Is funding for start-ups slowing to a halt?

8 Feb 2016

In 2015, fears grew of a marked slow-down in start-up valuation surges, with unicorn births grinding to a standstill. 2016 may be no different.

Last October, we looked at the end of the unicorns, with $1bn start-up valuations a thing of yesteryear.

‘Constipation’ of the VC industry, and a realisation that, just perhaps, profit won’t flow out of something with nothing more than a high valuation, saw funds get a little worried.

An excellent piece by Danielle Morrill of Mattermark described how unlikely it was for her (or anyone else’s) start-up to follow the likes of Uber into fictional financial success.

Fortune’s Dan Primack then went to San Francisco to gauge the mood of investors and, to his surprise, it wasn’t good. Rather than VCs universally driving for greater discoveries on the back of what, to an outsider like myself, seems spurious maths, now “their sentiment is fear”.

And now, one of those VCs, Upfront Ventures partner Mark Suster, is warning of a continued contraction of the market. “It’s certainly not sunny ahead,” says Suster, who noticed some strange trends over the past few years.

A decade ago, the money put into VC funds flowed at the same rate as money into start-ups. This seems sensible. But, in the past two years, the money that came out of VC funds into start-ups was 2.5 times that of the original income.

“This isn’t an ‘emptying out of the VC coffers’,” explains Suster, rather it’s less experienced people putting money forward.

“The result? Median pre-money valuations skyrocketed ― shooting up three times in just three years, as investors competed to christen imaginary animals with imaginary valuations. And then, seemingly all at once, the market felt constipated.”

In the US, tech firms’ valuations are down on the country average, with almost two-thirds of the 150 VC funds surveyed by Suster saying cost cutting is beginning in their portfolios.

This could mean that the start-up industry in the US could be heading into a form of “renewal”, with “a more realistic cohort of first-time entrepreneurs who know to be careful about every incremental dollar of spend” entering the VC world.

In December, CNBC looked into this area and found that it’s divided between haves and have nots, with start-ups at the top of the pile immune to this fluctuation.

“It’s a tale of two cities,” said Asheem Chandna, a partner at a California VC firm. The top-tier companies see plenty of investor demand, “but if you take the broader market beyond the top 10 to 20pc it’s fair to say there’s an adjustment happening,” he said.

The burst of European unicorns onto the scene may not happen any time soon and, for those in the US, where unicorns once roamed free, change is afoot.

Slow down sign, via Shutterstock

Gordon Hunt was a journalist with Silicon Republic