The great Silicon Valley shake-out

The techno beatlessness is now spreading to the private markets. Fundraising has slowed sharply compared with the second half of 2021. Between March and May the number of funding rounds was down by 7% in America, compared with the same period last year, according to PitchBook. In Asia it declined by 11% and in Europe by 19%. Things are almost certainly worse than those numbers suggest. A delay in reporting means they lag behind the reality on the ground by a few months. vc investors say that hardly any deals are being inked these days. Fewer startups are also “exiting”, vc lingo for being listed or sold on to other investors.

Investors’ reticence is having an effect on valuations in private markets. Such drops usually only come to light during private funding rounds or public listings, when a firm raises capital in exchange for equity, or when a company changes hands. Less fundraising and fewer exits makes this harder to assess.

ApeVue, a data provider, offers a hint of what is happening by tracking share prices in the secondary markets, where shares of private firms can be bought and sold. An equally weighted index of the 50 most-traded startups has declined by 17% since its peak in January. Using ApeVue’s data, The Economist estimates that a basket of 12 big startups worth $1trn at the start of this year is now worth about $750bn. That list includes Stripe, a fintech star, which has seen its secondary-market share price collapse by 45% since January, and ByteDance, TikTok’s Chinese parent company, the shares of which trade at a quarter below their value six months ago.

Secondary-market valuations of private firms have not yet dropped as far as public ones. ApeVue’s index is down by about ten percentage points less than the nasdaq composite so far this year. Comparing private firms with listed rivals reveals the same pattern. The share price of Impossible Foods, a private purveyor of meatless meat, has fallen by 17% since January, while that of Beyond Meat, a listed competitor, has slid by 61%.

This could mean that startup valuations are more robust than market capitalisations of listed firms. Alternatively, they could have further to fall. The ultimate test will be the number of “down rounds”, where firms raise new capital at a lower valuation than before. Founders dislike these more than secondary-market dips. Down rounds are a more definitive indication of falling value. They also hurt the morale of employees, who are often compensated for their grinding hours with stock options. And they irk vc firms forced to mark down the value of their investments, which is not something that their limited partners want to hear.

Only a few down rounds have been publicly reported. Last month, for example, the Wall Street Journal reported that Klarna, a Swedish fintech firm, was seeking fresh funds at a valuation two-thirds lower than its previous round a year ago. In March Instacart, a grocery-delivery firm, took the even more unusual step of valuing itself down from $39bn in March last year to $24bn, without raising fresh capital.

To avoid having to raise capital in a rush at a depressed valuation, founders are busy trimming the fat. “Last year one dollar of growth was all the same, whether it cost 90 cents or $1.5 to acquire it,” says Hilary Gosher of Insight Partners, a vc firm. Nowadays the watchwords are capital-efficient growth. The average cash-burn rate has fallen in the past year for all types of startup, from the youngest to the more mature, according to Brex’s data.

One way startups are containing costs is by cutting staff. According to Layoffs.fyi, a website, around 800 startups have reduced their payrolls since mid-March. Getir, a Turkish delivery app, has sacked over 4,000 people (or 14% of its workforce). Better.com, an online mortgage lender, has laid off 3,000 (33%). Another common strategy is to spend less on marketing. SensorTower, a firm of analysts, tallies how much firms spend on digital marketing. The median of the world’s 50 biggest startups has reduced such expenditures in America by 43% since January. Some categories, such as instant-delivery firms, including Getir and GoPuff, an American rival, have made even more swingeing cuts.

For some firms the cuts will not go far enough. Those most exposed to a Fast-like fate are early-stage companies. On average, their burn rate implies they have capital for about 20 months, less than the 30 months that most venture capitalists are warning founders to prepare for.

Among mature firms, three groups stand out as higher risk. One are companies in competitive businesses, such as cybersecurity, instant delivery and fintech, which suffer from an “oversupply of venture capital”, says Asheem Chandna of Greylock Partners, one more vc firm. “Any time something starts working, vcs will go and fund ten of these,” he adds. The winners could do well. Middling firms may struggle to survive.

The money has not dried up altogether. In Europe the average deal size actually edged up a bit (see chart 5). Well-capitalised companies smell opportunities. As the red-hot market for tech talent cools off, they will find it easier and cheaper to hire. And smaller rivals may be cheaper to buy. In the past few months the vc arms of established tech firms such as ibm, Intel and Salesforce have bought startups. So have industrial giants including Shell and Schneider Electric.

On June 27th Bloomberg reported that ftx, a deep-pocketed crypto exchange, was in talks to buy Robinhood, a day-trading app. One investor recalls a recent deal he concluded at about a third of the price discussed with a founder late last year. “The world has changed,” he notes. For many startups the change will be wrenching, maybe even fatal. For the startup scene as a whole, it will be salutary. ■

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