really shouldn't be engineers. Understanding your place in the ecosystem and the value you're able to bring gets lost and distorted when there's so much money sloshing around, and everyone you know is pushing you to go and start a company.

There's a sense of entitlement that I've never seen before in Silicon Valley among people who work for a big company for a while and make a lot of money. They think the next step for them is to start a company. That's often exactly the wrong thing for them to do. They will likely squander their own fortune or waste someone else's money.

Q: Sounds like funding can end up being a disservice.
Parker: Any great engineer these days, who has a good pedigree, can go and get a $250,000 or $500,000 check and start a business and they're probably not qualified to do so.

They think they're going to build a prototype and that's enough. They need to be focused on building a team, and it doesn't have to be a team of seasoned execs. It needs to be team of people who can perform all the functions necessary to run a business. I learned that the hard way--by starting companies that didn't necessarily have a complete team.

Q: But sometimes good businesses come out of these small ventures. Few become Facebook or Google.
Parker: I think that the lesson in all this is that while this can sometimes work, it much more closely resembles gambling than it does investing. The result is going to be a lot of lost capital, but the most deleterious affects is the dispersion of human talent, human capital. The dispersion of human talent to a huge number of startups--none of which is executing with the right product or have the right team members to really succeed.

And the good businesses find themselves competing not just against Facebook and Google and Dropbox and Groupon for talent. They're competing against literally thousands of startups, most of which will never succeed.

Q: How does this all play out?
Parker: I think that when the large established players are done going public, you'll see a few companies that are not ready to go public try. And if the market gets frothy enough, a few of those companies, which are too dependent on bubble economics, will go public and you'll start to see those companies going terribly wrong and then you'll see a lot of losses. And when those losses start to accumulate, you're going to see the public markets for technology shut down again.

Q: But the public markets aren't the only option. Google bought 27 companies just in the last quarter.
Parker: Google bought 27 companies last quarter and a lot of them are talent acquisitions, in some cases paying $1 million an engineer. That can't last forever. There's way more startups getting founded now than there are companies than Google and Facebook want to buy.

Q: The bubble bursting would obviously help the talent crunch.
Parker: The only countervailing force in that analysis is that Google and Facebook and Dropbox and Groupon, which are willing to pay exorbitant prices for talent, will stop having to do so.

Q: Yup. That has to have a ceiling.
Parker: And then you'll probably see a lot of these companies shutting down, and I guess this is where it really ends--when way more of these companies are shutting down then are getting bought. Then that causes this million-dollar price per head thing to drop, and the scarcity in the market goes away.

Then there aren't VCs willing to keep funding these companies; therefore they're forced to sell in a fire sale. So they essentially stop being mergers and acquisitions plays and they start being recruiting opportunities.

I see these deals now where Facebook or Google makes an offer not to buy the assets but to acquire the right to hire. They'll pay the company a certain amount of money and the investors a certain amount of money. It's a talent acquisition where you don't even buy the company. You'll probably see more of that, where companies just get rolled in or talent gets picked over and there's limited to no return back to the investors. At that point the whole system grinds to a halt.

Q: What's the time frame for all this doom and gloom?
Parker: I don't know how many more years of this we have--maybe it's a year a year or two, max. But eventually this graveyard of dead young companies is going to dramatically exceed the number of companies that Google and Faceook want to buy, at which point that gravy train is over.