Eugene Zhang, co-founder of Silicon Valley VC firm TSVC Spencer Greene, general partner of TSVC
Eugene ZhangA veteran Silicon Valley investor, he remembers the moment the startup market peaked this year.
He said the money flowing from venture capital firms, hedge funds and wealthy families to seed-stage companies had reached absurd levels. A company that helps startups raise money was in over-demand with a mind-blowing $80 million valuation. In another case, however, a small software firm with $50,000 in revenue received a $35 million valuation.
But that was before the turmoil beating public tech giants in late 2021 reached the smallest and most speculative startups. Zhang said the red-hot market has suddenly cooled, leaving the founders high and dry, leaving investors in the middle of funding rounds.
According to Zhang and others, as the balance of power in the startup world returns to those who hold the strings, the industry has settled on a new math that founders must accept.
“The first thing you have to do is forget about your classmates. Stanford who collected money  Valuations,” Zhang told the founders, CNBC, in a recent Zoom interview.
“We tell them to forget the last three years and go back to 2019 or 2018 before the pandemic,” he said.
According to Zhang, that equates to valuations roughly between 40% and 50% at the latest peak.
‘out of control’
The painful adjustment in Silicon Valley is a lesson in how luck and timing can affect the life of a startup and the wealth of its founders. For more than a decade, larger and larger sums of money have been thrown at startups companies, inflating the value of everything from small pre-revenue apparel. still private giants Like SpaceX.
The low interest rate era that followed the 2008 financial crisis sparked a global quest for returns, blurring the boundaries between various types of investors. increasingly sought after returns to private companies. Growth was rewarded, even if it was unsustainable or came with a weak economy. Amazon horse tesla would appear.
The situation reached a fever pitch during the pandemic when “tourist” investors and other newcomers from hedge funds piled on funding rounds backed by name-brand VCs, leaving little time for due diligence before signing a check. Companies have doubled and tripled in valuations within months, and unicorns have become so commonplace that the phrase has become meaningless. More private U.S. companies hit at least $1 billion in valuation last year the previous half decade combined.
“It’s gotten a little out of control over the past three years,” Zhang said.
The beginning of the end of the party came last September, when the stakes of the pandemic winners were included. PayPal and Block It fell as investors waited for Federal Reserve rate hikes to begin. The next hit was the valuations of pre-IPO companies, including the following. Instacart and klarnafell 38% and 85%, respectively.
As difficult as it was for founders to accept, valuation deductions have become standard across the industry. Nicole Wischoffand the startup manager turned into a VC investor.
“Everyone says the same thing: ‘What’s normal right now isn’t what you’ve seen in the last two or three years,’ said Wischoff. This is the new normal, it’s walking together saying ‘take it or leave it’.”
Beyond the headline valuation cuts, founders are also being forced to accept more. tough conditions in funding roundsprovide greater protection to new investors or more aggressively dilute existing shareholders.
Not everyone accepted the new reality, according to Zhang, a former engineer who founded a venture firm. TSVC in 2010. The team has early invested in eight unicorns among them. zoom in and Carta. Typically, a company holds shares until its IPO, although it sold some positions in December before the expected decline.
“Some people don’t listen, some people do,” said Zhang. “We work with people who listen, because it doesn’t matter if you raise $200 million and then your company dies; no one will remember you.”
with her partner Spencer GreeneZhang said that since 2000 he has seen cycles of boom and bust, a perspective that today’s entrepreneurs lack.
He said founders who have to raise money in the coming months will need to test the appetite of existing investors, stay close to customers and, in some cases, make deep layoffs.
“Instead of passively assuming that the money will show up someday, you should take painful measures and be proactive,” Zhang said. Said.
A good vintage?
Much depends on how long the fall lasts. If the Fed’s anti-inflation campaign ends sooner than expected, the money faucet could be turned on again. But if the downturn extends into next year and a recession begins, more companies will have to raise money or even sell themselves or close shop in a challenging environment.
Zhang believes the bearish cycle will likely last a long time, so he recommends that companies accept valuation cuts or bearish rounds as they “could be the lucky ones” if the market gets tougher.
According to Greene, the flip side of this era is that bets made today have a higher chance of being a winner in the future.
“It’s really great to invest in the seed stage in 2022 because valuations have improved and there’s less competition,” Green said. Said. “To look Airbnb and Loose and Uber and Groupon; all these companies were founded around 2008. Downturns are the best time for new companies to start.”
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