The bloodbath in the frothiest corners of financial markets may have some venture capitalists wondering if it’s time to walk away.
While it’s too early to say the good times are over — tech stocks rebounded strongly at the start of this week — there's bound to be some kind of reckoning for startups: landing a high-priced exit may get harder for their financial backers. Some may reflect it’s not worth the effort and head off to the beach — embracing a flavor of the “lie flat” philosophy of Chinese millennials who are opting out of the rat race. Don’t take my word for it. Here’s Miami-based venture capitalist Keith Rabois’s assessment in the wake of recent market mayhem.
VCs could certainly use a break: Total funding for startups doubled to almost $160 billion in the third quarter compared to the same period a year ago, according to data provider CB Insights.
Competition for deals has intensified with non-traditional tech investors such as family offices, mutual, sovereign-wealth and hedge funds joining the fray. To keep pace with free-spending giants like SoftBank Group Corp. and Tiger Global Management, funding rounds that once took weeks have been compressed into a few days. It makes you wonder how much due diligence everyone’s doing.
Naturally, prices have shot up too. It’s common for valuations to double in late-stage U.S. funding rounds and again when there’s an exit via an initial public offering, according to PitchBook data.
There are reports of seed rounds getting done at eye-watering $100 million valuations. The world now has around 925 unicorns (start-ups worth $1 billion or more), about twice as many as two years ago.
A cooling-off period was probably overdue but the emerging fears about sticky inflation sending interest rates higher sooner than expected present a quandary. Will investors in public markets be willing to pay such high multiples when it’s time for a startup to hold an IPO?
Here’s how venture capitalist/SPAC sponsor Chamath Palihapitiya appraised the situation on his podcast a few days ago. (Needless to say, some of the companies his SPACs took public, such as Virgin Galactic Holdings Inc. and Opendoor Technologies Inc., have taken a beating in the markets).
“The real problem is all these companies that raised a lot of money in private markets are now going to get stuck, because if the public markets have compressed multiples by 30-50%, they are the ultimate buyer.
The idea that you can wait and go public later may not stand to reason, especially if inflation really keeps these multiples in check. And so all these private businesses and then all of the ones that were planning IPOs in the next 12 to 18 months are probably in a little bit more of a challenging spot than they were before.
Palihapitiya and his “besties” also discussed another phenomenon that’s rattled the VC world lately: VC partners stepping back from their core investing duties while still a long way off retirement age.
Recent examples include Jeremy Liew of Lightspeed Venture Partners, Spark Capital co-founder Bijan Sabet and IA Ventures’ Roger Ehrenberg. Benchmark’s Bill Gurley transitioned to a new role last year.
Each had their own reasons, and often they're very personal. From what I’ve read, most don’t plan on just putting their feet up. Even if they’re not as busy pursuing new investments, there are still corporate boards to sit on or philanthropic projects to pursue.
Still, you can see why others might now decide it’s time for a change, as Rabois suggests. Due to the pandemic and increased competition, VCs are working harder to land the next deal. With so much capital sloshing around, entrepreneurs are the ones calling the shots now, not their paymasters.
If interest rates rise, it will be harder for start-up funders to generate the stellar returns they’ve made this past decade in speculative technology. Long-serving partners have made so much money, they need never work again. So if you’re looking for another sign financial markets have peaked, look out for VCs embracing the lie-flat philosophy.
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