“I think now we’re entering a more rational reality,” Balderton Capital partner David Thévenon said in a panel discussion. “Last year, rounds were closed sometimes in a matter of days, but companies need to realize that isn’t going to happen now. We’re going to ask a lot more questions, particularly around things like cash burn. With the new state of the market, raising money will take longer and it’s not going to be as easy.”
VC investment in startups grew at an unprecedented rate last year, with over $721 billion invested worldwide, according to PitchBook data—an increase of over 100% from 2020. For the first time since the beginning of 2020, capital raised declined in Q1, by more than 19% from the previous quarter. And with less than a month left in Q2, another drop is likely to occur.
Investors pointed to the sudden downturn in tech stocks precipitated by rising inflation and interest rates, as well as the ongoing war in Ukraine, as the cause of the muted activity. With the prospect of a global recession on the horizon, GPs are cautioning portfolio companies to hold off on raising more funds and to focus instead on extending their runways.
“I think that we, as an industry, forgot that economics do matter, and we’re going back to that,” Sapphire Ventures CEO Nino Marakovic said. “All of our companies are being directed to grow more efficiently, which means cuts.”
Hiring freezes and layoffs have already begun to help startups conserve more cash, even those that are well capitalized. B2C companies have been singled out by investors as the most likely to feel the impact of a downturn, and startups like Klarna and Gorillas have recently announced significant job cuts.
But refocusing on profitability will come at the expense of growth, which will necessarily lead to cuts in valuations as startups revise their growth rates.
The immediate impact of the downturn is unclear due to a lag in private data, but there are already signs that late-stage companies are seeing investor caution. In the US, average late-stage pre-money valuations decreased from the highs of 2021, along with the top-decile figure, according to PitchBook’s Q1 US VC Valuations Report.
PitchBook has yet to register an increase in recent down rounds due to the lag in private data, but firms including Balderton Capital, UVC Partners and Sapphire Ventures have marked down assets in their portfolios.
“There’s going to be a culling of the herd,” one GP at SuperVenture said. “There were so many excesses last year that it’s inevitable that companies are going to have to cut prices. It’s not pretty, but a down round is better than clinging on to your valuation and accepting bad terms on your next round.”
With such easy access to capital last year, founder-friendly term sheets were the norm, but investors are noticing that startups are increasingly considering unfavorable deals in order to get cash at a flat or modest increase to their current valuations.
More deals are being conducted at higher liquidation preference multiples—a term which guarantees investors a certain multiple of their invested capital upon exit—or with price-based anti-dilution provisions to protect investors in the event a company sells equity at a lower price.
While the downturn will likely hurt many startups, a good number of investors remain optimistic that the current market environment will be more short-lived than previous crises.
“There’s still a lot of dry powder in the market,” UVC Partners managing partner Ingo Potthof said. “Even if companies are overvalued, they have revenue and cash to survive compared to 2001 where investment demand dropped by 50%. If that happened, we’ll still be at the same level as 2018. We’ll see what happens over the next year, but we shouldn’t just look back at 2021.”
