There was a silent revolution in startup financing in 2021: more money, bigger deals, atypical investors. Experts are now warning that more startups could fail in the future.
The next unicorn? Or just hot air? Attendees at the North American Bitcoin Conference in Miami, January 19, 2022.
Sand Hill Road in Menlo Park is about as important for American technology start-ups as Hollywood is for aspiring actresses: This is where the money is, this is where the networks come together, this is where the people work, who give their thumbs up to an idea and thus a career or turn down.
But in the past year, power has shifted on Sand Hill Road. Investors have been queuing up for startups as soon as their business idea has even a bit of substance. Instead of founders presenting their ideas to investors, investors now turn up at startups without being asked.
For example at Hinge Health. The young company offers online health coaching for the relief of chronic pain. It has received over twenty letters from investors wanting to invest in the company since 2020. Some dossiers were ninety pages long and contained extensive analysis of the company, said founder Daniel Perez told the New York Times. Three of the investor letters even contained videos of famous people, including a jazz musician that Perez particularly enjoys listening to. The celebrities asked the founder to accept money from this or that investor.
Other startups experienced something similar. The founder of Workato, an automation company from Mountain View, describes in the same article that some investors even besieged the company’s customers. Workato later had to apologize to its customers for the behavior of the investors.
Where does all that money go?
So much money is currently flowing into the venture capital market that investors apparently have no idea where to go with all that cash. Almost $330 billion was invested in American startups in 2021, about twice as much as in the previous year, which corresponds to the largest increase in over a decade. Furthermore, with 15,500 start-ups, more young companies were financed than ever before. And, another record, the average deal size today is $19 million, three times what it was 10 years ago and 40 percent more than in 2020.
So the American venture capital market exploded in 2021. And with it the reviews of startups. With 340 more start-ups in 2021 will have the “unicorn threshold” with a valuation of over a billion dollars exceeded than in the past five years combined. Today there is with it over 1000 «unicorns» in the USA. In 2015 it was still thought 80 would be a lot.
Critics are therefore warning of a speculative bubble. “Many startups today are raising too much money too early,” says Roger Rappoport, partner at Procopio, a venture capital investor in Palo Alto. According to Rappoport, many founders “can’t resist the ego boost” of being offered more money than they actually asked for. He regularly speaks to founders who have raised twice as much money as they actually need. If the companies couldn’t grow fast enough, they would soon have “money lying around in the bank account”. This in turn is dead capital from the point of view of investors, but they take this risk in the hope of rapid company growth and thus large profits.
Losses after the IPO
IPOs also show that startups are currently raising too much money. The overvaluation becomes visible when prices fall after the IPO. According to analysis According to the Wall Street Journal, this was the case for two-thirds of all newly listed companies in the USA in 2021.
Falling prices for newcomers to the stock market are an expression of the fact that the companies have been particularly successful in raising money, says Max Meister, partner at the Swiss venture capital company Serpentine Ventures, who recently blog post wrote about the phenomenon. Nevertheless, falling prices are bad for everyone involved. The investors who got in last would have to bear the loss, “ergo mostly the private investors”. Shares held by employees would also become less attractive, especially since employees are often required to hold shares for several months when they go public.
Despite the signs that venture capital is overheating, anyone who mixes with investors in Silicon Valley primarily receives positive assessments of the current market. Critics have been warning of a bubble in tech company valuations for more than a decade, say two venture capital investors who meet for breakfast at a famous founders pub a few minutes’ drive from Sand Hill Road. But the big crisis never happened. They would assume that the high volume in the venture capital market is now establishing itself as the new normal.
More investor «tourists», more failed startups
The investor Max Meister believes that the market will normalize in the coming months, even in those areas where speculation bubbles had formed in his eyes: in fintech companies and in hyped areas such as the Metaversum or crypto startups.
According to Meister, however, the changes in the venture capital market are likely to result in more startups failing in the future than today. This is also due to the fact that in the last year more and more investors who are not very familiar with the market have entered startup financing. According to the analysis company Pitchbook, so-called investor “tourists”, i.e. atypical venture capital players such as industrial companies, governments or investors from other sectors, closed more deals in 2021 than ever before: 1777 alone in the US. In doing so, they spent around a billion dollars, which means that atypical investors accounted for every third dollar in the American venture capital market.
Geri Kirilova, head of the New York venture capital firm Laconia, summed up the situation for investors in a recent blog post: “Today it is easier than ever to become a venture capital investor. To remain one, but more difficult than ever», wrote them in mid-March. The same applies to startups. After all, start-ups tend to grow faster when they raise more money. But growth cannot be forced at will.