I don’t know what is going on in the startup market and it’s a bit of a pain in the ass.
The larger American economy, home to the largest technology startup and venture capital markets in the world, could be in a recession right now. We don’t know. To reach a technical recession, we need two successive quarters of negative GDP growth. We got that in Q1, when the United States’ gross domestic product fell 1.6% after growing 6.9% in the fourth quarter of last year.
Goldman thinks that we’re going to avoid a recession with a paltry bit of growth when Q2 data settles. The Atlanta Fed thinks we might land in a recession. We’ll see, but the smart money is not entirely sure yet which way the economy is heading.
The startup market feels similar. Venture investors have been ringing alarm bells for months now, and the IPO market is as dead as hopes for a post-Brexit boom. It’s easy to find commentary from various actors in the startup business — both those building and those investing — noting that the market is a mess and that many upstart technology companies are in for a drubbing.
There is some good reason for that. The incoming valuation implosion at Klarna is a good example of how some of 2021 is not translating into 2022. Many a unicorn is expected to struggle to raise more capital at a price that is palatable, and thus many down rounds and last-ditch rounds are anticipated.
And yet.
Funding totals are down but far from out. And with unicorns still being born at a good clip, just how much trouble is really out there for startups?
The startup fundraising market did not collapse in the second quarter. Sure, the dollar value of global startup investment dipped to a mere $120 billion in the second quarter, according to Crunchbase, but that figure is still a greater quarterly pace than all quarters that we’re aware of that did not take place in 2021.
For reference, the WSJ reports that back in 2000, the venture capital market was worth $105 billion ($164 billion today), an even more modest $41 billion in 1999 ($66 billion in today’s dollars). Other reports put the total for the United States’ venture tally in 1999 at $35.6 billion ($57.5 billion today). One further source indicates $161 billion for the United States during 1999 and 2000 ($251.7 billion in today’s dollars).
Now with a possible recession grinning in our faces, we’re down to $120 billion in a single quarter globally, and $66 billion in the United States, according to PitchBook. What kind of crisis is that?
The prevailing narrative is that things are bad. Citing the same set of PitchBook data that TechCrunch noted this morning, here’s how the Times framed the matter:
The numbers are stark. Investments in U.S. tech start-ups plunged 23 percent over the last three months, to $62.3 billion, the steepest fall since 2019, according to figures released on Thursday by PitchBook, which tracks young companies. Even worse, in the first six months of the year, start-up sales and initial public offerings — the primary ways these companies return cash to investors — plummeted 88 percent, to $49 billion, from a year ago.
The returns data is terrifying if it mattered, but as private-market investors have been content to inflate the global unicorn count every year since I was in my early 20s — I’m now 32 — it’s hard to say with confidence that a lack of exits is driving a recession in startup land. So, we’re left with venture capital totals that are not that bad.
In a sense, we’re seeing what appears to be a case of procrastination and manifestation. Procrastination in that startups and their venture backers failed to pull back when the public markets were flashing warning signs as 2021 was gathering to a close. And manifestation because, well, now that there’s a general expectation of things being hard or bad or slower or more uphill or whatever phrase you prefer. It appears that some venture investors are speaking a new reality into existence.
For VCs who don’t have a fresh fund, it’s a terrible time. They are deployed, meaning that they are now watching their portfolio companies pursue new capital under more exacting market conditions. But for VCs who do have fresh capital — and PitchBook notes that American VCs have raised more than $120 billion thus far in 2022 — the times are actually possibly good.
How so? Deals. If founders expect harder questions, lower valuations and more investor-friendly terms, they are easier to sell. And for venture investors that either slowed their deal-making during 2021’s valuation silly season or managed to raise a new venture fund on the strength of their paper returns, they now get to buy into the same market they believed in last year at a massive discount.
Not bad!
But enough with the macro environment and how investors are positioning their place in the market today. How are startups themselves doing? Fine? Yes. Recall our reporting from mid-June, not even one month ago today:
TechCrunch+ published an open letter to startups from Index Ventures partner Mike Volpi with advice for startups that have different levels of runway. In short, the more cash that a startup has, the more latitude it will have to be aggressive in the present downturn and the looming recession.
We asked Volpi how many startups were hitting their plans, and while the investor was hesitant to put too fine an approximation on a venture market that he has limited visibility into, he did estimate that around 75% of startups are hitting — or exceeding — their plans.
As one investor pointed out on Twitter to this publication today, the 75% number is a trailing metric but one that does indicate that through most of Q2, startups were doing pretty OK.
So what’s really going on? Fear — honest or maudlin, we cannot say. But it’s hard to parse exactly how things are as bad as we are being told when $40 billion was invested monthly last quarter and most startups are not withering on the vine.
Haven’t we been here before?
It’s easy to look back at the early 2020 startup correction and learn the wrong lessons. No, not every economic downturn will be short and boom-ish on recovery. And recall that other industries outside of tech did suffer for years after that downturn, even as tech companies soared.
Could we be seeing the same thing today? A worsening macro climate that is bad for the economy generally but not that bad for technology companies?
Maybe. But if that is the case, what is up with all the repricing action going on in the public markets? Surely software companies saw their valuations halved (or more) for good reason? Yes, many public tech companies were overpriced last year and had to deal with the gravitative impacts of changing investor expectations in the face of rising interest rates. But at the very same time, we’ve seen the value of software stocks not only stop falling in recent days but actually start to come back modestly from recent lows; the Bessemer Cloud Index is up 20% from its 52-week low, which is more than encouraging.
From where we stand today, it’s easy to see things from both positive and negative perspectives. But for every tweet like this that we see:
I can’t help but also note that YuLife just boosted its valuation from $346 million in 2021 to $800 million very recently. Just today, Tebra “raised more than $72 million in equity and debt funding, bumping to a valuation of more than $1 billion,” we reported. Yesterday, just adding to our list, Flexe raised $119 million in a Series D that pushed its valuation over the $1 billion mark.
Hello, new unicorns.
Hazarding a guess, I think that there’s more capital in the private markets than investors really want to admit. And the players who made the silliest wagers last year — Tiger, SoftBank, etc. — appear largely backed out of the market today. This leaves venture players, which, as we noted above, have plenty of cash and a ticking countdown to deploy it. Deals are going to get done.
Sticking to that idea, we are perhaps in a valuation correction and not a startup downturn. We’re seeing prices come to grips with reality while there is still capital in the market. This will swing the pendulum, yes, back toward investors, but from such an extreme position of founder friendliness that getting back to mere neutrality would be a feat.
The economy could get worse in Q3. We may have reached a technical recession in Q2. But there’s still ample money out there for startups, and as they appear to still be growing today, maybe everyone should relax a bit and try to put funds to work at less than a 100x multiple. That might work out.