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Tech sell-off has VCs worried about a drop in startup valuations

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After a blockbuster year of venture capital agreements, some investors are worried that boom times may not last much longer.

Technological start-ups raised a record $ 621 billion in venture financing globally in 2021, according to CB Insights, more than doubling from a year earlier. The number of privately owned “unicorn” companies worth $ 1 billion or more increased 69% to 959.

Private companies like Stripe and Klarna saw their valuations swell to tens of tens of billions of dollars, helped by a flow of cash as a result of ultra-loose monetary policy and the acceleration of digital adoption during the Covid-19 pandemic.

Now that the Federal Reserve is hinting at plans to raise interest rates in an attempt to cool rising prices, investors in high-growth technology companies are getting cold feet. The Nasdaq Composite has fallen above 15% so far this year, as fears of a tighter policy have led to a rotation of growth stocks to sectors that would benefit from higher interest rates, such as finance.

In the private markets, panic over technological sales is beginning to erupt. VC investors say they already hear about deals being renegotiated to lower valuations and even withdrawal of term sheets. Later stages are likely to be hardest hit, they say, while some companies’ plans to go public may be put on hold for the foreseeable future.

“It’s definitely seeping through to the private markets and the later rounds,” said Ophelia Brown, founder of Blossom Capital. “Term sheets are being renegotiated. Some term sheets have been pulled.”

The shift in tone is an echo of negative sentiment surrounding start-up investments around the start of the Covid pandemic. In March 2020, Sequoia warned the founders about “turbulence” in a blog post reminiscent of their 2008 presentation “RIP Good Times”. For a brief period, the Silicon Valley firm was right: A number of start-ups saw their valuations cut down in the beginning, while others got term sheets drawn.

But what followed was a banner year for startups, with companies raising $ 294 billion by 2020 globally. Hedge fund giant Tiger Global became a major driver of the market, supporting tech companies at much earlier stages than before, as traditional investors sought returns via alternative assets.

However, Brown believes that some of the reaction in both public and privately traded technology stocks has been exaggerated and that most start-ups should be able to cope with a changing economic cycle given the mountain of cash available in private markets.

“There is still so much dry powder for new rounds of funding,” she said. “Most companies have been very well funded, that unless they were completely ruthless with the cash, they should be able to figure this out.”

Down rounds

A handful of companies have managed to raise impressive funding rounds in the first few weeks of the new year., a UK-based payment firm Brown has invested in, made a $ 1 billion deal worth $ 40 billion, while Estonian company Bolt secured a $ 8.4 billion valuation in a $ 711 million fundraise dollars.

However, some VCs are concerned that we may be seeing a wave of “down-rounds” where start-ups are raising funds to a value lower than in previous rounds. They say companies in the later stages of fundraising are likely to be hardest hit.

“There will be more downward pressure on pricing in later phases,” said Saar Gur, general partner at venture capital firm CRV.

“We will see more valuation compression and it will be harder to get many later phase rounds completed,” Gur added. “And we do not want to see companies have such fast mark-ups without much more business growth.”

Gur, an early investor in DoorDash, said many private start-ups have achieved multi-billion dollar valuations based on comparisons with stock market multiples. Now that several high-flying tech companies have seen their stock prices fall, competitors in the private markets may be forced to follow suit, he says.

Still, that’s not all, according to Gur: “I still think the system is full of capital and big companies will travel.”

Dotcom buste?

Hussein Kanji, a partner at Hoxton Ventures, believes private technology companies are likely to pause any plans for listed offerings as liquidity conditions begin to tighten.

“I think the IPO window will be closed,” Kanji said. “All the funds with companies that think they would go out in 2022 are likely to stall.”

Still, there is plenty of money in SPACs or special-purpose acquisition companies sitting on the sidelines, Kanji said. SPACs are listed shell companies that take other firms publicly through merger agreements. In 2021, these companies raised a record $ 145 billion, almost doubling the amount of the previous year.

Some investors fear that a tighter policy could cause a dive in stock markets in line with the bursting of the dot-com bubble in the early 2000s. While worth noting, there has long been concern that U.S. stocks are in a bubble.

“I’m curious to see if that’s the case [a] dot-com correction and becomes prolonged, or [just] a blip, “Kanji said.

No matter what happens in the public markets, companies in the early stages are unlikely to be affected, according to Brown, who has previously worked at Index Ventures and LocalGlobe.

“It will take some time” before the fallout from technology outbreaks hits start-ups in the early stages, she said, adding that companies traveling in earlier stages “have always been somewhat protected from public markets.”

Mergers and acquisitions could, according to Brown, provide an alternative route for companies that had been sitting on plans to go public.

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