‘We will see spectacular failures’: CEOs and investors explain what the end of cheap money means for tech

LISBON, Portugal — Once upon a time, high-flying tech unicorns are getting their wings clipped as the era of easy money draws to a close.

That was the message from the Web Summit technology conference in Lisbon, Portugal earlier this month. Startup founders and investors took to the stage to warn their fellow entrepreneurs that it was time to rein in costs and focus on fundamentals.

“What is certain is that the fundraising landscape has changed,” Guillaume Pousaz, CEO of London-based payment software company Checkout.com, told a panel moderated by CNBC.

Last year, a small team could share a PDF game with investors and receive $6 million in seed funding “instantly”, according to Pousaz – a clear sign of excess in venture capital deals.

Checkout.com itself saw its valuation nearly triple to $40 billion in January after another round. The company generated revenue of $252.7 million and a pretax loss of $38.3 million in 2020, according to a company filing.

Asked about the valuation of his company today, Pousaz replied, “Valuation is something for investors who care about the entry point and the exit point.”

“Last year’s multiples are not the same as this year,” he added. “We can look at public markets, valuations are mostly half of what they were last year.”

“But I would almost tell you that I don’t care because I care where my income goes and that’s what matters,” he added.

Private tech company valuations are under immense pressure amid rising interest rates, high inflation and the prospect of a global economic slowdown. The Fed and other central banks are raising rates and reversing pandemic-era monetary easing to avoid soaring inflation.

This has led to a sharp decline in high-growth tech stocks which, in turn, has impacted private startups, which are raising funds at reduced valuations during so-called “downturns”. Companies like Stripe and Klarna have seen their valuations drop 28% and 85% respectively this year.

“What we’ve seen in recent years is a cost of money that was 0,” Pousaz said. “It’s very rare in history. Now we have a cost of money which is high and will continue to increase.”

Higher rates represent challenges for much of the market, but they represent a notable setback for tech companies that are losing money. Investors value companies based on the present value of future cash flows, and higher rates reduce the amount of those expected cash flows.

Pousaz said investors have yet to find a “floor” on how much the cost of capital will rise.

“I don’t think anyone knows where the top floor is,” he said. “We have to hit the floor on the top and then decide and start predicting what the lower end is, which is the long-term residual cost of capital.”

“Most investors are still doing valuations to this day on DCF, discounted cash flow, and to do that you need to know what the residual floor on the downside is. Is it 2%, is it 4%? I wish I knew. I don’t.”

A common topic of conversation at Web Summit was the relentless wave of layoffs hitting big tech companies. Payments company Stripe has laid off 14% of its employees, or about 1,100 people. A week later, Facebook owner Meta cut 11,000 jobs. And Amazon is expected to lay off 10,000 workers this week.

“I think every investor tries to push that into their portfolio companies,” Tamas Kadar, CEO of fraud prevention startup Seon, told CNBC. “What they usually say is if a business isn’t really growing, it’s stagnating, so try to optimize profitability, increase gross margin ratios and just try to lengthen the runway.”

Venture capital deal activity has declined, according to Kadar. Venture capitalists have “hired so many people”, he said, but many of them are “just talking and not really investing as much as before”.

Not all businesses will survive the impending economic crisis – some will fail, according to Par-Jorgen Parson, partner at venture capital firm Northzone. “We will see spectacular failures” from some highly regarded unicorn companies in the months ahead, he told CNBC.

The years 2020 and 2021 have seen eye-watering sums floating around stocks as investors took advantage of abundant liquidity in the market. Technology has been a key beneficiary thanks to societal changes caused by Covid-19, such as working from home and increased digital adoption.

As a result, apps promising under-30-minute grocery delivery and fintech services allowing consumers to purchase items with no upfront cost and virtually anything crypto-related have attracted hundreds of millions of dollars at valuations. of several billion dollars.

At a time when monetary stimulus is winding down, these business models have been tested.

“A whole industry has gotten its skis out of the way,” Parson said in an interview. “It was largely driven by the behavior of hedge funds, where funds saw a growth sector, gained exposure to that sector, and then bet on a number of companies in the hope that they will be the market leaders.”

“They increased the valuation like crazy. And the reason it was possible to do that was because there was nowhere else to go with the money at the time.”

Maëlle Gavet, CEO of startup accelerator program Techstars, agrees and said some later-stage companies are “not designed to be sustainable at their current size.”

“A turn down may not always be possible and, frankly, for some of them, even a turn down may not be a viable option for outside investors,” she said. told CNBC.

“I expect a number of development-stage companies to disappear.”