Startup culture is now so embedded in our life it seems almost impossible to imagine life without it. Everyone wants a bit of that entrepreneurial magic these days.
Even among the big companies, it’s in with the cereal stations, for those all-day millennial breakfasts, and out with the ties, as everyone competes for the coolest office. But there are worrying signs that all is not well in startup land.
After a lengthy boom, the financing climate is starting to shift, and startups face an even harder time convincing venture capitalists to loosen the purse strings.
It isn’t that those venture capitalists aren’t flush with cash. In fact, they are raising new money from eager pension funds, college endowments and other investors at the fastest clip that they have since the dotcom era, according to recent reports, collecting nearly $13bn in the first quarter alone.
Those investors are anxious to get an early stake in the next generation of “unicorns”, the companies like Uber and Pinterest that went, seemingly overnight, from being fledgling niche players to businesses with billion-dollar valuations. The problem now is some of those unicorns are teetering on the verge of becoming “unicorpses”, unable to turn in the kind of profits required to sustain those lofty valuations.
At the same time, investment companies like Fidelity and Blackrock are publicly disclosing that they’re writing down the value of their holdings in once flagship operations such as Snapchat and Square.
The answer for some venture capital outfits has been to go in quest of a new generation of unicorns.
That’s precisely what venture investors did during the first quarter, the data shows. The first-quarter MoneyTree Report, compiled by PricewaterhouseCoopers LLP and the National Venture Capital Association (and based on data provided by Thomson Reuters), showed that they invested $12.1bn in 969 deals in the first three months of 2016.
That’s the ninth quarter in a row during which these investors put more than $10bn to work in startup companies. But – and it’s a big but – there are some worrying trends for aspiring entrepreneurs behind that big number.
First, the total dollar figure, while huge, is also flat compared with the final three months of 2015, and down 11% from year-ago levels. Then, too, there was a 10% drop in the number of seed-stage, or early, deals being funded: seed deals fell 6%, while early-stage financings plunged 18% in dollar terms and 22% in terms of the number of transactions.
Clearly, venture capitalists are hanging on to their money and putting it to work in later-stage companies where the business idea has been better proven (a good thing), or using it to provide additional rounds of capital for companies already in their portfolios (maybe necessary for those businesses, but not such great news for other entrepreneurs hoping to get added to the list of young startups backed by one of these firms). Even then, the size of those late-stage deals was smaller: only $16.3m, on average, down from $17.7m in the previous quarter.
It’s a prudent strategy, but it also signals that they are at least slightly wary of what might be heading their way next.
As do those “down rounds”.
Those of us who recall the bloodshed that followed the bursting of the dotcom bubble in the early months of 2000, and endured for years that followed, will also vividly recall the so-called down rounds, which became a fact of life for those startup companies that even managed to survive.
I spent two days sitting in at a venture capital offsite session in July of 2000 in downtown Palo Alto, during which a group of investors discussed the funding needs of one company after another. Each of those businesses was one that the investors had carefully chosen to back from among dozens, if not hundreds of rivals; their CEOs and team members were people they knew well and had worked closely with. And now they were doing triage, deciding which would get the funding they needed and wanted, and which would only get a fraction of that amount, in a tighter environment. (One of the big winners in this brutal process would be Netflix.)
Estimates vary, but between $5tn and $6tn in wealth vanished in the years that followed. Talking about those years now can feel like talking to someone who survived the sinking of the Titanic, or four years of battle on the Western Front in the first world war, or a life-or-death struggle with cancer. That’s how vivid (and admittedly overwrought) some of their descriptions can get.
And then Silicon Valley and venture capital sprang back to life, thanks to a new round of startups, from Google, to Facebook and Twitter, to Uber, Instagram and Snapchat. Things got so overheated that one veteran venture capitalist, Bill Gurley, even took to Twitter to proclaim that “arguing we aren’t in bubble because it’s not as bad as 1999 is like saying that Kim Jong-un is fine because he’s not as bad as Hitler.” In the other corner of the ring, Marc Andreessen of Andreessen Horowitz – a firm that managed to bring its portfolio technology companies public even in 2001, in the depths of the nuclear winter that followed the dotcom debacle – refuses even to contemplate the idea of another bubble.
Bubble or not, we are seeing down rounds: the phenomenon in which a company raises a new round of funding at a valuation that is lower than the one where it raised money the last time around. That’s a bit like taking a new job and being handed a fancy new title – but being told that you’re getting a lower salary.
Foursquare, an app that allows users to find and “check in” to local restaurants, raised new capital in December that valued the company at only $250m – half of what it was worth two years earlier. Jawbone’s valuation plunged by $1.5bn when it raised $165m, mostly from the Kuwait Investment Authority. Couchbase, a database company still reporting healthy gains in customers, raised $30m in new capital last month – but at a valuation 41% below where it was in mid-2014. The company’s CEO says it is still on track to an IPO, however.
Startups don’t even have to encounter stingy venture capitalists to get stung by the new, more difficult financing environment. Gilt Groupe didn’t opt to try to raise more money, but instead decided to sell itself to the parent of Saks Fifth Avenue. The price tag was more gilt than golden: the originator of the flash sales fetched a mere $250m, a fraction of the billion dollars it once was worth.
Nor, in this turbulent market environment, should startup companies expect that the IPO is a rescue strategy. Yes, I know that Bats Global Markets, an exchange operator, went public yesterday in its second attempt at an IPO, and the deal went well. But – cliche alert – just as a single swallow does not make a summer, so a solitary successful IPO does not signal that the market is ready to absorb the estimated 120 plus offerings that have been lingering on the sidelines for months, waiting for a green light. The first quarter of 2016 was the worst three-month period on record for IPOs since 2009. If anything, in the wake of the market’s turbulence and in view of the high valuations that venture capitalists will want their startups to realize in an IPO, ordinary investors may be skeptical of new deals being heavily marketed – and they may have every reason to be.
History rarely repeats itself precisely. During the dotcom bubble, it was ordinary investors who ended up paying the price for the foolishness, directly, because we had snapped up shares in companies like Pets.com (with its cute sock puppet earnestly telling us, in costly Superbowl ads, that the company’s pet supplies delivery business was a winner, because “pets don’t drive”) and Kozmo.com, and indirectly, because the mutual funds we owned were stuffed full of them, too. This time around, however, the damage will be more indirect. Most of these overvalued businesses are still private, backed by institutional investors.
That doesn’t mean we won’t feel the pain, though. Those institutions include pension plans, endowments and foundations. If they lose money, they’ll be less able to deliver on their obligations to retirees, to offer college aid packages to offset the truly horrific tuition prices levied by their institutions, or to finance much-needed philanthropic works. Just something to remember when the down rounds start coming thicker and faster, and the venture funding dwindles still further.
This article was written by Suzanne McGee, for theguardian.com on Sunday 17th April 2016 14.26 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010