Tech start-up valuations are looking frothy. Pre-IPO high flyers such as Uber, Airbnb and Snapchat are seeing their valuations soar to the skies to as much as $50 billion, $24 billion and $16 billion, respectively. Meanwhile, smaller and lesser-known start-ups with names like Zomato (a restaurant finder app), Kabam (which develops multi-player social games) and SimpliVity (purveyor of IT infrastructure platform OmniCube) are reaching the once rarefied level of $1 billion as well.

Last year, the number of new pre-IPO tech start-ups attaining billion-dollar valuations increased by 150% to 38 worldwide, according to CB Insights of New York. Globally, there are now 111 private billion-dollar start-ups. In 2013, there were only 25 such companies. Such high numbers have earned these tech companies new monikers as well: “unicorns” for start-ups with valuations of more than $1 billion and “decacorns” for those that manage to surpass $10 billion.

But is there a tech start-up bubble? “Although it’s hard to call a bubble, there are many who are concerned about the level of pricing across asset classes including venture and private equity,” says Christopher Geczy, adjunct finance professor and academic director of the Wharton Wealth Management Initiative. Valuations are being driven up by capital chasing higher returns in a low interest rate environment that has depressed historical performance. “Many investors are seeking return and seeking yield,” he adds.

And more money could be coming down the pike to drive valuations even higher. “One of the concerns that I have is that private equity and venture capital has seen a growth in overhang,” or the amount of capital committed to the asset class but not yet called or invested, Geczy notes. Sources of the capital include institutions, sovereign wealth funds and individual investors. “Everyone’s chasing the same good deals,” he says. “You can’t really say it’s irrational, but it is a concern.”

One VC’s Story

One veteran venture capitalist was so concerned about valuations that his firm is liquidating all of its start-up holdings. The firm started six months ago and thus far has sold about a quarter of its portfolio with more exits coming. They invested in these start-ups from 2010 to 2012 after the businesses attained “B” and “C” rounds of funding. “We’re planning to sell all of them — everything,” says the VC, who preferred to remain anonymous because of the confidential nature of the deals. “We’re beginning to see all the signs of the first boom of the 1999” dot-com peak right before the crash.

“When companies today are raising private money at what used to be IPO prices and you’re beginning to have a number of [non-traditional] investors coming into the market,” it is one sign of a possible bubble, the venture capitalist adds. These investors include big mutual fund companies that are buying ownership stakes from VCs and company insiders. When early investors and start-up founders start heading for the exits, it is a telling sign, he says.

There is yet another sign of trouble brewing: New funds are being raised by people who don’t have investing backgrounds and yet are becoming venture capitalists. “Now, you have crowdfunding platforms where little investors can invest in venture capital or you have [sites such as] Angel.co where you can publish your start-up and get people to invest in it,” the VC says. He saw the same trend in 1999, when taxi drivers were giving stock advice.

But what makes today’s possible tech bubble so much harder to discern is that much of the financial metrics are private. The dot-com boom and bust of 1999 to 2000 mainly centered on public companies with publicly available data. That is why one can say that “high valuations aren’t necessarily evidence of a bubble, since those high valuations could just reflect high expected growth in profits,” says Wharton finance professor Luke Taylor. “The important and unanswerable question is whether our current growth expectations are rational.”

Globally, there are now 111 private billion-dollar start-ups. In 2013, there were only 25 such companies.

Take Airbnb. According to a June 17 story in The Wall Street Journal, the start-up’s $24 billion is supported by a projection of more than $900 million in revenue for this year, revised upward from $850 million. That is nearly triple the $250 million Airbnb claimed as revenue in 2013. The company expects to see revenue of $10 billion in 2020, with $3 billion in earnings before interest, taxes, depreciation and amortization. Airbnb has grown around 90% over the past two years compared with a 17% boost for Expedia, which is expected to bring in $6.5 billion in revenue this year. Airbnb is seven years old.

But such leaks of internal metrics are far from common for the majority of private start-ups. Indeed, David Wessels, a Wharton adjunct finance professor, cautions that since the companies are not public, it is difficult to definitively judge whether they are overvalued without knowing more specifics. “Everyone is focusing on an artificial number for valuations, but in private markets, you’re getting a special kind of contract,” he points out. “Yes, they are really rich valuations, but what are the exact terms? Are they truly buying common stocks? Or are they preferred shares with other options? Those can really affect rates of returns for investments.

“Private markets are much more complex,” he adds. “Traditional valuation methods don’t apply, so price is a lot more difficult to pin down, and valuations become biased upwards. We need to look at deal terms before ascribing valuations. However, we don’t have the data because they’re private transactions.”

Rush of Investors

In the meantime, venture capitalists, private equity firms, hedge funds, angels and other investors continue to pour money into these start-ups. Venture capital funding hit $47.3 billion in 2014, the highest since 2001, according to CB Insights. The year-over-year growth was a robust 62%, fueled by half-billion-dollar rounds of funding. Indeed, the number of companies that have gone through mega-rounds of funding more than doubled from 20 in 2013 to 50 last year, the firm said. This investor demand is helping to push up valuations.

Take Spotify, the music streaming service. The European start-up raised $526 million in its latest round of funding, with Swedish telecom operator TeliaSonera investing $115 million. The company’s purchase of a mere 1.4% stake drove the valuation upward to $8.2 billion. The move “drove the reevaluation of the rest of the stock so it’s a very marginal stake affecting total price. It’s illiquid and you’re likely to have gaps across the capital structure, especially between preferred and common stock,” notes Ian D’Souza, professor of venture capital and behavioral finance at New York University’s Stern Business School.

Some start-ups might also hope to benefit from large companies wanting to scoop them up, with Facebook paying $19 billion for WhatsApp, the instant messaging service, and Microsoft paying $2.5 billion for Mojang, the Swedish start-up that designed the video game Minecraft. “Many tech companies are playing a game of chicken, hoping to be bailed out by a desperate acquirer,” notes Wessels. Companies like Microsoft and Yahoo might pay high prices for private companies in a strategic acquisition. While that was a huge win for WhatsApp, there are only so many Facebooks out there; only a handful of companies can make these large purchases, he says.

Indeed, those success stories are the rare fairy tales that have come true. In 2014, only 1.1% of the tech exits were greater than $1 billion. Most went public with valuations of less than $200 million, according to CB Insights. However, the number of private tech exits at $1 billion valuations nearly doubled to 32 last year from 17 in 2013, perhaps fueling the aspirations of so many entrepreneurs who may be pinning their hopes on that big payout.

“High valuations aren’t necessarily evidence of a bubble, since those high valuations could just reflect high expected growth in profits.”–Luke Taylor

Moreover, the stock market has been bullish for about six years now so start-up founders might feel they have plenty of time to go public. With Fed rates hovering near zero, there is also the matter of plenty of cash looking for a home — and aiming for extraordinary returns in spite of higher risks. D’Souza notes that “there’s so much liquidity out there, there is no reason to tap public markets. Anyone with a decent business plan is getting funding for their ventures without undue regulatory oversight, GAAP or quarterly reporting requirements when listed.”

There is also the fear of missing out, or the “FOMO,” factor. Benchmark Capital partner and Uber board director Bill Gurley predicts lots of failures for the new crop of unicorns. However, he told Fortune magazine in a January 22 article, “You can’t choose not to play. If you’re in the enterprise segment and your competitors are raising $150 million at high valuations and pouring it into sales, you either can do something similar or be conservative and no longer matter.”

“For those investors going in, it could be FOMO or they could be seeing something else,” Wessels says.

Traditional Investors as VCs

A change in the types of investors getting into riskier, pre-IPO tech start-ups is also driving up valuations. These include those that do not typically participate in the late-stage venture capital rounds, such as hedge funds, mutual funds, private equity, sovereign wealth and corporations. “Less than three years ago, no one would have thought that hedge fund and mutual fund managers as a collective herd would provide so much support for private companies,” notes D’Souza. “The landscape has morphed.”

Fidelity Investments, one of the world’s largest mutual fund and financial services firms, joined the fray in Uber’s last financing round, contributing $425 million of the $1.2 billion raised. Fidelity was also a pre-IPO investor in Facebook.

One reason for their interest in privately held start-ups is that it has become more competitive and expensive to get stock allocation once the company goes public. “It’s a logical response to another trend we’re seeing: Pre-IPO tech companies are raising much more money before their IPOs,” Taylor says. “For investors like mutual funds to get exposure to companies at this stage in their life-cycle, they now have to invest before the IPO.”

Notes D’Souza: “Most active fund managers are finding it nearly impossible to beat stock-market indexes and want to capture the illiquidity discount or IPO pop ahead of a listing — something that was historically the domain of VC firms, angels, founders and employees.” Investing in companies early allows both mutual funds and hedge funds to potentially beat the public market indexes with blended private and public investments, as well as demonstrate their alpha generating skills relative to passive index funds or ETFs, he adds.

“Anyone with a decent business plan is getting funding for their ventures.”–Ian D’Souza

Wessels explains further that some of these hedge funds and mutual fund companies are not seeing the IPOs they used to see in the 1990s. “Hot companies are not going public and they’re staying private longer. Secondary-market companies want to get them relatively young. There’s a sophistication of the private markets. When you’re in the private markets, there is more flexibility and complexity to the contracts,” he says.

However, it doesn’t mean traditional investors have necessarily become high-risk venture capitalists. In these late-stage financing rounds, companies could ask for preferred shares and negotiate “ratchets,” which essentially protects their investments. The investors get a guarantee on their return on IPOs, usually with more shares, but the deals also dilute the profits early investors stand to gain.

Some companies have undergone “down rounds,” meaning they fetch lower valuations than what they received at their prior round of financing. Also, around 20% of tech companies went through IPO haircuts, a drop in valuation at the IPO from the last financing round, according to PitchBook.

When cloud-storage service Box went public in January, its shares were 30% lower than the valuation the company received six months prior in its last round of financing. Investors did not lose out though, instead profiting with a 10% unrealized gain due to a ratchet deal. PitchBook reported that many of these haircut IPOs regained their valuations, if not exceeded them.

Game of Risk?

Though the idea of investing in pre-IPO tech start-ups sounds like the risk is confined to private companies, there might be repercussions to the capital markets as well. Morningstar found more than 100 mutual funds with hefty stakes in pre-IPO tech firms like Dropbox and Snapchat.

Even the expectation of higher interest rates from the Fed might not deflate the high valuations of private start-ups. Wessels notes it “will affect valuations of [public] markets, no question. However, the valuations of [private] companies are based on fundamentally different economics. It’s more based on what these companies are promising for the future.”

The current tech frothiness is different from the dot-com bubble that burst in 2000 in some important ways. Tech companies are waiting longer to go to IPO so valuations might be rising on the late-stage financing side rather than when the firms go public on the stock market. Another difference is that the level of venture capital today is only a third of where it was at in 2000, according to Google Ventures data published in TechCrunch. But then, interest rates are “dramatically lower” today and money supply has increased, Geczy says. While there are signs that a tech start-up bubble could be forming, it is tough to say whether it has peaked. “It’s very hard to pick the top of a bubble,” he adds.

The venture capitalist cited earlier believes the current boom could go on another 12 months or so, since many start-ups still have enough money to last that long. But once that money is gone and they try to raise more funds but cannot get it, the market will get spooked. “The bust will come when they cannot raise the next round,” the VC says. “Then everyone will begin to question the fundamentals.” He notes that most VCs have exit plans, but it is another matter for the funds, which could be left holding the bag if the tech bubble does burst. “I think they will be in for a rude awakening,” he says.