Layoffs, rising interest rates, rising valuations – this is a tough time for startups.
Amid the general economic downturn and the bear market for tech stocks, investors have favored profitability — or at least a reasonable path to it — over the promise of future growth.
That was a tough sell for the VC-backed startup market’s ability to monetize innovation, at least in the short term.
One of the biggest takeaways of 2022 was the “lethargic” pace of exits, according to PitchBook and the National Venture Capital Association’s just-released annual overview of venture fund trends. Total exit value generated was $71.4 billion, down 90.5% from 2021’s record $753.2 billion. It was the first time since 2016 that exit value had fallen below $100 billion, with late-stage companies being hit the hardest. IPOs by VC-backed companies fell to levels not seen since the early 1990s, with just 14 public listings in the fourth quarter.
We’ve been here before.
As the economy collapsed in 2008, legendary venture firm Sequoia released the infamous memo titled “RIP Good Times,” in which it proclaimed to startups that “cutting is a must” along with the “need to become cash flow positive “.
More than a decade later, those who heeded that advice became game-changing tech giants, including CNBC Disruptor 50 companies block, Pinterestrelaxed, Twilioand Cloudera.
One of these achieved a market cap of more than $50 billion despite going public in a volatile environment: Airbnban eight-time Disruptor 50 company that shares the same distinction with only one other company in the history of the annual list – Stripe.
Airbnb Inc. signage on an electronic monitor during the company’s initial public offering (IPO) at the Nasdaq MarketSite in New York, the United States on Thursday, October 12, 2020.
Victor J. Brown | Bloomberg | Getty Images
Stripe topped the 2020 Disruptor 50 list, released shortly after the Covid crash. Months earlier, Sequoia released another widely read memo, titled “Black Swan,” which pointed to persistent inflation and geopolitical conflicts that would limit the ability for “quick” policy fixes like interest rate cuts or quantitative easing.
Last year, Sequoia’s partners admitted they had underestimated the monetary and fiscal policy response to the Covid crisis. Two months later, we got an idea of the market correction they were signaling when Stripe cut its internal valuation by 28% from $95 billion to $74 billion, in one of many private company cuts in 2022. This week, The Information reported that Stripe had again cut its valuation by 11% to $63 billion.
Founded in 2010, Stripe’s business took off as the US economy and job market began to recover from the financial crisis and took a boost during the Covid-19 pandemic. “We have been far too optimistic about the near-term growth of the internet economy in 2022 and 2023, and underestimated both the likelihood and impact of a broader slowdown,” the founders wrote in a recent memo about layoffs.
“The world is changing again now. We face stubborn inflation, energy shocks, higher interest rates, reduced investment budgets and tighter seed funding. … We believe that 2022 will mark the beginning of a different economic climate. … Today, that means building differently for leaner times,” the founders told employees.
“Investors continue to invest in innovation at times like these,” said Kyle Stanford, senior analyst at PitchBook. But he added that it’s most noticeable in the difference between early-stage and late-stage venture growth.
Seed rounds hit an all-time high in 2022, and valuations continued to rise even as late-stage venture companies that were moving closer to the public market suffered. With sales multiples as high as 150x in 2021 and now up to 10x for listed peers, investors see companies that are close to the public markets as in a penalty box because investors “can’t afford those valuations.” “Won’t get it to phase out in the next year or so,” Stanford said.
That huge gap and funding difficulties will remain for many of these companies, especially given the opportunistic investors who have flocked to them — crossover funds, private equity funds and sovereign wealth funds — who are pulling out as they see the quick exit gains cannot achieve with high multipliers which were plentiful in 2021.
Smaller tech bets keep getting bigger
Despite the environment and lack of public deals, VC funding remains strong. According to PitchBook and the NVCA, venture funds raised a record amount of money in 2022 with $162.8 billion closing across 769 funds. It was the second year in a row to exceed $150 billion. And younger companies get more money. In 2022, early-stage VC deals raised $68.4 billion, approaching 2021’s figure, although the first half of the year accounted for over 60% of the money. Meanwhile, investors fled late-stage VC deals, with fourth-quarter transaction value of $13.5 billion, a five-year low.
Previous recessions have ultimately produced dominant tech companies, including iconic names like Hewlett Packard, Microsoft, and Electronic Arts. Specifically, during the 2008-2009 downturn, Tech unicorns totaling $150 billion were created, including 24 Disruptor 50 companies, according to startup Genome. Including Airbnb, Block, Pinterest, Slack and WhatsApp.
In the short term, things aren’t getting any easier for the largest venture-backed firms.
“Late-Stage Venture is in a difficult position,” Stanford said. “But an IPO on a down lap won’t end these companies. We’ve seen companies struggle as public companies and then shoot up, so a lower-value IPO isn’t the end of the road.”
But with the roughly 3,600 venture funds that have closed in the US over the last four years, what investors are really looking for are the many funds (about 1,650 of them) under $50 million that focus on seed and pre-market deals. Focus seed companies. “There’s a lot of capital for new ideas and new technologies,” Stanford said.
Tougher times also mean better pitches from founders and better run companies. Starting a business during a downturn implies a business plan for more sustainable growth, and startups today have to present much more detailed and perfected pitches to investors. “You have to be at your best now to get capital,” Stanford said. “But if you can generate new market share in a tough market when the market turns, you are in a perfect position to gain more market share and customers.”
Whatever Airbnb and Uber have become during the decade of ebullient valuations and startup “growth at any cost” business models, they started out as brawling companies in troubled times, embracing disruptive ideas.
“Investors should pay particular attention to the companies emerging from this downturn,” said Julia Boorstin, CNBC’s senior media & technology correspondent and creator of the Disruptor 50, in an appearance on CNBC’s “Squawk Box” earlier this week. “The leanest of times can force new types of piecemeal innovation,” Boorstin said.
CNBC is now accepting nominations for the 2023 Disruptor 50 list – our 11th annual look at the most innovative venture capital companies. Learn more about eligibility and how to submit an application by Friday, February 2nd. 17