Why VC funding is drying up

This is an audio transcript of the Behind the Money podcast episode: Why VC funding is drying up

Michela Tindera
Over the last several years, venture capital investing has been on a tear.

Richard Waters
I think just a couple of numbers, you know, tell this story. In 2021, $330bn poured into US venture capital. Now, that’s twice as much as the year before, which itself was twice as much as three years before.

Michela Tindera
That’s the FT’s west coast editor Richard Waters. He says that pretty much everyone wanted a piece of the action.

Richard Waters
It wasn’t just traditional venture capital firms. It was hedge funds, private equity firms, sovereign wealth funds, mutual funds. Everybody piled into the market at the top. It was really quite extraordinary. So you just saw this kind of, you know, rapid increase leading to a, just a massive boom.

Michela Tindera
But Richard says there’s always been this thought lingering in the background that one day all of this might come crashing down.

Richard Waters
A lot of us journalists have been saying for many years, is there some kind of bubble building here? And what I’ve learned over the years in the tech world is, you can never call a bubble while it’s happening because these things can go on, you know, much longer and get much bigger than you ever imagined.

Michela Tindera
More recently, he’s noticed a change. There aren’t as many indicators as you’d find in the public markets. But he says a downturn is definitely under way and money is drying up. And as to whether anyone in the venture capital world is actually acknowledging it . . . 

Richard Waters
It’s a bit like a, it’s a bit like the Road Runner cartoon.

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You know, we all know that’s where Wile E. Coyote runs off a cliff, and he just keeps running out in thin air. And until he looks around, he’s fine. But as soon as he looks down, that’s it

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Well, venture valuations are a little bit like this because as long as everybody believes that a company is worth 50bn, and there’s no market, there’s no stock market telling them it’s not worth 50bn, then, you know, everybody wants to, there are a lot of incentives for people to continue believing in a rather like Wile E. Coyote running off the cliff, there’s a huge resistance to accepting that the ground has just dropped out from under you.

Michela Tindera
In venture capital investing, timing is key. So what does it mean if the fundraising and valuation bonanza is over?

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Venture capital fundraising hit a record high last year. There were more deals and more money poured into start-ups last year than at any other time in history, far more than the dotcom bubble 20 years ago. But now things are slowing down. We’re already seeing lay-offs from some companies. Meanwhile, others are keeping things running until perhaps they realise that they’re running on air. On today’s episode, we’re looking at what it means for the start-up world when VC money starts to disappear. I’m Michela Tindera from the Financial Times, and this is Behind the Money.

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Hi, Richard. Thanks for coming on the show today.

Richard Waters
Well, nice to talk to you, Michela.

Michela Tindera
So, Richard, there was this giant boom in venture capital investing. How did it happen?

Richard Waters
So this venture boom was really driven by these kind of macroeconomic factors. So, you know, we’ve lived through a long period of low interest rates, low inflation and low growth. And many investors have just been hunting for growth, anything that would give them a return. And so there was this hunt for, you know, for things that might, that actually gave you a chance of a double-digit return, for instance. And venture was one of the very few places you could get that because, you know, you can get in on a tech company that’s going to the moon then, you know, that was a great bet.

Michela Tindera
And what were your sources telling you around this time?

Richard Waters
Well, it’s a real kind of paradox when you cover venture capital that, you know, everybody wants to be the smart money. And so everybody you talk to says, you know, there’s some crazy deals going on out there. There are some crazy valuations, but we’re not doing those. But you should see what those other guys are doing. And those other guys meant SoftBank’s Vision Fund that had $100bn to burn and was kind of famous for driving up prices and throwing large amounts of money at things. But then a lot of other people came in behind them — Tiger Global, Coatue Management, you know, some of these so-called crossover funds, people from outside the venture world with a lot of money. And so, you know, the people who like to think of themselves as the more cautious, the smart money were saying, you know, we’re not doing that. But of course they were. And when we look now at what happened last year, you know, even the more disciplined investors were buying at the top because they had no choice. Everybody was piling in.

Michela Tindera
So you mentioned SoftBank, Tiger Global and Coatue Management. Were they the major investors, or where else was this money coming in from?

Richard Waters
You know, there’s a term in the venture capital world, they call them venture tourists. And it’s how the people who have been in this business a long time like to try and dismiss the newcomers, the people who come in it, wondering at times like this, when there’s a lot of money around and everybody wants a bit of the action. And so, you know, they like to try and draw this clear dividing line between, you know, the smart people, the people who can ride out the cycles and then just the kind of dumb money, the people who are just chasing the latest valuations. And, you know, quite honestly, there is a little bit of truth to that. I mean, just to give you one number, because I find this really quite amazing, last year, $500bn of money like that from outside the venture world came in, and that was like two-thirds of all the money that went into start-up companies. And so, you know, we’d never seen anything like that.

Michela Tindera
So what sort of sectors or companies were actually benefiting and getting this money?

Richard Waters
You know, when everybody’s optimistic and they’re looking for in a bigger, longer range bets they wouldn’t have taken before, they take risks. And so I would point to a couple of things. One is just the scientific, you know, the deeply difficult scientific things that got backed, things like quantum computing and nuclear fusion, you know, these kind of really long-range technical bets. And who knows if they’re ever going to pay off, I mean, quite frankly. But even if they do, it might be many years into the future. I think the other thing we saw was industries that didn’t previously attract a lot of money, like space, commercial space companies. You know, the amount of money pouring into rockets and satellites and, you know, even companies that want to build commercial space stations to replace the International Space Station, I mean, these companies would never have raised money before. Who knows when they’re ever going to make money? But a ton of money went into them so I saw this kind of huge spread of capital just across the waterfront.

Michela Tindera
So when did you first notice that something was starting to change in the market?

Richard Waters
It’s taken a long time. It’s been a delayed reaction. So the stock market for, you know, the valuation of growth companies really peaked last November, November of 21, and then it started to come down rapidly. And the private market, you know, responds, the venture capital market responds very, very slowly. There’s a lag here because, you know, people don’t know whether this is just a short-term stock market move. And so the first thing that happens is there’s a pause. There aren’t as many deals. People wait to see what’s going to happen because they don’t want to rush out and raise money at a lower valuation if the market bounces back again. So I would say that, you know, there was nervousness, a bit of a, you know, a bit of a pause in the early part of this year.

Michela Tindera
And then what happened?

Richard Waters
I think when things really set in was in April. April was a real, was a bloodbath for tech stocks in (inaudible) ways about it. And it was the moment that changed everybody’s view and made everyone realise, you know, we are now in a different world. Things are not going to come back to where they were. And so it’s really been just this last, you know, since April, I would say the end of April, you know, that everyone’s now been trying to reset and this kind of big mental reset going on that after 15 years of easy money is a difficult thing.

Michela Tindera
So the public markets have been giving off these warning signs for months. But like you mentioned, companies are sort of prone to put their head in the sand or just keep running off the cliff like the Road Runner cartoon. Have you been able to see any clear changes in the private markets yet?

Richard Waters
Last year, Klarna, which is a Swedish online finance company, in March was valued at $30bn, which is a lot of money. But three months later, it raised money at $45bn. So the people that came in three months, you know, just three months’ time, thought the value had gone up 50 per cent. And it recently raised money at a valuation under $7bn. So just a huge fall, you know, unlike a lot of these companies that had to go out and raise money. I mean, if you don’t, if you’re a private company and don’t have to raise money right now, you don’t want to raise money because you’d be admitting how much your value has fallen. Klarna didn’t have the luxury. They had to raise money. And so they got, you know, they got really hit hard.

Michela Tindera
Yeah. So what’s going on in the public markets is kind of spilling over into the mentality and thinking of decision-making in the private markets, you’d say?

Richard Waters
Yes, completely. I mean, particularly for the bigger, you know, older companies that are thinking eventually they’re going to go public, maybe in a year or two or three, you know, they have to value themselves against what’s happening in the public stock market, and that’s come down. But the other thing is just, you know, and this is the real factor at work here is what’s happening in the, you know, the wider economy. So it starts with just the financial environment. Inflation leading to higher interest rates leads to, you know, investors can get higher returns in other places. You can put money into government bonds and get more of a return. And so you don’t need to chase growth companies. And so there’s a, there’s an overall shift in the market from growth valuation. When that happens, all the easy money that was going into growth disappears. And so suddenly, you know, rather than everybody chasing a deal and pushing the price up 100 per cent, nobody wants to deal, and it goes down 50 per cent. So it’s, you get these crazy swings in valuation just based around that. So it’s the end of easy money.

Michela Tindera
So if we’re shifting from growth to value, how do you see this playing out in the future?

Richard Waters
I think the good news is that a lot of people realised that they needed to raise money when times were good. And so that’s why we saw these huge amounts of, you know, capital going into these private companies. They didn’t need the money right away. You know, an awful lot of them, you know, hopefully have kept that money. So I think for, you know, for those with good businesses that are now saying to themselves, you know, can we find a way to get to break even with the money we’ve got so that we don’t need to go back to the markets in a year or two or three, then, you know, they might have smaller businesses than they otherwise would because they’re just not dashing for growth in the same way. But, you know, they should be fine. And I think we’ll see a lot of great companies come out of this period.

Michela Tindera
And what about for the companies who aren’t so well positioned?

Richard Waters
Michael Moritz from Sequoia is the chairman of Klarna. Now, it’s no coincidence that Sequoia sent a presentation out saying, look, you’ve all got to realise that the world has changed, and a lot of you have never lived through a period like this because we haven’t seen that for a couple of decades. And essentially, you know, you have to conserve cash and that means, if necessary, you have to cut costs. And look at cost-cutting as a sign of strength. And we’re seeing, across the board now, we’re seeing 10 to 20 per cent job cuts across a lot of these companies that are burning cash. Even, you know, though there are a lot of these companies would say our business is are doing just as well as they were before, you know, they’re not feeling the impact of a recession. A lot of them feel that the opportunity is just as great as it was before. Nonetheless, they’re suddenly realising they’re not going to have any more money coming very easily in the future.

Michela Tindera
So how do you think this impacts start-ups down the line?

Richard Waters
I think you have to look back at what we’ve just lived through, and you have to say, did all that money create something amazing for the world even though there was all this waste, and we can all point to the, to the nonsense companies that got built, and we can point to the WeWorks that collapsed or nearly collapsed. You know, nonetheless, did that money, just the sheer, you know, volume of it, create things that wouldn’t have got created, drive technologies that wouldn’t have, you know, into existence, that wouldn’t have got driven and so on? And, you know, I think the answer is, you know, actually a boom, although massively wasteful, is also hugely beneficial. You know, we saw it at the dotcom period at the end of the nineties when an entire internet infrastructure for the world got built, if you like. I mean, there was so much money wasted on telecom networks, but all that infrastructure, you know, has supported the digital world we’re now in. And I think something, something similar has been happening in this boom. You know, we haven’t talked about crypto at all. Something like $2tn in value has evaporated around the crypto industry. But all the money that went in, a lot of it is building out a blockchain infrastructure, a new industry that, you know, for the believers, it’s going to be like an entirely new version of the internet. Now that, you know, that’s an entirely different question. It may be completely wrong, but on the other hand, you know, all that money, yeah, the valuations are collapsing, but something got created. Businesses got created. Infrastructure got built.

Michela Tindera
And how should potential founders of start-ups be thinking about this time, then? Will they be able to raise money if they need it?

Richard Waters
Everybody likes to point out that, you know, some of the best companies were started in a bust, in a bad period or got funded. I mean, eBay went public in the middle of the worst market. You know, if you’re a great company, it’s not going to stop you. It’s going to stop a lot of the hangers-on, the people that kind of wanted to jump in because they thought there was easy money. So, you know, to that extent, this is a really important kind of salutary moment we’ve been waiting for for a long time. And it’ll hopefully, you know, shake out the, some of the nonsense in the system, some of the hype from the system, and get people to refocus on what these businesses can really create and what the, you know, what the real potential is.

Michela Tindera
So it’s the end of easy money in the VC world, and it sounds like we’ll just have to wait and see to find out which companies will succeed and which ones will run off a cliff, just like the Wile E. Coyote.

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Behind the Money is hosted by me, Michela Tindera. Stephanie Horton is our contributing producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.

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