The past decade in the tech space was not normal as venture capital, private equity, and growth equity funds were awash with capital. This excess capital—driven by low interest rates and a lack of "real-return" alternatives—led to a boom in private tech company valuations. There was a gold-rush mentality to fund any kind of technology start up that had the promise of fast growth.
During that time, closing an equity financing was easier for founders than it had ever been and valuations were higher due to increased demand from investors.
COVID-19 became the cherry on top for tech valuations. As other asset classes suffered due to pandemic-related restrictions and other economic shifts, technology fund assets were even more in-demand, and already absurd valuations climbed even higher.
Inflation turned out to be the ‘great equalizer.’ As central banks put the brakes on the economy with rising interest rates to drive down inflation, the asset class that flew the highest—technology venture capital—has fallen the farthest.
Comparing the valuation of several publicly traded tech companies from early 2021 to May 2022, we see Zoom’s (ZM) stock price drop 79.28% from $433.11 to $89.74, Stitchfix (SFIX) drop 91.44% from $96.92 to $8.30, and Affirm (AFRM) drop 80.19% from $125.29 to $24.82.
Even though companies funded today may not go for an IPO for five years from now, there is still a direct link between public market valuations and equity funding availability. If an investor loses confidence in their startups’ ability to IPO for $1 billion, they also lose interest in the startups.
Technology is not bursting; the technology financing bubble is
The world is abuzz with recession talk—especially the tech world. The stock market is down, interest rates are rising, valuations are decreasing, and venture capital is drying up. But despite all this, the tech bubble is not bursting. There is still a huge demand for technology and innovation.
What is bursting is the technology financing bubble. The unsustainable period of irrational valuations and hefty VC rounds is over. Anyone surprised by that either has a very low understanding of basic economics or is too young to remember other economic downturns.
The new normal for technology financing means that investors will be more selective about the companies they invest in. Companies with poor unit economics and unrealistic growth strategies will find it a lot harder to access growth capital than in previous years. Is this really a bad thing? Companies that are creating value and being efficient with their capital will be rewarded with investment and companies that are not, won’t.
People calm down. This is NOT a tech business bubble bursting (not yet anyways), but rather a financing and valuation bubble bursting. It was long overdue and valuations are reverting to the long term mean.
— John Ruffolo (@ruffoloj) May 10, 2022
In a recent interview with The Business of Business, Clari founder Andi Byrne offered his fellow founders some sage advice:
“Reset your f-ing expectations. It is going to be tough. It’s going to be eye-opening. It’s going to be—in a lot of cases—brutal. Worry less about valuation and worry more about passion and about your vision and what you want to do. Because it’s not about the money, it’s about realizing your dreams,”Andi Byrne, CEO, Clari.
An economic meltdown is not happening, but…
…an overdue correction is happening in the technology space.
But Wall Street, Palo Alto, and Main Street do not always behave the same way. If tech stocks take a tumble from their inflated highs, it doesn’t mean the entire economy is imploding.
Unemployment is lower than it has ever been and consumer demand is still high. Central banks are raising interest rates to regain control of inflation and, while that’s happening, funding—especially venture capital—will be harder to come by.
Is debt a better option in the new normal?
By placing the focus firmly on unit economics and business fundamentals — customer acquisition costs, cash conversion cycles, customer payback, etc. — and away from the ego-driven hype around valuations and funding rounds, debt creates a more sustainable standard in the industry than venture capital.
Debt providers—particularly those operating in the private credit space—will still be open for business, since debt doesn’t have the same direct linkage to public markets as venture capital.
While it is true that debt providers will likely tighten their lending criteria, if you qualify for debt, it is a much better option than equity-based capital at the current time—especially since your equity valuation is probably a lot lower than it was four months ago.
Managing cash flow will be an absolute requirement in this new normal, regardless of whether debt is used or not. But for those that can manage cash flow, the future is bright.
Looking for non-dilutive capital?
TIMIA Capital works with B2B SaaS and software-enabled
companies between $2 – $20 million ARR.