What’s Next In Venture Financing?
Is the failure of Silicon Valley Bank one of the first dominoes to fall signifying the end of the easy money in venture financing? Or will the days of wine, roses, cheap money, and SPACs return with the resurgence of the stock market?
Ventures are said to be holding on to the cash they raised earlier, and are reluctant to raise more because some valuations have fallen by half or more. They are also waiting for the return of the glory days and high valuations of the recent past.
Here is one key reason for the heady valuations. VC funding has soared by 12X in 12 years. The low interest rates of the last 14 years channeled a lot of capital from debt and bonds to equity and venture capital in the search of high returns. VC funding increased from $28 billion in 2009 to nearly $345 billion in 2021. Some think that the current tightening in venture capital is temporary. VC has had many ups and downs.
3 Reasons Why this Time may be Different.
Is the downturn temporary? Is this increase in interest rates and corresponding decline in VC availability a temporary phenomenon like previous hard times in VC, or is this time different? There are three compelling reasons why interest rates may not fall even if they do not rise more, why the current tightening of VC might not be temporary, and how it could shape the future of the industry.
#1. A Shifting Economic Landscape: The federal deficit has ballooned from $12 trillion in 2009 to $31 trillion in 2022. This means that sooner or later, the federal government will reach a threshold where borrowing more money will become very expensive and more stifling. And the fears of an increase in rates are already here.
#2. Constraints on Monetary Policy: Historically, loosening the money supply has been a popular strategy during economic downturns to stimulate growth. However, the current situation presents new challenges. Increasing the money supply runs the risk of increased inflation, which can have adverse effects on the economy. This constraint further supports the notion that the easy money era might be transitioning into a new norm with tighter financing conditions. And the bills are hitting the fan.
#3. Global Economic Dynamics: Most importantly, the formation of a consortium led by China to challenge the dominance of the U.S. dollar with a gold-backed currency introduces potential disruptions to the U.S. economy. If successful, this initiative will drastically shift global financial dynamics, leading to changes in the flow of capital, and will impact venture financing, making it more challenging to obtain easy money and prompting a shift towards finance-smart approaches.
Implications for the Future.
Venture CEOs are already reluctantly seeking shelter in the arms of large corporations or even other startups and selling themselves off because they have run short of funding. When everyone is forced to sell their ventures, rather than waiting for corporations to pay high for strategic value, the valuation falls like a stone and investors are lucky to get a portion of their investment back. This will cause further pain to investors, who may call it a day, and to employees – making people in safe jobs stay there instead of risking their careers for stock-option riches in VC-seeking ventures.
MY TAKE: If these changes end the days of Theranos, FTX, and IRL, it would be an improvement. It is increasingly likely that U.S. financial conditions will return to higher interest rates similar to those seen in the 1990s and early 2000s. This shift will require businesses to adopt more prudent capital utilization practices, and entrepreneurs to use smarter financial strategies to build sustainable growth ventures. While this shift may result in the downfall of ventures that relied on “free” money, it also brings opportunities for viable and financially-responsible startups and finance-smart entrepreneurs to thrive – and build real unicorns without VC hype.