Silicon Valley start-ups brace for a summer of pain

Patrick and John Collison: Stripe has already taken a valuation cut.

The global start-up world has had a tough year — plagued by mass layoffs, plummeting venture capital investment and the chaotic collapse of Silicon Valley Bank. But many in tech believe the worst is yet to come.

As the market downturn drags on and investor cash remains hard to come by, more start-ups will start to run out of money, experts say. Some venture-backed companies will be forced to raise new funding even if it means agreeing to a lower valuation than they once secured, a deal called a down round, dreaded by founders and investors alike.

High-profile companies like financial giant Stripe, Swedish payments startup Klarna and security firm Snyk have already taken valuation cuts, and others like Blockchain.com are said to be in talks to do the same. 

Founders assiduously avoid down rounds because they signal a company’s to-the-moon trajectory has been derailed, battering morale and wiping out millions, and sometimes billions, of paper wealth for start-up founders and employees. They also represent a loss for venture capitalists and their investors, called limited partners, and can result in legal headaches.

While many companies have cut costs and taken on debt to avoid raising money on unfavourable terms, those delay tactics have limits. 

More than 400 companies — one-third of all unicorn start-ups, those valued at $1bn or more — have not raised new funding since 2021, according to PitchBook. That’s a long time for a company that is not yet turning a profit, coasting on the cash they brought in from previous funding rounds. Most venture-backed companies usually raise every year or two, and about 94% of tech unicorns are unprofitable, according to PitchBook.

Stripe, headed by Limerick brothers John and Patrick Collison, completed a financing deal valuing it at $50bn (€45.38bn), or about half its 2021 valuation. 

Several crypto start-ups have taken or are taking down rounds, as are multiple companies overseas, including Klarna, which saw its value fall more than 85%. 

But as more start-ups are learning, a down round is better than no funding round. Venture investing in all start-ups has declined precipitously in recent months. 

The number of start-ups that raised money in the first quarter of 2023 hit its lowest level in five years — a pace that falls far short of demand. A PitchBook internal estimate shows that for every $3 start-ups need, just $1 is being deployed.

Investors are becoming more sceptical and driving harder bargains for every start-up. That is true even in the buzzy space of artificial intelligence — a rare bright spot in the venture investing landscape, which has been flooded with talent and cash to create new companies.

• Bloomberg