‘Forget the past three years'


Eugene Zhang, founding partner of Silicon Valley VC firm TSVC Spencer Greene, general partner of TSVC

Courtesy: TSVC

Eugene Zhang, a veteran Silicon Valley investor, recalls the exact moment the market for young startups peaked this year.

The firehose of money from venture capital firms, hedge funds and wealthy families pouring into seed-stage companies was reaching absurd levels, he said. A company that helps startups raise money had an oversubscribed round at a preposterous $80 million valuation. In another case, a tiny software firm with barely $50,000 in revenue got a $35 million valuation.

But that was before the turmoil that hammered publicly traded tech giants in late 2021 began to reach the smallest and most speculative of startups. The red-hot market suddenly cooled, with investors dropping out in the middle of funding rounds, leaving founders high and dry, Zhang said.

As the balance of power in the startup world shifts back to those holding the purse strings, the industry has settled on a new math that founders need to accept, according to Zhang and others.

“The first thing you need to do is forget about your classmates at Stanford who raised money at [2021] valuations,” Zhang says to founders, he told CNBC in a recent Zoom interview.

“We tell them to just forget the past three years happened, go back to 2019 or 2018 before the pandemic,” he said.

That amounts to valuations roughly 40% to 50% off the recent peak, according to Zhang.

‘Out of control’

The painful adjustment rippling through Silicon Valley is a lesson in how much luck and timing can affect the life of a startup — and the wealth of founders. For more than a decade, larger and larger sums of money have been thrown at companies across the startup spectrum, inflating the value of everything from tiny prerevenue outfits to still-private behemoths like SpaceX.

The low interest rate era following the 2008 financial crisis spawned a global search for yield, blurring the lines between various kinds of investors as they all increasingly sought returns in private companies. Growth was rewarded, even if it was unsustainable or came with poor economics, in the hopes that the next Amazon or Tesla would emerge.

The situation reached a fever pitch during the pandemic, when “tourist” investors from hedge funds, and other newcomers, piled into funding rounds backed by name-brand VCs, leaving little time for due diligence before signing a check. Companies doubled and tripled valuations in months, and unicorns became so common that the phrase became meaningless. More private U.S. companies hit at least $1 billion in valuation last year than in the previous half-decade combined.

“It was kind of out of control in the last three years,” Zhang said.

The beginning of the end of the party came in September, when shares of pandemic winners including PayPal and Block began to plunge as investors anticipated the start of Federal Reserve interest rate increases. Next hit were the valuations of pre-IPO companies, including Instacart and Klarna, which plunged by 38% and 85% respectively, before the doldrums eventually reached down to the early-stage startups.

Deep cuts

Hard as they are for founders to accept, valuation haircuts have become standard across the industry, according to Nichole Wischoff, a startup executive turned VC investor.

“Everyone’s saying the same thing: `What’s normal now is not what you saw the last two or three years,'” Wischoff said. “The market is kind of marching together saying, `Expect a 35% to 50% valuation decrease from the last couple of years. That’s the new normal, take it or leave it.'”

Beyond the headline-grabbing valuation cuts, founders are also being forced to accept more onerous terms in funding rounds, giving new investors more protections or more aggressively diluting existing shareholders.

Not everyone has accepted the new reality, according to Zhang, a former engineer who founded venture firm TSVC in 2010. The outfit made early investments in eight unicorns, including Zoom and Carta. It typically holds onto its stakes until a company IPOs, although it sold some positions in December ahead of the expected downturn.

“Some people don’t listen; some people do,” Zhang said. “We work with the people who listen, because it doesn’t matter if you raised $200 million and later on your company dies; nobody will remember you.”

Along with his partner Spencer Greene, Zhang has seen boom-and-bust cycles since before 2000, a perspective that today’s entrepreneurs lack, he said.

Founders who have to raise money in coming months need to test existing investors’ appetite, stay close to customers and in some cases make deep job cuts, he said.

“You have to take painful measures and be proactive instead of just passively assuming that money will show up someday,” Zhang said.

A good vintage?


Image and article originally from www.cnbc.com. Read the original article here.

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