Silicon Valley Gears Up for Adverse Impact as Funding Declines

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Clear evidence of the increasingly challenging landscape of venture capital emerged this month as two prominent industry firms faced setbacks.

After nearly a year of marketing their new multibillion-dollar funds, both Insight Partners and Tiger Global have fallen far short of their targets. This news comes as venture capital and start-ups continue to struggle after a difficult year.

According to a Silicon Valley veteran, this is the first real indication that existing investors are pulling back. Insight Partners, known for being one of the top venture capital managers, has experienced a sharp decline in investor commitments, raising only $2 billion of a planned $20 billion fund. This is a significant decrease compared to the $20 billion Insight raised in 2022.

Tiger Global faces a similar situation, having to write down a third of its venture investments after investing billions of dollars into tech start-ups during the peak of the funding boom in 2020 and 2021. Investors have committed approximately $2 billion of its planned $6 billion new fund, which is less than half the size of its previous fund.

One major institutional investor in Insight Partners expresses concerns about allocating more cash to illiquid private funds due to plummeting valuations and rising interest rates. They admit to avoiding further discussions with Insight, unsure if they will continue investing.

The funding shortfalls in the venture capital industry will have a painful impact on start-ups and companies relying on VC money. While the immense amount of cash injected into start-ups during the tech valuation bubble of the pandemic era has kept many entrepreneurs afloat, the difficult IPO market and increasingly expensive debt capital are driving even the best start-ups to seek more funding from equity investors. This will result in a wave of “down rounds” and insolvencies.

Several prominent start-ups, such as Stripe, Klarna, and Snyk, have already experienced down rounds. However, many founders are still trying to manage their cash reserves.

With time running out, Zume, a robot pizza-maker backed by SoftBank, closed down in June despite raising nearly $500 million in venture capital. Tiger Global is also accepting bids for a portion of its portfolio companies. The fortunate companies able to raise money, even at a significant discount compared to their last funding round, will be the exception.

Industry insiders foresee a major turning point in the second half of this year, when companies that raised funds near the end of the boom in late 2021 and early 2022 will have burned through 18 months of cash. Many companies have even longer cash burn periods.

An investor shares the example of a start-up that secured a valuation of $1.5 billion last year but is now struggling to find buyers at a valuation of only $500 million. They comment that bankruptcy may be the only other option.

Further evidence of the impending pain can be seen in the secondary market, where shareholders trade stock privately. Data from Carta shows that the value of preferred equity in start-ups valued at over $500 million has dropped by 25% since the first quarter of 2022. The value of common equity in such start-ups has declined by an average of 36%.

The difference in price between what sellers want and what investors are willing to pay has significantly decreased. The “bid-ask spread” has gone from 44% to 17%, indicating that sellers are now more willing to accept substantial discounts compared to a year ago.

The one ray of hope amidst the gloom is the artificial intelligence sector, which is so hyped that it could attract new investments and lift many companies out of the downturn.

Venture capitalists excel at telling compelling stories about the future. However, they can no longer rely on the story of their last fundraising round. “People who are new to the business think this is temporary,” says a partner at a Silicon Valley fund. “It will dawn on them that the world has changed.”

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