Startups are risky. One way to consider them
is a high stakes gamble for a better (in most cases) tomorrow. Because most of
the bets fail, the success stories look even more compelling.
In recent years, the traditional definition
of success for startups though has transformed into something very different. Public
listing on a prestigious stock exchange such as NASDAQ or NYSE was the ultimate
end game for startups particularly those funded by venture capital (VC) funds.
The onerous amount of paperwork along with the pressure and scrutiny of
quarterly reporting cycles were an irritant rather than a deterrent. At a time
when a public listing was the only true measure of the company’s worth and the most
acceptable path to exit investments, the startup companies – sometimes under
pressure from the VCs, embraced the hardships of a public listing.
Following the financial crisis of 2008, the
advent of quantitative easing (QE) has turned into a game changer for startup
funding. Thanks to the prolonged low interest rate regime in the developed
world, investor funds now have a much longer threshold for generating returns.
This has coincided with an emerging generation of entrepreneurs with a strong
contempt for the public markets and its attendant regulations. Many of these
with billion dollar valuation tags have been dubbed as “Unicorns” by the media.
The most successful of these startups such as Uber have really put their
investors between a rock and a hard place.
It is reported that Uber lost close to $1
billion in the first half of 2015, despite its (net) revenue tripling to
more than $1.5 billion. The scale of their ambitions and operations may differ,
but the story is being mirrored in successful startups across the board.
Grand investment plans are launched to
realize their global ambitions but with no access to public capital, the gap is
filled by private venture funds, which require ever increasing valuations. It’s
a vicious cycle, as each investor either needs to double down on their bets or
find another believer at ever-larger valuations for the expanding grand visions
of the Unicorns – hoping that everyone keeps dancing until the music stops.
Investors, though, have no one but
themselves to blame for this situation. Between their enthusiastic support for
entrepreneurs with grand visions and not wanting to miss out on the next
multi-bagger story, they have failed to rein in the ambitions of the current set
of Unicorns’ leaders. A more demanding financial environment not driven by easy
QE fueled easy money may have seen these behemoths either go public at a much
earlier stage. If not, they would have sunk into obscurity, being unable to
find a willing and patient investor base for their grand world domination
schemes.
Things may be taking a realistic note
though. Since the US Fed’s signal to end their QE program in December 2015 by increasing rates for the first time since 2006, the Titanic of the soaring valuations game has hit the
iceberg of rationality.
Investors funded fewer U.S. startups in Q4
2015 than any period in more than four years. Since November 2015, at least a
dozen tech companies, which combined raised well over $2 billion in venture
funding, have announced layoffs, letting go hundreds of people. Other companies
are closing money-losing projects and raising debt to tide them over. Some
companies are raising funding by selling shares at lower prices than they had
in earlier rounds. Others are turning to debt, which lets them raise money
without setting a lower price for their equity.
Eric Setton, co-founder and chief executive
of messaging app maker TangoMe, said he was cutting 20% of its staff to “createa sustainable business.” Less than two years earlier, the Mountain View,
Calif., company raised $280 million in financing led by Alibaba Group Holding
Ltd. at a $1 billion valuation.
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| Global spread of unicorn startups |
The launch of the European Central
Bank’s 1.1 trillion Euro quantitative easing program in January this year will draw investors around
the globe into riskier assets in Europe. Eurozone stock markets have already outperformed
the U.S., U.K. and Japan since the ECB confirmed it would go through with the
bond-buying program. As the stock market investment options get saturated, the
excess capital will inevitably find its way into higher risk private
investments such as venture funds for startups.
The party may be ending in Silicon Valley, but may just be starting in Europe.
