Napster was a failure of a company financially, yet it completely destroyed the music industry, absolutely leveled it.

I’ve been chewing on this theme for a few weeks as I think about what happens when sell side equity research is completely disrupted, which it will be soon. It relates to Estimize, StockTwits, and a whole host of other companies that are leveling the playing field in our industry, breaking down barriers, and opening up access to information.

But just because we’re knocking down walls, does not mean that all that money is gonna come spilling out the other side for us to pick up. When you disrupt an industry, you often erase a large portion of the profit for everyone. Consumers benefit greatly, as they did with Amazon in pricing transparency, and music services that allow you to access content without buying it, but the companies themselves have not had an easy go of it given the amount of revenue they pull in.

Technological advance is naturally a deflationary force. I’m sure Mr. Bernanke stays awake at night trying to figure out how to put the breaks on it, the access over ownership economy is crushing the labor market, or at least the labor market he understands how to control with his tools.

We’re building a new business model at Estimize on top of the data. We’re adding value not by selling access to content, but by providing a whole new alpha generating data source that no one else can. I often get questions from people asking if we will build an independent research portal on top of Estimize. The answer is no. That industry is dead. Content is dead, it’s worth nothing. Why would you pay for equity research when people are sharing great stuff for free on Estimize and StockTwits and blogs?

I look at companies like 42 Floors which is disrupting the commercial real estate rental business and wonder how they will try and make money once they have destroyed all the brokers. I see several examples a day like this.

We live in an amazing world that is moving so quickly, and it’s not always easy to see where the money will come from once you knock over those walls of inefficiency. But that’s the fun part, figuring it out.

I walked away from the meeting excited for what Philip was building, which to be honest, is often not the case. There are not a lot of teams that I have met over the past few years who are both building interesting and innovative fintech products, especially of the active trading variety, and have the right DNA/philosophy to pull it off. A lot of fintech products right now are being created by Silicon Valley nerds who don’t have the necessary market DNA to really pull it off. It’s like trying to throw technology at a philosophical problem.

In short, Philip was building tournament poker for the stock market.

Let that sink in.

The idea was that if you could build the most realistic paper trading engine out there, and provide a social dynamic to the trading experience, you could create a myriad of different market based games, with little to no risk, but large potential reward to the players.

It’s a BIG idea, and one that is not easily executed. There are a lot of different moving parts, social dynamics, and hooks that Philip had to get right in order to pull off his vision. And that’s why he asked me to help out on the product side.

One of the many reasons I haven’t slept much over the past few months is my involvement in Tournament Trading Technologies trying to help mold their first game, Super Stock Jockey, from the product side.

For me, the fun in this revolves again around an experiment, similar to the one we’re running at Estimize. What will happen when market participants are put into a scenario where in order to win a monetary prize based on trading financial instruments, they must perform better than the second best guy in the tournament, with no worry about absolute return.

Down the road, we can put together games such as, who can lose 50% of the money in their portfolio the fastest, who is the first to make 5 trades of 10% return or higher, who can make the largest absolute return trading only Facebook stock over the course of a week, on and on. The fun is in creating the different market based games, and seeing who is the best at what.

Super Stock Jockey is built on the Facebook platform, which allows us to do some interesting stuff around social, but limits the game in other places. On Facebook, the prizes for winning the tournaments will be sponsor based, and they will be significant. Down the road the vision is to create a web based platform allowing for participants to ante up to play in a tournament, just like online poker.

I’m excited to be involved and to help Philip in any way I can to execute on his vision.

Go check it out at SuperStockJockey.com

The answer is simple, my DNA (previous experience / skill set) and deep desire to build this product (Estimize) in order to disrupt a very broken and inefficient industry.

There is no right answer, but that’s about as right as it’s every going to get for me.

We talked a little bit about pivots, Y-Combinator, and some other companies in our space. I used one of my favorite lines of all time, from Jeff Bezos, “We’re stubborn on vision and flexible on details.” I think I got my point across pretty well.

This morning I saw that a company I was tracking, CityPockets, is pivoting into Reclip.it. CityPockets was a daily deals wallet thing that never quite worked out, and Reclip.it is some kind of coupon Pinterst type thing.

The two conversations codified something for me that I had been piecing together for some time.

While I love the fact that there are SO MANY people jumping into the tech startup space and becoming entrepreneurs, it doesn’t mean that you are the right person for your idea. I met with an ver senior investment banker yesterday morning who reached out to me randomly. He was a great guy, and had a lot of praise for what we’re building. He also was very honest about the fact that he wants to get into something more entrepreneurial. We talked about ideas and trends, but I made it very clear that in my experience, successful founders come from the industry they are trying to disrupt, or are working on solving a problem they’ve had for quite some time.

When we think about what is taking place at Y-Combinator, where many teams come in and have their ideas pivoted into totally different things, and some people now come in with no ideas at all, we have to ask ourselves, are these the right founders for their own companies?

If you take VC funding, then pivot your company to a completely different product, maybe in the same industry, maybe not, are you there right person to run that company? There are cases where VCs give money to “Labs”, groups of entrepreneurs who just love building things. Twitter was born out of this type of environment, many other great companies are as well. But the vast majority of successful companies are born by founders with deep knowledge of their industry.

Why are the CityPockets founders the right people to be building a coupon sharing Pinterest type site? The answer is they aren’t. But you don’t just give the money back to the VCs in this game.

I told the people I was meeting with that if we pivoted Estimize to something totally different (not happening) that I most likely wouldn’t be the right person to run this company. Pivots are fine (for a founder) if they continue with that vision (don’t stretch the vision). But when you’re building a totally different product for a different purpose, it’s time to take a long look in the mirror and ask, why am I the right person to be running this company?

At the end of the day, this new system accomplishes two things. It allows us to compare the relative difficulty of estimating EPS and Revenue on an apples to apples basis, and it allows us to compare estimating on different assets and releases on an apples to apples basis. The result is that we can create aggregate leaderboards (coming soon), and do all sort of other really cool stuff.

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At Estimize, we are faced with the basic problem of how to clearly measure and compare the accuracy or difficulty of an analyst’s estimate. Until now we’ve used real accuracy, which is essentially the estimate divided by the actual. To allow for estimates larger than the actual and negative eps estimates, we use:

real_accuracy = 1 – ( |actual – estimate| ) / |actual|

This has the helpful properties of being very simple and technically correct, but has some readily apparent flaws. Once the difference between your estimate and the actual is greater than the actual, you get a negative accuracy score. This can happen surprisingly easily for small EPS estimates – for instance, if your estimate is 8 cents, and the actual reported EPS is 2 cents, you’ll have a -300% accuracy.

Because of this, we wanted a new scoring system that would keep all scores between 0 and 100, but use increasingly less room to differentiate very bad scores. We also wanted to normalize between the relative difficulties of estimating on EPS and on revenue, and between the difficulties of estimating on different denominations, so that scores can be usefully compared between different stocks. Analysts should also not be afraid that making estimates on small denominations would hurt their average score.

Finally, the average accuracy score overall for wall street estimates was in the high 80%’s, meaning we would be using a tenth of the range of scores to differentiate between half of the estimates. Because of this we wanted to be able to move the total accuracy lower in our new scoring system, while maintaining relative ranking.

The first part of our new scoring algorithm is to map the real accuracy scores, which can be from negative infinity to 100%, into 0 to 100 on a curve, so that the high scores are relatively similar consistent, but you’re punished less and less as your accuracy decreases. The curve we use is:

new_accuracy = 1 / ( 2 – real_accuracy )^exponent

Where we can choose the exponent for each actual denomination to normalize it, and to map the total average score to our chosen average score.

With an exponent mapping the global average score to 0.70, and the the x-axis representing real accuracy, the y-axis represents the new score. Note that for any x value less than 1, the y value will be greater than 0 and less than 1.

Normalizing between actual denominations gets more complicated. To begin, we calculated the real accuracy of Wall Street for EPS and Revenue, for all past releases on which we have Wall Street analyst estimates and reported actual values. We grouped those real accuracy scores by the size of their actual, using a log scale to get similar sized groups.

We then calculated the average real accuracy for each denomination group, connecting these dots gives us an expected average real accuracy for an estimate of any denomination.

The EPS curve makes sense, because very small EPS actuals are increasingly harder to estimate accurately on accurate. Revenue is relatively stable, especially considering the smaller number of releases with small revenue values, and the effect of truncated precision. Overall revenue has an an average real accuracy score of 0.9250.

The Average Accuracy with Count graph represents the number of releases inside a denomination group by the size of the circles.

We use this expected average score to normalize between denominations, by solving for an exponent that maps the expected average score of that denomination to our chosen global average score in our new formula.Essentially, for an actual and an estimate:

1. Use this graph to find the expected average real accuracy score of an estimate on this denomination actual.

2. Calculate the exponent that maps this average accuracy score to our chosen global average accuracy score.

3. Plug the real accuracy score and this exponent into our mapping function to get our new accuracy score.

Comparisons:There is a certain amount of arbitrariness in creating a new scoring system designed to provide useful comparisons to us, rather than storing exact data about the estimates. While exploring new algorithms, we used a couple benchmarks to test that we were preserving important information while trying to reach our goals of understandability and comparability.

First, any new scoring formula should maintain a very similar proportion of Wall Street vs Estimize wins. For releases with 4 or more estimates, which has been our benchmark for statistically significant Estimize consensuses, we scored the Estimize consensus to the Wall Street Consensus and counted their respective wins.Under our new system, the total number of Wall Street wins increased by 3% of all past releases with 4 or more estimates.

Because we’re technically only normalizing the average accuracy score, another important metric we needed to consider was how well normalization works for scores across the range of possible difficulty scores.

This graph shows the difference between EPS and Revenue score for all releases under the old and new scoring systems, a general measure of correlation. In general, the smaller the absolute value of the difference, the more accurately we’re normalizing between EPS and Revenue.

For purposes of comparison, the old real accuracy scores have been mapped between 0 and 1 using an exponent mapping the old global average score to our new chosen global average score.

As the graph shows, we shifted the distribution of differences more evenly around 0. While we lost a small amount of correlation in the most accurate (-0.05 to 0.05) category, the following graph shows overall we had a positive trend towards higher correlation.

When singling out the hard EPS denominations, the benefits of the new system become much more clear. The following graph shows the differences between EPS and Revenue scores for Releases with EPS Denominations below 15 cents.

The severely lopsided distribution of the old system shows the much higher difficulty of estimating on small EPS, compared to small Revenues. The distribution under our new system is both much more even around 0 and closer to 0.

Recently, huge steps have been taken, not only by excellent entrepreneurs, but more importantly by some of our most prestigious universities and accomplished professors. Stanford, MIT, Harvard, and a host of other institutions are making their courses available online, for free, and offering certificates of accomplishment to students who successfully complete courses and prove that they have mastered the material.

I won’t get into the specifics of these courses or how the learning is being verified. It is, and that’s all you need to know.

What I would like to talk about is the impact on higher education, as well as primary education, that this new paradigm is going to have.

David Brooks writes a good op-ed this week entitled “The Campus Tsunami” in which he asks several good questions about this shift. These questions are reminiscent of those asked in the early days of newspaper disruption. In essence, they cast doubt into the revolution on the basis of the lack of understanding for what will replace certain seemingly important institutions that some believe can not or should not disappear. In the end, this line of thinking is both useless and counter productive, and in many cases leads people to the conclusion that the revolution will not take place, on the basis of the fact that they don’t have answers as to what will come next.

What we often see in industries that are destine to be disrupted, is a rearranging of the deck chairs as their proverbial Titanic has already hit the iceberg. This takes place primarily because the incentive structure built around people who work for these institutions does not lend itself towards admitting that the foundation of their business has taken on irreparable damage. Their incentive is to bide as much time as possible until they can jump ship, not build a new one. We see this in the New York Times, which just sold off a slew of local newspaper properties, but which fundamentally is unwilling to recognize that people paying for their core product is a thing of the past.

This metaphor holds true for higher education as well. While these institutions attempt to shuffle the deck chairs, the foundation of their whole reason for existence is being eaten away by innovation. And so while like the New York Times, they are attempting to bend in the wind, their root system is being slowly washed away by an oncoming tsunami, it just won’t matter.

Brooks asks the questions that many will use to call into doubt the fact that these institutions can or should (the latter of which doesn’t matter one bit) disappear. And while I obviously don’t have the answers to all of these questions, we’re starting to see some people who may. But beyond that, I just want to strike home one more time the fact that we don’t need answers to these questions now to understand that the old paradigm is done for. So here we go, one by one.

“Will online learning diminish the face-to-face community that is the heart of the college experience?”

This is the most important question for those who will enter college in the near future. Is college about the learning, or the community? Well, it was definitely about both in the past, where professors had knowledge in their brains that you needed to get directly from them. That’s obviously not the case anymore as you can take the same course, for free, from the best professors in the world online. But the community aspect is just as important, if not more.

I like to use the example of church, or synagogue, or whatever other religious meeting place you may patron. As the great majority of people who attend these places of worship why they go, and the answer you’ll get is not “to pray”, it’s “I want to be part of the community”. Community is the most important aspect of religion, it’s the one thing religion got right. So we’ve interwoven religion into community so deep, that even atheist like myself go to synagogue to be with people they share many things in common with.

If the point of going to college isn’t for the learning, but for the “community”, then why are we weaving the two together to the point where people believe we can not separate them. I see this as a fallacy of the highest order. You don’t make long last friends and connections with people sitting in a classroom listening to a lecture. You make great friends building things, going through hard experiences, traveling, being part of an athletic team, or any competitive team for that matter. These are all things that take place at college, but which have zero to do with academic learning.

The answer to David’s question is this. The “college experience” will be disaggregated into pieces that make far more sense on their own than they do mashed together with academic learning. As the academic aspect of college is taken over by online learning, the other aspects will be pulled away from those institutions as well as less people choose to pay $50,000 a year to “party” and “make connections”. We need a whole new set of institutions for 18-25 year olds in this country, to take the place of everything else that goes on at college. I believe that entrepreneurs will provide us with these.

“Will it elevate functional courses in business and marginalize subjects that are harder to digest in an online format, like philosophy?”

Yes, but not for the reason that David gives. Here’s the rub, many of our institutions of higher learning were created for the purpose of developing well rounded individuals, a liberal arts education if you will. But this way of thinking came about during a time when not many had access to this type of learning, not many went to college. And if you are a rich kid who doesn’t have to worry about tuition or a job after college, you can get whatever type of education you like.

But as a great percentage of our population goes to college now, and have to get a return on their investment in the form of employment, this structure is broken. The liberal arts degree does not fit the great majority of people. So yes, David, those subjects will get marginalized, but not because everything is moving online, it’s because they don’t offer the skills needed to compete in today’s workforce. And I wouldn’t really shed a tear for them anyway. The job of our higher education institutions can not be to create well rounded individuals who understand the allegory of “The Cave”, not for $50,000 a year, no.

The more kids who take engineering, computer science, math, biology, chemistry, and other applicable courses the better of we’ll be as a country, and the better of they will be entering the workforce.

“Will fast online browsing replace deep reading?”

No, this has and always will be a stupid question. There is a time and place for the deep understanding of a subject via deep reading, and that isn’t going away just because we’re moving education online. Giving people fast access to information does not limit their ability to dive deeper into a subject. I always fund this question to be so dumb.

If a few star professors can lecture to millions, what happens to the rest of the faculty?

I think we all know the answer to this question, whether you like it or not. If I can learn biology 101 from the best professor in the world at teaching that course, why do the other 5,000 professors need jobs? It’s just reality. Now, here’s the better question. Who is going to be the in person tutor who helps to explain material I need further help understanding in person. The job of the professor might vanish, but it will be replaced by faculty of some sort which help you in person. When we flip the classroom, the other side doesn’t just disappear, it evolves. If i’m having a hard time getting through a specific section of calculous I’m learning on Kahn Academy, I need someone there in person to ask questions to.

Look for this to be a huge business down the road.

And as for those professors, sorry, I’m not crying for your lost jobs. No one is going to cry about the deflation in the price of information and learning, no one.

“Will academic standards be as rigorous?”

Yes, and even more so than they are today at these institutions. Our current online learning universities have given a horrible name to the industry. The University of Phoenix offers zero to no value. Getting a liberal arts degree online is even more useless than getting it in person.

Look at some of the courses offered from Stanford which team software as a service. They require serious work submitted online in order to obtain a certificate of accomplishment or whatever it is. I had a friend take that course, and I saw the material and the work she did, it was brutal.

“What happens to the students who don’t have enough intrinsic motivation to stay glued to their laptop hour after hour?”

Ah, the million dollar question. What will students who were getting a free pass and a free degree do when they actually have to prove that they have learned the material? What will they do when the standards rise?

I feel no remorse for these people who won’t be able to compete. The reason why a degree is worth nothing anymore is because everyone has one because we’re just handing them out like candy. No one should cry for those students who don’t have the motivation to obtain one. We need to reinstitute a sense of accomplishment in obtaining a degree, not everyone should have one.

If you want to learn and strive for a better education and future, go do it, or don’t, no one is forcing you.

At the end of the day, it comes down to this. The college experience will be disaggregated, chopped up, and remolded piece by piece into a better whole. Each piece will offer more value, but it will be looser connected to each other piece. You won’t pay $50,000 a year for everything, you’ll pay a minimal cost for the actual learning, and a la carter for the other experiences you want. And you will receive far more value this way.

While these are some of my answers and ideas, the fact remains that we don’t need to have these answers for the revolution to take place. The old paradigm is dead, and it is now up to entrepreneurs to answer these questions, and build new institutions that offer more value.

These are exciting times.

That said…

It is time for the whining to stop from this community. You people are the most ungracious group ever, on both sides, the entrepreneurs and the investors. The press is no better as we saw this weekend with that dumb as rocks post in the NYT Bits section, but that is to be expected, you all should be held to a higher standard.

You rightfully fought for a startup culture in this country that would revitalize the economy. You wanted kids to leave their analysts jobs on Wall Street to start companies, you wanted MBAs to take their shot instead of walking mindlessly into a managerial job at a fortune 500. You invested in open source tools, companies that provide cheap infrastructure, and made it amazingly cheap to start and run a company. You wanted more kids to build more companies to create more jobs and jumpstart this economy.

You built accelerators and incubators to help them do it. You shifted your funding structures to earlier stages and less capital so that you could take more shots with the same dough. You even pushed for the crowdfunding bill for god sakes, and you won!

And now, now all of this god damn whining! Holy christ you people are amazing.

Now you complain about the “wantrepreneurs” who are invading your ecosystem. You complain about the glut of incubators and accelerators. You complain about VCs who aren’t looking to build large long lasting profitable companies. You complain about early stage valuations you yourselves created by moving down scale in time frame, maybe in response to other market forces, but you did it.

Really people, really?

I am 26 years old. I was lucky to come out of school a few years early to work for a hedge fund under a great mentor while finishing my degree. But when he unfortunately died right after the crash of 2008, I found myself without a job in the worst economy in over half a century. This country was in fucking shambles. I had to sleep on a friend’s couch for six months while I build Surfview Capital while my parents told me to go get a job stocking shelves at Urban Outfitters. There was none of this only a few years ago, do you remember where we were?

And now we have a booming economy (for the people who are part of this world). We have a booming entrepreneurial spirit rising from young people who are sick of waiting around for someone to give them a job just because they played by the rules and went to college for that completely useless degree no one cares about anymore. We have amazing things being built, amazing value being created. And you are complaining that there are too many people taking their shots?

Fuck you.

And stop whining about VCs who aren’t in this game to build long lasting great companies that solve the world’s problems. That’s not their job, it never was, and it never will be. They are speculators, plain and simple, and they take advantage of the need for capital at early stages. Whether they exit at 30 million valuations, 300 million valuations, or in a 3 billion dollar IPO, that’s not your place to say what is right. It’s their job to produce returns for the investors in their fund, and the way they do that is to serve entrepreneurs well, help them build companies, and then manage risk.

And no, this hasn’t changed, it was always this way.

As for the incubators and accelerators. Let there be 1,000,000 of them! The same way there are good colleges and poor colleges. Let me get this straight, you are complaining that there are too many groups now set up that are giving capital, office space, legal support, mentorship, and even housing in some cases to kids looking to build businesses. Are you kidding me, you are complaining about this? The other option was for them to throw away hundreds of thousands of dollars to get an MBA, or go work a mindless fortune 500 job. Yes, there will be accelerators and incubators that add much more value than others, just as some schools add much more value than others. But for you to be complaining is just disgusting. This is what we fought so hard for, to have an ecosystem that supports entrepreneurs.

A final thought.

Crowdfunding is about to set the stage for an incredible number of people to take their shots at building things. Just as has always been the case, there will be the same percentage of failures and successes. And that means that in the aggregate there are going to be an amazing amount of failures. There will be a tremendous amount of money lost by investors in these companies, just as there is right now by early stage VCs. Many startups can’t raise real A rounds.

But, the beautiful thing is, that there will be, in the absolute sense, a tremendous number of successful companies which revitalize this economy, providing jobs and innovative products. Not to mention the fact that the education that entrepreneurs get when they start companies is 100 times more important than any you will get in business school. Those who fail once will have the chance to go back a second time, and they will have a much greater chance at success.

Only good will come out of more access to capital at the earliest stages, especially from the crowd, a larger ecosystem of incubation and mentoring, and to put it bluntly, VCs who may not be looking for huge blow it out of the park companies, but those they can help grow to a certain stage and hand off to the next private venture firm to take on that risk. Good markets are about spreading risk around to the places where they can best be handled, in order to increase the amount of capital in the system and reduce the friction between those who have it and those who need it.

So please, shut up about the “wantrepreneurs”, the VCs looking to flip, and the accelerator boom. The people who should not be involved in these things will be handled by the market on their own. Enjoy this boom while it lasts, because it may some day turn into a bubble.

A few days ago ChartIQ launched their platform into the iOS app store and so far they are killing it.

The product is simple but very elegant. There are a number of free stock charting applications out there, including the one I currently use called freestockcharts.com. But each has its huge flaws, including the fact that freestockcharts is built on the HORRIBLE Microsoft Silverlight platform. Dan set out to build the best charting application possible, and he succeeded. But he didn’t stop there, he build a learning tool into it as well that allows you to go back and replay different types of market scenarios, like crashes, breakouts, trending markets, choppy markets. You can trade virtually in the past along with these difference scenarios and learn how to handle them.

Coming from a technical trading background, I think this is pretty awesome. There have been other games and charting packages, but not done this well. The other awesome part, it’s all on the iPad right now, which is where I do more and more of my market work these days. I use my MarketSmith iPad app to flip through my screens once a week now (it used to be once a day), and I love looking at the growth rates on there. But MarketSmith doesn’t allow you to do technical analysis, mark up your charts, or share your charts with others.

Dan is out to make the sharing of technical analysis within the social finance community seamless and fun. He’s got a lot of awesome stuff planned for the app and I’m really bullish on his company as I believe he’ll be able to take the next steps towards becoming a data business and not just a company that sells charting apps.

I highly encourage you to go download the app, and to support Dan, he’s a good dude.

Every platform needs to hustle to solve that initial quandary, believe me in the early days at StockTwits Howard would ask us 10 times a day if there was anyone on the stream. We fought for every person. And then one day, it happened, and the engine starting turning.

The engine is turning now at Estimize, and while I still have just as much to hustle for, it’s nice to see that I don’t have to tell people what the value will be, I can show them what the value is.

So what’s the value? It’s the signal. Our little crowdsourcing experiment is working. Below you will find a spreadsheet created by Jesse Youngmann, our junior developer and data scientist which shows the relative accuracy scores for every release on Estimize since we launched the public beta with 4 or more estimates (what we deem statistically significant).

The results are, to put it lightly, amazing. Over 124 releases, the Estimize community won 79 as a group, that’s 64% or almost 2/3.

We’re also seeing that as the number of estimates goes up, so does the accuracy. As well, the community’s accuracy has been getting better over time as we add an increasing number of different people with different perspectives to the platform.

I’ll shut up now and just let the numbers speak for them self.

But what happened today just takes the cake. Facebook filed its amended S-1 with full accounting for FQ1 2012. In the updated filing, Facebook reports 1.058B in revenue and EPS of 9 cents.

A little more than a month ago we put Facebook up on Estimize, our first private company listing. We had no clue what would happen as there hasn’t been and still isn’t any type of baseline estimate from the sell side. The Estimize community of buy side and independent analysts was all on its own, with no spread to game or baseline scenario to use.

Because of how the site works, we needed to give a Wall Street estimate, so we made one up. We projected 25% YOY revenue and EPS growth. But as the last month went on, we saw the Estimize numbers diverging greatly from this.

And guess what happened. With no guidance what so ever, from the company or the sell side, the Estimize consensus nailed the revenue number, coming in at 1.07B. There were 14 estimates with quite a wide range of opinions, but average together the result was amazing.

Click through the image to see the results.

I was at an event last week called the Entrepreneurs Roundtable where Bo Peabody, formerly of Village Ventures, and now at Greycroft, was speaking. He said something very insightful that really stuck with me. Bo remarked that we’re in a private bubble, and a public boom.

He went on to say that there are companies recently which have come public, like Demand Media and GroupOn, who were not ready to be public companies. They had great growth, but their business models were flawed and they had not yet figured out how to turn a profit. Bo went on to remark that as long as firms like his are losing money, and not the public pension funds, mutual funds, and mom and pop, we’ll be fine.

Back in July I wrote a post titled “The Coming Tech Crash” in which I made the case that we were in fact not headed for a classic asset bubble, but would see many new tech companies come public, and flop, losing public investors a ton of money.

I wasn’t able to articulate it as simply as Bo, but it is true, we are in a private market bubble and a public market boom. Valuations for private tech companies are through the roof, beyond any rational metrics used to value companies, even very high growth companies with massive markets to execute on. Instagram gets bought by Facebook for one billion dollars without a stitch of revenue, enough said.

Interestingly enough, these valuations are not being driven by asset inflows, the cause of asset bubbles. In fact, venture funding has actually been declining recently.

Our private market bubble is being driven by speed and scale. Like no other time in history does a company have the potential to scale as quickly and to such great depth as they do now. This changes the game for investors, who in the past had the opportunity to jump in along the scaling process. Now, because a tipping point can lead to scaling so quickly, investors have moved up their time frames, and are pumping large sums of capital into companies at earlier stages.

These valuations are not being driven so much by classic valuations metrics as they are simply by venture investors wanting to pump large sums of money into companies which they believe have the ability to turn scale into profit down the road.

Bo is right, many of these companies are not ready to be public where they face a market which use classic valuation metrics to determine where they will trade. We’re seeing that in the demolition of Pandora, GroupOn, Zipcar, and Demand Media now. Scaling a user base to massive proportions does not equal being able to show stable growth in profit quarter over quarter.

And that is why we’re seeing these companies stay private for far longer market cap wise than we used to. While companies can scale a lightning speed, it still takes just as much time to build a real business, a business that can withstand the scrutiny of public markets.

One thing that the recently passed JOBSAct does is allow companies to stay private longer by raising the number of shareholders a company can have before having to file an S-1. Many in the market peanut gallery were dismayed by what seemed as giving companies a pass on transparency. While I didn’t quite voice this opinion loudly, I did agree. But, while the transparency issue is an unfortunate side effect, what I realized the other night is that it goes a long way to preventing these companies from coming public well before they should.

And as Bo said, the important thing is that its people like him who lose money on the inflated valuations of these companies, not public investors. While I strongly believe that individuals should be investing in startups at the earliest stages given they undertand the risks, the last thing we need is for these companies to end up in mutual funds. As long as we privatize the losses that this private bubble is going to create, we won’t see a market crash which has a material effect on our economy.