Fast’s demise will teach us just how fragile newly built unicorns really are

The first quarter of 2022 was a great period for startups to raise venture capital compared to any time other than the bonkers 2021 private-capital cycle. Although there was still ample capital in the market and deal-making appeared strong at the start of this year, we’re seeing stress cracks appear across the startup sector.

What gives?

It appears that many startups raised money last year beyond the limit of defensible pricing, leaving them in an effectively zero-margin situation. Any startup that raised at a two- or three-figure revenue multiple in 2021 now faces an environment of declining values for technology companies and high-profile investor groups retreating from deal-making. This could lead to down-rounds (or worse).

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What makes the situation ironic is that we’re starting to see the startup layoffs, implosions, and valuation cuts that appear when venture capital is frozen. New data from PitchBook that The Exchange reviewed this morning paints a picture of a still-warm U.S. VC market. And yesterday, when we explored the global venture market with data from Crunchbase News, we saw a similar picture. (More information drops tomorrow, so expect more detail regarding sectors and geographies as the week continues.)

Things just aren’t that bad in the startup market, at least according to investment totals that we tallied in the first quarter. And yet you can’t fire up Twitter without running into startup doom and gloom these past few weeks. So what’s happening?

Unicorn fragility

Early PitchBook data shows that there were likely 4,822 venture capital rounds in the United States during Q1. Those deals were worth $70.7 billion, the data company said. If the Q1 pace is maintained for the rest of the calendar year, those work out to 19,288 deals and $282.8 billion.

Compared to 2021 totals from the same source, U.S. VC activity in 2022 is on pace to surpass last year’s deal volume (17,105) while falling short of its dollar volume ($342.2 billion). That’s hardly a collapse, frankly, even if all startups would like to see more capital disbursed each year than the last.

The irony of today’s situation is that if 2021 had been less exuberant, fewer startups would be facing valuation and cash issues this year.

More simply, if startups had raised at lower valuations last year, they would have had more space in the coming quarters to raise without worrying about a flat or down-round. Instead, many startups raised at prices that felt reasonable in the crucible of 2021, when venture capital funds were ever-larger, the stock market only went up, and crossover investors were helping push valuations consistently higher.

In early 2020, when COVID lockdowns spread around the world, the venture capital market actually paused. It was a radically different situation than where startups find themselves today. And when we look back, there were layoffs and issues at some companies whose business activities were blindsided by a frozen world. Layoffs at Toast and Airbnb are canonical examples.

But both those companies made it through, coming out the other side in good enough shape to go public in the intervening quarters.

I’d hazard that’s because those companies, and others like them that hit turbulence during the market change and venture pause of early COVID, were simply less fragile than today’s myriad new unicorns. They were built when conditions for raising capital were stiffer, making them a bit more hardened against a deteriorating VC market. This is not to say that late-stage startups heading into the pandemic were built during lean times, but they were also not constructed amid the rich climate of late 2020 and 2021.

Which is why it seems that some startups are struggling today — they simply got ahead of themselves. They’re failing to hit marks and are thus stuck between their last private market valuation and today’s reality.

There’s a startup doom loop that can form for such companies. It goes something like this:

  • Raise at a rich revenue multiple when market conditions allow, predicated on top-decile growth.
  • Spend on hiring to grow according to plan.
  • Miss growth targets for one reason or another.
  • Now the company has a high burn rate, missed growth, and is staring down the barrel of a more conservative market for startup investment.
  • Two options emerge: Cut spend to lower burn at the cost of growth or keep spending in hopes of catching up to the original plan and risk investors worrying about high levels of cash consumption.

Damned if you do, damned if you don’t.

The way to avoid the above is to price startup equity less aggressively, which venture capitalists are now doing. But for companies that raised last year and spent accordingly, it’s going to be a tough road ahead. Which brings us to Fast! Yes, you knew this was coming.

The following excerpt from an NPR story on Fast’s shutdown is illustrative:

Several rank-and-file workers, whom the company referred to as “Fastronauts,” told NPR they had noticed Holland pouring significant money into deals aimed at creating marketing buzz, like partnerships with sports teams. They questioned the benefits.

“With Fast,” said one former employee who requested anonymity out of fear of retaliation. “It was like, ‘how quickly can we set money on fire?'”

That era is over. Now, the question is this: How many startups that managed to shrug into a unicorn rank ahead of their ability to actually command such a valuation will be able to avoid what happened to Fast — and instead hunker down and survive?

To avoid going Fast, in other words, they might have to go slow.