Throughout most of 2021, the tech market behaved with bipolar disorder with euphoria followed by depression. Tech shares on Wall Street, including the many Israeli companies that held IPOs in the first half of the year when valuations skyrocketed, saw their market cap plunge by tens of percentages towards the end of 2021. These companies are currently traded at much lower multiples of their revenue.
According to the index of US venture capital firm Bessemer Venture Partners, growth companies providing cloud software are being traded on Nasdaq at an external valuation of eight times their expected revenue over the next year compared with 15 times, in February 2021. On the other hand, privately-held startups in every stage are continuing to enjoy record investments at very generous valuations.
But in recent weeks the first signs have been seen that suggest that the declines in the stock market are beginning to trickle down to the world of startups and the era of quick and easy money might be coming to an end. There have been reports in the US media in recent weeks that the largest venture capital funds like Tiger Global, one of the most important startup investors and one of the most active in Israel, has begun revising investment agreements and lowering valuations.
While this has been happening, other funds are choosing to slow down, check more thoroughly, and mainly wait and see where things are going. One senior investor in the startup market said, "Over the past year, if I saw a new and cool company in a hot sector, I wouldn’t think twice about giving it a valuation of $20 million, before money, in the seed round. But today, it’s something that psychologically you think about more. Nobody wants to be the last person to sign a memorandum of understanding for an investment with a high valuation, at the moment before prices in the market fall."
A well known Israeli entrepreneur, who has already raised more than $100 million for his startup, said, "Nobody from the funds has told us that they are not ready to invest but they all proposed that we should wait until next quarter to see where the wind is blowing. The funds want to see if they can continue to cut the valuation."
Sequoia’s forecast at the start of the Covid crisis proved false
In March 2020, when the Covid pandemic was just beginning, US venture capital firm Sequoia, one of the world’s most important startup investors, published an open letter entitled the Black Swan of 2020 to startup entrepreneurs and managers, recommending that they examine their business plans in the light of the hard times ahead that were expected. The letter said, "Having weathered every business downturn for nearly 50 years, we have learned an important lesson - nobody ever regrets making fast and decisive adjustments to changing circumstances."
The letter has since become a joke as the tech sector underwent massive growth due to Covid. But now, with interest rates set to rise in the US, which will slow the flow of cash to the tech sector, and with nervousness in the markets, startup entrepreneurs are again being asked to devote more time to thinking about how to cope with a negative scenario. Such a scenario could be an inability to raise the next financing round at the desired valuation.
Bessemer Venture Partners partner Amit Karp said, "The thinking in the market is changing and some startups still don’t understand that this will influence them but this will influence them. Many companies are banking on being able to complete a financing round every six months and that they will receive an investment without reaching milestones. In the world of last year, it was sufficient to grow from one to two and somebody already forecast that you would soon reach five - and gave you money according to this. Now you really need to move from one to five in order to raise money again, just like it was two or three years ago."
"No need to panic, there is no real crisis"
The real change according to Karp is in the need to improve efficiency - and not just to focus on growing revenue. "There is no need to panic, there is no real crisis and there is no need to reduce development spending. It is still important to build big because there are big opportunities. But you need to do it a little less fast and more efficiently. This could be by reducing marketing and sales expenditure, for example. When there is a lot of money, so you automatically quicken the monthly pace of burning cash but now is the time to be a little more conservative - and not greedy."
TPY Capital managing partner Dekel Persi said that he still does not feel a slowdown in investments in early-stage startups. "Just now we led our largest seed round ever of more than $20 million. There is still a lot of money in the market and so the situation on the stock exchange trickles down to growth stage companies at first and only afterwards to early-stage startups. But ultimately nobody is immune from this.
"When the market slows down, you must do a deep rethink"
Persi’s main advice to entrepreneurs who are starting out is to come with a more mature and well-rounded concept before raising their first funds.
"During a time when money is available, we see entrepreneurs raising investment funds even before they have found the problem that they want to treat or have formed an idea. But when the market begins to slow down, you have to take time out to think deeply about the solution because the aim is not only to complete the financing round but also to succeed over time."
Pitango Venture Capital managing partner Eyal Niv said, "The market today wants to see both a profitable business model and quick growth, and it expects companies not only to meet the targets that they set but to exceed them. These are things that we take into account when we invest in a startup. You must think that if the same company reaches $100 million will there be a profitable model and if it’s market is big enough to allow growth of tens pf percentages."
"To be cautious and behave with respect with the money"
According to Niv although we are not in a situation where there is a shortage of money - startups still need to make adjustments. "The stock exchange is nervous and startups need to prepare for the possibility that this will reach the private market. They need to have options for the next 18 months and must be more cautious and behave with respect with the money. A degree of modesty and stability is required that is appropriate to the spirit of the times and they must refrain from overly ostentatious steps.
Published by Globes, Israel business news - en.globes.co.il - on February 10, 2022.
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