New climate: Highflying startups have been increasingly grounded due to layoffs, skeptical investors, the possibility of money laundering and valuation cuts.
Last year, e-commerce startup Thrasio LLC was expected to be valued at $10 billion or more in a funding deal that would have led the four-year-old company to go public. The deal didn’t work out, and Thracio, which buys and collects retailers that sell on Amazon.com Inc., continues to burn through more than $3.4 billion in debt and equity.
In recent weeks, Thresio has cut 20% of its workforce, announced a new CEO, put the brakes on acquisitions and started engineering projects, according to an internal company memo reviewed by former employees and the Wall Street Journal. reduced.
Thracio’s trajectory—and the stratospheric rise of many startups—benefited from years of low interest rates and declining numbers of public-company stocks, which helped spur investors into venture capital. The trend accelerated in 2020 when stimulus and other pandemic-relief measures created a flood of cheap capital, which some investors parked in startups as pandemic restrictions, making digital apps and services a hot asset class .
The reversal marks a turning point in the broader tech industry, where stocks are under attack and companies ranging from Facebook parent Meta Platforms Inc. to Twitter Inc. and Uber Technologies Inc. are moving to cut costs.
Many big money managers have fled startups. Venture capitalists shy away from high valuations and are demanding that companies spend less and improve their margins—a face after years of profitability is taking a backseat to growth. The pressure, combined with uncertainty over where the next investor checks will come from, has prompted startups that came a few months ago to fire staff members, cut marketing spending, cancel projects and make their money last. He is inspired to do anything he can.
“It’s clearly not a momentum bump,” said Mike Volpi, a venture capitalist with Index Ventures. “It’s a fair improvement. End of a cycle.”
In March, Doug Ludlow, the startup’s CEO, cautioned his fellow founders on Twitter: “If you haven’t already started on the path to break-even, start right away. In 2022, VCs are going to backtrack in a big way.”
Mr. Ludlow has dealt with this himself. According to a person familiar with the matter, the fundraising plan with new investors failed after markets turned sour and disagreements with investors over the price. He returned to Plan B: a much smaller funding round with his existing investors, known as an insider round.
Mr. Ludlow said he developed a plan for his three-year-old financial-services firm, Mainstreet Work Inc., to break even in six months to a year. It lays off 45 people, which is about a third of the workforce.
“With every dollar you have to treat it as if you had the last dollar,” he said.
Matt Schulman, CEO of software startup Pav, said his investors are scrutinizing gross margin in a way they haven’t before. Payv, which helps employers develop compensation plans and discuss them with employees, has transformed itself from a service to hiring firms that helps companies retain employees. Yes, he said. Too many hiring freezes to understand the previous strategy.
Mr. Shulman recently made a list of 15 possible ways to cut spending. One was more hiring in cheaper regions such as Latin America.
The venture-capital pullback is a correction from extraordinary heights. Investors poured $1.3 trillion into startups over a decade, producing hundreds of companies annually that received valuations in excess of billions of dollars, attracting interest from foreign governments and top-tier hedge funds.
Venture-capital funds raised $132 billion to invest in startups in 2021, nearly double the amount in 2019 and six times the total raised a decade ago, when the number of funds was about a third of what it is today. In the fourth quarter of last year, venture capital investment reached a record $95 billion, according to Pitchbook Data Inc.
Some investors say that was too much money to effectively or wisely deploy. According to data from venture-capital firms, the valuation multiple considered acceptable for software startups reached 100 times annual recurring revenue, which was nearly 10 times the historical benchmark for companies in that industry.
“If you keep marking everything, you’re eventually going to believe those marks are accurate,” said London-based venture capitalist Gil Dibner.
Startups that raised large sums of money at high valuations faced pressure to grow, which they did by rapidly adding employees and making acquisitions. In some companies, the quality of work has deteriorated, acquisitions are not considered, leadership has been eroded and cash has been burned, some investors and startup founders said.
“It was a scam,” said Mr. Dibner. “When you put that much money on anything, you change the way people make decisions.”
Now, the public tech companies that powered the pandemic-era stock-market rally are facing some of the market’s biggest losses. Shares of Facebook parent Meta and Amazon.com are down more than 30% this year, with Apple Inc., Microsoft Corp. and Alphabet Inc. All have fallen about 20% and Netflix Inc. 69% have fallen. The S&P 500 is down 16% from the start of the year, and the Nasdaq Composite Index is down more than a quarter from its high in November.
Private tech companies quickly seemed to be worth more. With interest rates hiked to fight inflation in excess of 8%, startups whose profits were years into the future had little appeal.
Especially important for startups seeking large amounts of capital are crossover funds, large wealth managers that invest in both stocks and private companies. Those managers were responsible for about 70% of the dollars startups raised last year. Some, including Coatue Management LLC and D1 Capital Partners, quickly withdrew from startup investing when a stock market crash affected their investments in public companies. According to Pitchbook, in the first three months of 2022, crossover fund venture capital investment fell to its lowest level in six quarters.
SoftBank Group Corp, which operates two startup investment pools as part of its Vision Fund unit, on Thursday reported a $26.2 billion loss on its large portfolio of technology companies for the first three months of the year. SoftBank said it would cut the number of startup investments by half, or three-quarters, from last year’s pace by next March.
Hedge fund Tiger Global, one of the heaviest startup investors during the pandemic, remains on track to its worst year yet in venture capital investing, with its core fund down 45% year over year. But Tiger is shifting to early-stage companies that have plenty of room to grow and are years away from going public.
According to data from Pitchbook, venture capital investment declined 26% in the first three months of this year from the fourth quarter. Some investors say they’re looking at roughly a third to half of the number of potential deals last year. According to data provided by Carta Inc., valuations for a group of high-growth startups fell an average of 42% from the end of last year to the first quarter.
Venture capitalist David Sachs said the lack of funding has turned the sentiment in Silicon Valley to “the most negative since the dot-com crash” two decades ago.
People familiar with the matter said that Thracio, which has more than 300 retail brands selling items ranging from insect nets to mops, is valued as a tech company despite having limited technology ($15,000 in previous private financing). over 5.5 billion). The startup made its first $100 million or so in revenue without an engineering team and was using Google Spreadsheets, one of the people said.
According to people familiar with the plan, its discussions with a special-purpose acquisition company to go public last year were sparked by Thresio’s accounting and investor souring over SPAC deals, which have traded poorly in public markets.
Thracio is now facing not only venture-capital withdrawal, but also rising costs of merchandise and advertising, and Amazon’s large fees for sellers. The cost situation is squeezing many others as well, and has contributed to more than 8,200 layoffs at US venture-backed startups since March, according to a survey by layoffs announcements and tracking website Layoffs.fyi.
Reef Technology Inc., which builds kitchens for parking lot food delivery services, is struggling to raise funds. It was initially seeking more than $1 billion.
As markets tightened and capital became harder to secure, Reef laid off hundreds of workers, closed kitchens and delayed paying bills. People familiar with the matter said the company recently struck a deal worth more than $250 million in funding.
A Reef spokesperson said the company recently secured new funding from investors, and it expects to add additional investors in the future.
Rapid-delivery startup Gopuff said in a company filing in December that it was seeking to raise up to $1.5 billion in debt that would be converted into equity. According to a person familiar with the matter, the full amount has not been made available. Gopuff is now working to secure a $1 billion loan. According to a memo from the company, it has laid off about 450 people, or 3% of its workforce.
There are structural reasons to believe that the funding turmoil is not leading to a stir. Investors say the digital transformation of the industries the pandemic has helped fuel is permanent. Many startups are cash-strapped and need to keep a lid on spending.
The past loopholes that proved to be brief show the resilience of the tech industry. One of these was in 2016, when investors cooled down on software-as-a-service companies, and another in 2019, when investors punished newly public tech companies for their huge losses. Each time, startup investment boomed and soared to higher levels.
“It’s not, in my opinion, or a 2008 scenario,” said John Chambers, former CEO of Cisco Systems Inc., now a venture capitalist. “Marginal startups just won’t get funded, but I really think it’s a healthy phenomenon.”
For venture capitalists, who no longer have to jockey with multibillion-dollar hedge funds, the recession comes as a relief. Mr. Sachs said his firm, Kraft Ventures, has been able to invest in two late-stage companies without facing competition from big money managers that would have pushed the price too high six months ago.
Meanwhile, venture capitalists are taking back some of the power they gave to company founders when the market was hot. More deals now include protections such as so-called full ratchets, which ensure that investors can recoup the value of their investments in case the startup’s valuation declines in future funding rounds or public offerings. Some investors are providing a startup with capital but not giving a valuation until they can assess its revenue and losses at the end of the year.
According to Jay Zack Stein, president of human resources software startup Lattice, startups must be prepared for things to get worse before they get better.
“Many people join startups to fight adoption,” he said. “They just might get that opportunity.”