The Exchange has dedicated different information for quite some time to highlight the changes in the startup market. In short, the value of tech companies has been redesigned by investors, and it seems that some of the speculative enthusiasm that drove startup results in 2020 and 2021 has disappeared.
For many companies, short-term market changes do not have much of an impact. Some startups have enough capital to operate and will resolve falling earnings multiples with sustained growth.
But for a good number of startups, the situation seems different. Some startups find themselves in these situations:
- They raised a historically large round in 2020/2021 at a high price thanks to the market being flush with hot money.
- They spent heavily on hiring and growth targets, leading to elevated consumption rates through the end of 2021.
These are not bad situations, as long as the startups we're referencing have enough cash to see them through 2022. By then, perhaps tech company valuations will have recovered somewhat. But with companies growing faster than ever last year, sometimes as much as three times in a single year, some startups clung to growth targets that were tied to burning cash. This means that many 2020 and 2021 raises will not allow businesses to make it through this entire year.
That means they have to raise again, and the time factor is not a plus point.
So some tech startups are now considering two options: grow more slowly, save cash, or keep the pedal to the metal at the expense of cash. the complicated thing is that neither of the two options may work for them. What is the reason?
- Emerging companies that priced high on the expectation of rapid growth and are now facing a potential next-round valuation that doesn't match their expectations may limit growth to conserve cash. This would provide longer temporary thresholds for your next funding round. However, this will hurt their growth rates, leading to a much lower value associated with their capital, limiting fundraising options and calling into question their long-term viability.
- Those that priced high on the expectation of rapid growth now facing a potential next-round valuation that doesn't match their expectations could continue to spend to grow, limiting their cash balance. This would in turn reduce its cash flow, but keep its growth rate comparatively high. However, with investors pointing to profitability as important, simply spending to grow could end up in a very low-return scenario and thus fail to attract new capital.
This is the paradox of startup growth. It is solved by going back in time and taking capital at lower prices, or perhaps with a more limited growth plan. However, given that last year was a record for early-stage fundraising in terms of volume and pricing, it's a bit late for that.
Precisely how startups will handle this challenge will likely be a key in 2022.
There are some factors for improvement. Investors could fund their existing portfolio companies with extension rounds at fixed prices. That would dilute startups, but it wouldn't be lethal. And startups can take advantage of some growth methods that are less expensive (product-based growth, etc.) in the hope of managing a good revenue expansion without significant operating losses.
But such forms of growth are not easy to achieve, even for the companies built on such marketing methods in mind from day one. How to move to new sales methods or organic growth is unclear to startups that suddenly need to find a way to attract new customers without hiring more sales staff or spending more on advertising.
Considering last year's investment tone, this is the hangover.
