What happens to the flow of venture capital when the market falls? Investors and start-ups must recalibrate and make tough choices when tough times lie ahead.
RACHEL MARTIN, HOST:
The market is down, especially for technology stocks. And that changes the math for private equity investors known as venture capitalists. As Wailin Wong and Adrian Ma of the Indicator podcast explain, investors and startups face some tough choices.
ADRIAN MA, BYLINE: Before we get into pessimism, let’s revisit some of the high-flying times in technology. Nicole DeTommaso is a senior partner at Harlem Capital. It is a company specializing in seed funding for startups led by women and people of color.
NICOLE DETOMMASO: Valuations have exploded. You know, people were getting 30 million ratings of an idea. And we always wanted to be with those great founders. You couldn’t sit down because otherwise you just wouldn’t be deployed.
WAILIN WONG, BYLINE: Deployment is basically spending money. It’s what venture capitalists live to do because the sooner those funds go to work helping a company create the next world-changing technology, the sooner they might see a return on that investment.
MA: And it turns out that VCs have their own investors to answer to. These investors are called limited partners – or LPs.
WONG: Sponsors are often wealthy individuals or institutions who spread their money in many places, including venture capital funds. And one of the reasons they’re called sponsors is because they don’t get involved in deciding which startups to invest in.
MA: So basically, startups get their money from venture capitalists, who get their money from sponsors. And so now it’s time to follow that same flow of money that we talked about, and follow it into a bear market. Nicole says the problems started with this thing we all live with now, high inflation.
DETOMMASO: Honestly, it probably started when inflation hit 40-year highs. Interest rates have gone up. Once these rose, stock markets fell.
WONG: Stock markets tend to fall when interest rates rise. And publicly traded tech companies set the value expectations of private tech companies. So as public valuations fall, so do private valuations, meaning a startup that was once perhaps on the verge of being the next Uber or Shopify now looks like too risky a bet.
MA: So now startup valuations are falling, which means venture capitalists aren’t getting the kind of return on investment that they want.
WONG: And remember, venture capitalists invest the money they got from their sponsors — the people who trust them to make smart bets on startups. Now venture capitalists are returning less money to their LPs.
M.A.: Right. And when it comes time for venture capitalists to raise funds, their sponsors write smaller checks. And then the venture capitalists, they have less money to invest. And so, in turn, they write smaller checks to startups.
WONG: Nicole says the advice she’s heard is that in this market, startups should have 18 to 24 months of cash because they can’t rely on the ability to raise funds like they did before. For businesses that don’t have that cushion, it’s time to start cutting costs.
DETOMMASO: Unfortunately, sometimes that means you have to fire people. But, I think, something you have to consider as a founder is that if you don’t fire some people, the whole company could sink, right? And then you fire everyone.
WONG: Nicole says her venture capital firm is still actively investing in startups. And as the pace of deals slows, she expects valuations to be based less on hype and more on a founder’s ability to navigate the difficult times ahead.
MA: Adrian Ma.
WONG: Wailin Wong, NPR News.
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