(I'm not an economist) Good, point but think of the following example. You have 10 startups and supply and demands has dictated that $1M is a good price for 10% equity. Now let us say a group of VC suddenly have $20M dollars to deploy. The system only has capacity for $10M, what will play out over time is that VC will bid ever higher amounts for that 10% of equity because they _have_ to deploy capital. It seems silly when outlined like this but imagine this taking place over a few years time and with many complicated variables. It becomes really easy to rationalize that the 10% is really worth $1.2M, $1.4M, etc (there are also some feedback loops here of VCs buying from each other at greater valuation thus justifying their other purchases at higher prices etc). Repeat for X year and you get to $2M.
Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool.
The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone.
Those programmers have needs to, a house for example, let us assume there are only 10 houses and...
You get where this is going.
This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops.
This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.
> Now let us say a group of VC suddenly have $20M dollars to deploy.
Wouldn't that come from their ever decreasing margins? it sounds like there's a feedback loop there that should balance itself at some value, but that's probably assuming people are rational which they are most decidedly not.
Of course as you point out that money will go to the seller and does not simply evaporate. Now in the heads of a founders. They could decide to sell less equity (say only 5% to still raise just $1M) but let's be honest, they won't VC will tell you it is a bad idea and the startup down the street is expecting the $2M (again still plays out slowly over time so you don't really notice the slight raises in valuation). The founder can then use that money to do more work (initially) of course the founder has to bid for workers (programmers) which to assume a simplified model is also a finite pool.
The example repeats, this time not for equity but for labor. The programmer is really worth $100K but you _really_ need one and if you don't pay them $110K he will take an over at the other startup. You can afford them after all you just raised $1.2M. This pattern repeats until you have programmers demanding $200K. All of the sudden you NEED that $2M valuation otherwise you cannot afford to hire anyone.
Those programmers have needs to, a house for example, let us assume there are only 10 houses and...
You get where this is going.
This can continue as long as the underlying value of the business can support it (the margins of VC, founders, programmers, etc just decrease gradually). So who loses? The people that are not part of this subsystem that got money injected, the people holding the 'bag' as they say when the bubble pops.
This is essentially a trap that is hard to get out of because there are many different stages in the process each with costs. The programmer can only go work for $100K if the house goes back down in price etc.