Drop in funding is a warning to startups

FOR the first time in 3 years, startup funding is dropping.

The numbers are stark. Investments in US tech startups plunged 23 per cent over the past 3 months, to US$62.3 billion, the steepest fall since 2019, according to figures released Thursday (Jul 7) by PitchBook, which tracks young companies. Even worse, in the first 6 months of the year, startup sales and initial public offerings - the primary ways these companies return cash to investors - plummeted 88 per cent, to US$49 billion, from a year ago.

The declines are a rarity in the startup ecosystem, which enjoyed more than a decade of outsize growth fuelled by a booming economy, low interest rates and people using more and more technology, from smartphones to apps to artificial intelligence. That surge produced now-household names such as Airbnb and Instacart. Over the past decade, quarterly funding to high-growth startups fell just 7 times.

But as rising interest rates, inflation and uncertainty stemming from the war in Ukraine have cast a pall over the global economy this year, young tech companies have gotten hit. And that foreshadows a difficult period for the tech industry, which relies on startups in Silicon Valley and beyond to provide the next big innovation and growth engine.

"We've been in a long bull market," said Kirsten Green, an investor with Forerunner Ventures, adding that the pullback was partly a reaction to that frenzied period of dealmaking, as well as to macroeconomic uncertainty. "What we're doing right now is calming things down and cutting out some of the noise."

The startup industry still has plenty of money behind it, and no collapse is imminent. Investors continue to do deals, funding 4,457 transactions in the past 3 months, up 4 per cent from a year ago, according to PitchBook. Venture capital firms, including Andreessen Horowitz and Sequoia Capital, are also still raising large new funds that can be deployed into young companies, collecting US$122 billion in commitments so far this year, PitchBook said.

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Startups are also accustomed to the boy who cried wolf. Over the past decade, various blips in the market have led to predictions that tech was in a bubble that would soon burst. Each time, tech bounced back even stronger, and more money poured in.

Even so, the warning signs that all is not well have recently become more prominent.

Venture capitalists, such as those at Sequoia Capital and Lightspeed Venture Partners, have cautioned young firms to cut costs, conserve cash and prepare for hard times. In response, many startups have laid off workers and instituted hiring freezes. Some companies - including payments startup Fast, home design company Modsy and travel startup WanderJaunt - have shut down.

The pain has also reached young companies that went public in the past 2 years. Shares of onetime startup darlings like stocks app Robinhood, scooter startup Bird Global and cryptocurrency exchange Coinbase have tumbled between 86 per cent and 95 per cent below their highs from the last year. Enjoy Technology, a retail startup that went public in October, filed for bankruptcy last week. Electric Last Mile Solutions, an electric vehicle startup that went public in June 2021, said last month that it would liquidate its assets.

Kyle Stanford, an analyst with PitchBook, said the difference this year was that the huge checks and soaring valuations of 2021 were not happening. "Those were unsustainable," he said.

The startup market has now reached a kind of stalemate - particularly for the largest and most mature companies - which has led to a lack of action in new funding, said Mark Goldberg, an investor at Index Ventures. Many startup founders don't want to raise money these days at a price that values their company lower than it was once worth, while investors don't want to pay the elevated prices of last year, he said. The result is stasis.

"It's pretty much frozen," Goldberg said.

Additionally, so many startups collected huge piles of cash during the recent boom times that few have needed to raise money this year, he said. That could change next year, when some of the companies start running low on cash. "The logjam will break at some point," Goldberg said.

David Spreng, an investor at Runway Growth Capital, a venture debt investment firm, said he had seen a disconnect between investors and startup executives over the state of the market.

"Pretty much every VC is sounding alarm bells," he said. But, he added, "the management teams we're talking to, they all seem to think: We'll be fine, no worries".

The one thing he has seen every company do, he said, is freeze its hiring. "When we start seeing companies miss their revenue goals, then it's time to get a little worried," Spreng said.

Still, the huge piles of capital that venture capital firms have accumulated to back new startups has given many in the industry confidence that it will avoid a major collapse.

"When the spigot turns back on, VC will be set up to get back to putting a lot of capital back to work," Stanford said. "If the broader economic climate doesn't get worse." NYTIMES