Fred Wilson, a venture capitalist at Union Square Ventures, recently published a blog post titled “The Great Public Market Reckoning“. In it, he argued that the narrative that had driven start-up hype and valuations for the past decade was now falling apart.
His post quickly ricocheted across Silicon Valley. Other venture capitalists soon weighed in with their own warnings about fiscal responsibility. At some start-ups, entrepreneurs began behaving more cautiously. Travis VanderZanden, chief executive of the scooter start-up Bird, declared that his company was now focused on profit not growth.
Cash burn is over
The moves in our opinion all point to a new gospel that is starting to spread in start-up land. For the last decade, young tech companies were fueled by a wave of venture capital – funded excess, which encouraged fast growth above all else. But now some investors and start-ups are beginning to rethink that mantra and instead invoke turning a profit and generating “positive unit economics” as their new priorities. Finally, the time has come.
The nascent change is being driven by the stumbles of some high profile “unicorns” – the start-ups that were valued at 1 billion US-Dollar and above in the private markets – just as they reached the stock market. The most visible of those was the office rental start-up WeWork, which dramatically ousted its chief executive and withdrew its initial public offering in September.
At the same time, shares of Peloton, a fitness start-up and SmileDirect Club, an online orthodontics company, immediately cratered after the companies went public. And Uber, Lyft and Slack – which also listed their stocks this year – have similarly dealt with falling stock prices for months. The lackluster performances have raised questions about Silicon Valley’s start-up formula of spending lots of money to grow at the expense of profits. And most of these companies in our opinion are losing insane money with little chance of recovery. Softbank with its Vision Fund were willing to play that game but public market investors, as it seemed, just weren’t having it.
Wall Street reality check
A lot of these highly valued companies in our opinion have run into the buzz saw of Wall Street, where they’re questioning or reminding us that profitability matters. We now at Calvin • Farrell anticipate a “ripple effect” on private start-up valuations that most probably will start with the largest, most valuable companies and trickle down to the smaller, younger ones.
For start-ups and investors that were used to heady times and big spending that means it may be time for a rest. At Eniac Ventures, a venture from in New York and San Francisco, the partners recently combed through their companies and identified the “gross margins” – a measure of profitability – for each of their investments.
It seems that venture capitalists in general will push entrepreneurs in future meetings for far more detailed financial models, even so if the companies are very young.
Tech start-ups based on our experience have long gone through different cycles of fear and loathing. When the 2008 recession began, Sequoia Capital for example, one of the highest – profile venture firms, called a mass meeting with its start-ups and presented a slide deck titled “R.I.P. Good Times” that featured a graphic of a “death spiral” and a skull. The event was intended as a way to shock the start-ups into reining in costs to survive the downturn. Sequoia’s presentation at that time quickly become the talk of Silicon Valley, which did not fall into as deep an economic junk as other parts of the US. Yet other alarms about the state of the start-up economy fell on deaf ears. In 2016, Jim Breyer, a venture capitalist who was an early Facebook investor, also predicted “blood in the water” for the unicorns.
But the money as we have seen continued to flood into tech start-ups from overseas investors, private equity firms, corporations, and Softbank’s behemoth Vision Fund, loaded with over 100 billion US-Dollar.
that allowed founders to command higher valuations and delay going public. By the end of 2018, start-ups in the US had raised a record of 131 billion US-Dollar in venture funding, surpassing the amount collected during the late 1990s dot-com boom, according to Pitchbook in the National Venture Capital Association.
A revival
Complaining about high valuations is a long-standing pastime among venture capitalists, of course, since most prefer to invest their money in cheaply priced start-ups rather than expensive ones – including us. This year in our opinion, the warnings are being revived – for the start-up economy as well as for the stock market. Based on these facts and based on the criticism of WeWork mounted over the last month, latest start-up funding’s were already taking place at lower valuations and with stricter terms than the start-up companies and entrepreneurs had hoped for.
At the end, what we at Calvin • Farel would like to see is a bit more rationality and we are hopeful that we are getting there.
