A growing chorus of venture capitalists are encouraging entrepreneurs to spend cash more carefully amid rising interest rates and continued stock market turbulence in the tech sector.
A few are even raising the specter of layoffs and down rounds, which is when a company raises money at a lower valuation than its previous round.
Such talk may not make one popular at cocktail parties in Silicon Valley, but the sentiment among venture capitalists, most still with plenty of cash to invest, also doesn’t bode well for the Bay Area, where startups’ spending and hiring is a key driver of the regional economy. It’s been a long time since we’ve heard such talk, with the exception of the brief panic in the early days of the pandemic.
This year such talk has moved from one-on-one conversations with VCs and panel discussions to larger stages, such as this month’s in-person SXSW conference in Austin, where NYU Stern School of Business professor Scott Galloway shared a forecast for layoffs at tech unicorns and down rounds in the year ahead.
Others sizing up the current state of affairs were just as candid, and more colorful.
“What’s happening right now is a little bit like a car crash in slow motion,” Morgan Flager, managing partner at Austin-based venture firm Silverton Partners, told the Austin Business Journal. “It’s been a pretty good rout in the public markets. Yet, the private stuff hasn’t really moved that much.”
Flager and others expect VC-backed companies to come under growing pressure to rein in expenses.
“Some of these companies will go out of business,” Flager said. “It’s been running hot for a long time. At some point the bloom has to come off the rose a little bit.”
Controlling expenses was a recurring theme at an outlook conference held early in the year by FT Partners, a San Francisco investment bank focused on fintech.
“One of the mistakes companies make is ‘we have the money, we’re expanding. Let’s get big everywhere,’” Matt Harris, partner at Bain Capital Ventures, told those attending the conference, “State of Fintech Investing in 2022.”
“Everyone needs three direct reports, then they need five. No,” Harris said. “If you’re putting money into go-to-market, it should be highly measurable. If you’re putting money into R&D, it needs to be wildly disciplined. If you’re putting money in (general and administrative expenses), you should probably stop.
“You should take a really sharp pencil on these categories,” Harris said.
A prominent investor in startups agreed.
“Maintaining that sharp pencil, particularly regarding overhead, is very important,” Nigel Morris, managing partner at prolific investor QED and co-founder of Capital One, said at the same virtual conference. “It’s often overhead that grows much faster than revenue once a company starts to lose its bearings and it’s something very much to focus on.”
The advice to startups on spending wisely occurs as many tech shares in the public market are down substantially from recent highs. That’s affecting valuations in the private market.
“Valuations are coming down. I continue to come across entrepreneurs who are lamenting the fact that if they had closed in the fourth quarter of last year, they would have seen a valuation far higher than they see today,” venture capitalist Ryan Gilbert, founder of Oakland-based Launchpad Capital, told me in a late February interview. “We’re still trying to understand the knock-on effects of the repricing in the public markets.
“The future rounds, particularly A’s, B’s and C’s, I think are going to find themselves experiencing pricing pressures,” Gilbert said. “Why invest at crazy, nosebleed valuations in a private company, when successful startups that are already public and making money are trading at a relative discount?”
