Markets

The Tech Sell-Off Has Some Venture Capitalists Worried the Good Times May Be Coming to an End

Sean Gladwell | Moment | Getty Images
  • Tech start-ups raised a record $621 billion in venture capital funding globally in 2021, according to CB Insights.
  • Some VC investors worry the boom times may not last much longer as tech stocks fall amid talk of higher interest rates.
  • VCs say they're already hearing about deals being renegotiated at lower valuations and even withdrawal of term sheets.

After a blockbuster year for venture capital deals, some investors worry the boom times may not last much longer. 

Tech start-ups raised a record $621 billion in venture funding globally in 2021, according to CB Insights, up more than double from a year earlier. The number of privately held "unicorn" firms valued at $1 billion or more rose 69% to 959.

Private companies such as Stripe and Klarna saw their valuations swell to the tens of billions of dollars, aided by a flood of cash as a result of ultra-loose monetary policy and the acceleration of digital adoption during the Covid-19 pandemic.

Now, with the Federal Reserve hinting at plans to hike interest rates in a bid to cool rising prices, investors in high-growth tech firms are getting cold feet. The Nasdaq Composite has fallen over 15% so far this year as fears of tighter policy have led to a rotation out of growth stocks into sectors that would benefit from higher rates, like financials.

In the private markets, panic over the tech sell-off is starting to set in. VC investors say they're already hearing about deals being renegotiated at lower valuations and even the withdrawal of term sheets. Later-stage companies are likely to be the hardest hit, they say, while some firms' plans to go public could get put on hold for the foreseeable future.

"It's definitely trickling through to the private markets and the later-stage rounds," said Ophelia Brown, founder of Blossom Capital. "Term sheets are being renegotiated. Some term sheets have been pulled."

The shift in tone echoes negative sentiment on start-up investing around the start of the Covid pandemic. In March 2020, Sequoia warned founders of "turbulence" in a blog post reminiscent of its 2008 presentation "R.I.P. Good Times." For a brief period, the Silicon Valley firm was right: a number of start-ups saw their valuations slashed initially, while others had term sheets pulled.

But what followed was a banner year for start-up investment, with companies raising $294 billion in 2020 globally. Hedge fund giant Tiger Global became a significant driving force in the market, backing tech firms at much earlier stages than before as traditional investors sought out returns via alternative assets.

Brown thinks some of the reaction in both public and privately traded tech stocks has been overdone, however, and that most start-ups should be able to weather a changing economic cycle given the mountain of cash available in private markets.

"There is still so much dry powder for new funding rounds," she said. "Most companies have been very well funded that, unless they were being completely reckless with the cash, they should be able to see this through."

Down rounds

A handful of firms have managed to raise impressive financing rounds in the first few weeks of the new year. Checkout.com, a U.K.-based payments company Brown has invested in, bagged a $1 billion deal at a monster $40 billion valuation, while Estonian ride-hailing firm Bolt secured an $8.4 billion valuation in a $711 million fundraise.

But some VCs are concerned we may be about to see a wave of "down rounds," where start-ups raise funds at a valuation lower than in earlier rounds. They say companies at the later stages of fundraising are likely to be the hardest hit.

"There will be more downward pressure on pricing in later stage rounds," said Saar Gur, general partner at venture capital firm CRV.

"We will see more valuation compression and it will be harder to get many later stage rounds done," Gur added. "And we won't see companies have such rapid mark-ups without much more business progress."

Gur, an early investor in DoorDash, said many private start-ups have achieved multibillion-dollar valuations based on comparisons to multiples in the stock market. Now that several high-flying tech companies have seen their share prices fall, competitors in the private markets could be forced to follow suit, he says.

Still, it's not all doom and gloom, according to Gur, "I still think the system is full of capital and great companies will raise."

Dot-com bust?

Hussein Kanji, partner at Hoxton Ventures, thinks private tech companies are likely to pause any plans for initial public offerings as liquidity conditions begin to tighten.

"I think the IPO window will be closed," said Kanji. "All the funds with companies thinking they would go out in 2022 will probably be stalled."

Still, there's plenty of money in SPACs, or special purpose acquisition companies, sitting on the sidelines, Kanji said. SPACs are listed shell companies that take other firms public through merger deals. In 2021, these companies raised a record $145 billion, almost doubling the previous year's amount.

Some investors fear tighter policy could cause a plunge in stock markets on par with the bursting of the dot-com bubble in the early 2000s. Though it's worth noting there have long been concerns that U.S. stocks are in a bubble.

"I'm curious to see if this is like [a] dot-com correction and becomes protracted, or [just] a blip," said Kanji.

Whatever happens in the public markets, early stage firms are unlikely to be impacted, according to Brown, who previously worked at Index Ventures and LocalGlobe.

"It will take some time" for the fallout from the rout in tech shares to hit early-stage start-ups, she said, adding that companies raising at earlier stages have "always been somewhat protected from the public markets."

Mergers and acquisitions could provide an alternative route for companies which had sat on plans to go public, according to Brown.

Copyright CNBCs - CNBC
Contact Us