We will be blunt. The Bubble is over. The days of easy money are over. We are not trying to be alarmist, nor are we predicting some gloom and doom crash. Nonetheless, it is clear that conditions in the Venture economy are tightening.
Go pick your favorite mid-stage start-up. If you get the CEO in an honest mood, she will admit that raising money is harder. Not impossible, just much harder. Companies that raised a B-round last year in three months, are struggling to raise their C-round in nine months now. Investors are taking longer to make decisions. They are adding milestones to funding requests. And increasingly looking to turn the screws on deal terms.
Admittedly, the data is not clear on this. There is ostensibly still a lot of money coming into venture funds. Publicly available valuation data also seems to remain mostly positive. However, data about private investments is always hard to come by. Our sense is that the good data sources for these sort of things will start to reflect this trend in coming months. CB Insights is clearly on this path. And when the accounting and analyst groups start publishing their rearward-looking data later this year, our guess is that they will start to show negative indicators as well.
The reason for the disconnect between the data and the common wisdom about funding conditions is that no one has an incentive to point this out. Companies raising money do not want to say that it is becoming harder for them out of (justifiable) fear that these general conditions will be interpreted as a company-specific problem. Venture investors do not want to talk about this either. While it may help them negotiate the next term sheet more favorably, they can do that without saying it publicly. More to the point, if VCs admit that valuations are trending down, they may have to mark down the value of their existing investments. This just makes it harder for them to raise their next round from their own investors (i.e. LPs).
Public market investors generally have little insight into venture fundraising rounds, so they have not seen these trends. And those that do make late-stage, pre-IPO investments often have valuation guarantees built into their term sheets, shielding them from the pain. Public investors have not participated in the upside of many start-ups because companies are generally going public much later in their development. This was once a cause for much teeth-nashing in certain Boston and Manhattan bars, but it turns out to be a blessing now. Hopefully, this means that the downturn from this Bubble will not have the widespread impact on the broader economy that we experienced in 2002.
For those deeply entrenched in the start-up/private company economy, a few words of warning.
First, now is probably not a good time to start on a new venture. Thinking about jumping ship from a cushy corporate job into a heavily-equity-compensated start-up role? Discretion may be the better part of valor here. Are you the CEO of a venture-backed start-up? You should double or triple the estimate of how much time it will take to close your next round. If you only have two months of cash, make cuts now. Do not wait. If you are a venture investor, the same probably applies. You should anticipate longer lead-times raising your next fund. On the other hand, you can now enjoy considerably more leverage when negotiating the next investment term sheet.
One other side effect, when there is blood in the water, the sharks emerge. One start-up we spoke to this week related the experience with one investor who waited to the last minute to issue a revised term sheet that deliberately pushed the company into bankruptcy. Everyone should expect this kind of behavior to get much worse in coming months. New types of personalities are entering the fray. We saw this extensively in 2002-2003, when VCs went from being everyone’s favorite ‘visionaries’ to become the sharpest elbows in the room.
As we have written in the past, the whole tech industry is much more mature than it was 15 years ago. So may not see a major ‘bust’ with mass layoffs this time. But conditions are worsening, and this will lead to many unforeseen outcomes.