For Tech Startups, The Party Is Over
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For Tech Startups, The Party Is Over

Funding is suddenly scarce as venture capital firms grow stingy, forcing young companies to get frugal and focus on breaking even

By Heather Somervile
Wed, May 18, 2022 10:58amGrey Clock 7 min

A dizzying turn in technology-startup investing is undoing the fortunes of founders and investors riding a 13-year bull run.

Highflying startups have been grounded, swiftly, by the new climate: layoffs, sceptical investors, an exodus of funds and the prospect of a valuation haircut.

Last year, e-commerce startup Thrasio LLC was expected to be valued at US$10 billion or more in a funding deal that would have led to the four-year-old company going public. The deal didn’t happen, and Thrasio, which buys and aggregates retailers that sell on Amazon.com Inc., continues to burn through the more than US$3.4 billion of debt and equity it had raised.

In recent weeks Thrasio has cut close to 20% of its workforce, announced a new CEO, tapped the brakes on acquisitions and scaled back engineering projects, according to former employees and an internal company memo reviewed by The Wall Street Journal.

Thrasio’s trajectory—and the stratospheric rise of many startups—benefited from years of low interest rates and a decline in the number of public-company stocks, which helped drive investors into venture capital. The trend accelerated in 2020 when stimulus and other pandemic-relief moves created a flood of cheap capital, which some investors parked in startups as pandemic restrictions made digital apps and services a hotter asset class.

The reversal mirrors a turn in the broader tech industry, where stocks are being hammered and companies from Facebook parent Meta Platforms Inc. to Twitter Inc. and Uber Technologies Inc. are moving to cut costs.

Many big money managers have fled startups. Venture capitalists are steering clear of high valuations and demanding that companies spend less and improve their margins—an about-face after years of profitability taking a backseat to growth. The pressure, combined with uncertainty over where the next investor check will come from, has prompted startups that seemed to be soaring just months ago to fire staff members, cut marketing spending, cancel projects and do whatever they can to make their money last.

“This is clearly not a speed bump,” said Mike Volpi, a venture capitalist with Index Ventures. “This is a proper correction. The end of a cycle.”

In March, startup CEO Doug Ludlow cautioned his fellow founders on Twitter: “If you haven’t already started on a path to break-even, start immediately. In 2022, VC’s are going to pull back massively.”

Mr. Ludlow has confronted that himself. Plans for a fundraising round with new investors fell through after the market turned sour and there was disagreement with investors over price, according to a person familiar with the matter. He reverted to plan B: a much smaller funding round with his existing investors, known as an insider round.

Mr. Ludlow said he has developed a plan for his three-year-old financial-services firm, MainStreet Work Inc., to break even in six months to a year. It entails laying off 45 people, about a third of the workforce.

“Every dollar you’ve got to treat as if that’s the last dollar you may have,” he said.

Matt Schulman, CEO of software startup Pave, said his investors are scrutinizing gross margins in a way they hadn’t before. Pave, which helps employers develop compensation plans and discuss them with employees, has repositioned itself from a service to help firms with hiring to one that helps companies retain employees, he said. There have been too many hiring freezes for the previous strategy to make sense.

Mr. Schulman recently made a list of 15 potential ways to cut spending. One was to do more hiring in cheaper regions such as Latin America.

The venture-capital pullback is a correction from extraordinary heights. Investors poured US$1.3 trillion into startups over a decade, producing hundreds of companies annually that attained billion-dollar-plus valuations, attracting interest from foreign governments and top-tier hedge funds.

Venture-capital funds raised $132 billion to invest in startups in 2021, nearly double the amount from 2019 and six times the total raised a decade ago, when the number of funds was about a third of what it is today. In last year’s fourth quarter, venture capital investments reached a record $95 billion, according to PitchBook Data Inc.

That was too much money to deploy effectively or wisely, some investors say. The valuation multiple that was deemed acceptable for software startups reached 100 times annual recurring revenue, roughly 10 times the historical norm for companies in that industry, according to data from venture-capital firms.

“If you keep marking everything up, you’re eventually going to believe that those marks are accurate,” said Gil Dibner, a London-based venture capitalist.

Startups that raised big sums at high valuations faced pressure to grow, which they did by rapidly adding staff and making acquisitions. At some companies, the quality of work deteriorated, acquisitions weren’t thought out, leadership got distracted and cash burn soared, said some investors and startup founders.

“It was a scrum,” said Mr. Dibner. “When you shove that much money at pretty much anything, you change the way people make decisions.”

Now, the public tech companies that powered the pandemic-era stock-market rally are suffering some of the market’s biggest losses. Shares of Facebook parent Meta and Amazon.com are down more than 30% this year, Apple Inc., Microsoft Corp. and Alphabet Inc. have all dropped around 20% and Netflix Inc. has fallen 69%. The S&P 500 is down 16% since the start of the year, and the Nasdaq Composite Index is off by more than a quarter from its high in November.

Private tech companies quickly looked overpriced. With interest rates rising to fight 8%-plus inflation, startups whose profits were years in the future had less appeal.

Particularly important to startups seeking big sums of capital are crossover funds, large money managers that invest in both stocks and private companies. Those managers accounted for around 70% of the dollars startups raised last year. Some, including Coatue Management LLC and D1 Capital Partners, quickly backed off from startup investing when the stock-market decline hammered their investments in public companies. In the first three months of 2022, crossover funds’ venture capital investments sank to the lowest level in six quarters, according to PitchBook.

SoftBank Group Corp., which operates two startup investment pools as part of its Vision Fund unit, reported a $26.2 billion loss Thursday on its big portfolio of technology companies for the first three months of the year. SoftBank said it would cut the number of startup investments through next March by half or three-quarters from last year’s pace.

Hedge fund Tiger Global, one of the heaviest startup investors during the pandemic, is staying in venture capital investing despite being on track to have its worst year, with its main fund down 45% year to date. But Tiger is shifting to early-stage companies that have lots of room to grow and remain years away from going public.

In all, venture capital investments fell 26% in this year’s first three months from the fourth quarter, according to data from PitchBook. Some investors say they are looking at about a third to half the number of prospective deals they were last year. From the end of last year through the first quarter, valuations for one cohort of high-growth startups fell 42% on average, according to data provided by Carta Inc.

The vacuum in funding has turned sentiment in Silicon Valley “the most negative since the dot-com crash” two decades ago, said venture capitalist David Sacks.

Thrasio, which has more than 300 retail brands selling items ranging from insect traps to mops, is valued as a tech company (at more than $5.5 billion, in its last private financing) despite having limited tech, people familiar with the matter said. The startup made its first $100 million or so in revenue without an engineering team and was using Google spreadsheets, one of the people said.

Its discussions last year with a special-purpose acquisition company to go public were scuttled by complications with Thrasio’s accounting and investors souring on SPAC deals, which have traded poorly in the public markets, according to people familiar with the plan.

Thrasio now faces not only the venture-capital retreat but also rising costs for goods and advertising, and larger Amazon fees for sellers. The cost predicament is squeezing many others, too, and has contributed to the more than 8,200 layoffs at U.S. venture-backed startups since March, according to a survey of layoff announcements and tracking website Layoffs.fyi.

Reef Technology Inc., which builds kitchens for food delivery services on parking lots, has been struggling to raise a round of funding. It initially was seeking as much as US$1 billion.

As the market tightened and capital became harder to secure, Reef cut hundreds of staff, closed kitchens and delayed paying bills. The company recently struck a deal for over US$250 million in funding, people familiar with the matter said.

A Reef spokesman said the company recently secured new funding from investors, and it expects to add additional investors in the future.

Rapid-delivery startup Gopuff said in a company filing in December it was seeking to raise up to $1.5 billion in a loan that would convert to equity. The full funding hasn’t materialized, according to a person familiar with the matter. Gopuff now is working to secure a $1 billion loan. It has laid off around 450 people, or 3% of its staff, according to a company memo.

There are structural reasons to believe the funding turmoil isn’t headed to a bust. The digital transformation of industries that the pandemic has helped spur is permanent, say investors. Many startups remain flush with cash and just need to keep a lid on spending.

Past pullbacks that proved brief show the tech industry’s resilience. Among these were one in 2016, when investors cooled on software-as-a-service companies, and another in 2019, when investors punished newly public tech companies for their heavy losses. Each time, startup investment rebounded quickly and rose to a higher level.

“It’s not a 2001, in my opinion, or a 2008 scenario,” said former Cisco Systems Inc. CEO John Chambers, who is now a venture capitalist. “Marginal startups just will not get funded, but I actually think that’s a healthy phenomenon.”

For venture capitalists who no longer have to jockey with multibillion-dollar hedge funds, the slowdown comes as a relief. Mr. Sacks said his firm, Craft Ventures, has been able to invest in two late-stage companies without facing the competition from big money managers that, six months ago, would have driven the price much higher.

Meanwhile, venture capitalists are clawing back some of the power they ceded to company founders when the market was hot. More deals now include protections such as so-called full ratchets, which ensure that investors can recoup the value of their investment in case a startup’s valuation declines in a future funding round or a public offering. Some investors are providing a startup with capital but not assigning a valuation until they can assess its revenue and losses at the end of the year.

Startups should be prepared for things to get worse before they get better, according to J Zac Stein, president of human resources software startup Lattice.

“Many people join startups to embrace the struggle,” he said. “They may just get that opportunity.”

Reprinted by permission of The Wall Street Journal, Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: May 18, 2022.

 

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How 20 Seconds Can Make You a Better Investor

Investors are taming impulsive money moves by adding a little friction to financial transactions

By IMANI MOISE
Tue, Mar 14, 2023 4 min

To break the day-trading habit that cost him friendships and sleep, crypto fund manager Thomas Meenink first tried meditation and cycling. They proved no substitute for the high he got scrolling through investing forums, he said.

Instead, he took a digital breath. He installed software that imposed a 20-second delay whenever he tried to open CoinStats or Coinbase.

Twenty seconds might not seem like much, but feels excruciating in smartphone time, he said. As a result, he checks his accounts 60% less.

“I have to consciously make an effort to go look at stuff that I actually want to know instead of scrolling through feeds and endless conversations about stuff that is actually not very useful,” he said.

More people are adding friction to curb all types of impulsive behaviour. App-limiting services such as One Sec and Opal were originally designed to help users cut back on social-media scrolling.

Now, they are being put to personal-finance use by individuals and some banking and investing platforms. On One Sec, the number of customers using the app to add a delay to trading or banking apps more than quintupled between 2021 and 2022. Opal says roughly 5% of its 100,000 active users rely on the app to help spend less time on finance apps, and 22% use it to block shopping apps such as Amazon.com Inc.

Economic researchers and psychologists say introducing friction into more apps can help people act in their own best interests. Whether we are trading or scrolling social media, the impulsive, automatic decision-making parts of our brains tend to win out over our more measured critical thinking when we use our smartphones, said Ankit Kalda, a finance professor at Indiana University who has studied the impact of mobile trading apps on investor behaviour.

His 2021 study tracked the behaviour of investors on different platforms over seven years and found that experienced day traders made more frequent, riskier bets and generated worse returns when using a smartphone than when using a desktop trading tool.

Most financial-technology innovation over the past decade focused on reducing the friction of moving money around to enable faster and more seamless transactions. Apps such as Venmo made it easier to pay the babysitter or split a bill with friends, and digital brokerages such as Robinhood streamlined mobile trading of stocks and crypto.

These innovations often lead customers to trade or buy more to the benefit of investing and finance platforms. But now, some customers are finding ways to slow the process. Meanwhile, some companies are experimenting with ways to create speed bumps to protect users from their own worst instincts.

When investing app Stash launched retirement accounts for customers in 2017, its customer-service representatives were flooded with calls from panicked customers who moved quickly to open up IRAs without understanding there would be penalties for early withdrawals. Stash funded the accounts in milliseconds once a customer opted in, said co-founder Ed Robinson.

So to reduce the number of IRAs funded on impulse, the company added a fake loading page with additional education screens to extend the product’s onboarding process to about 20 seconds. The change led to lower call-centre volume and a higher rate of customers deciding to keep the accounts funded.

“It’s still relatively quick,” Mr. Robinson said, but those extra steps “allow your brain to catch up.”

Some big financial decisions such as applying for a mortgage or saving for retirement can benefit from these speed bumps, according to ReD Associates, a consulting firm that specialises in using anthropological research to inform design of financial products and other services. More companies are starting to realise they can actually improve customer experiences by slowing things down, said Mikkel Krenchel, a partner at the firm.

“This idea of looking for sustainable behaviour, as opposed to just maximal behaviour is probably the mind-set that firms will try to adopt,” he said.

Slowing down processing times can help build trust, said Chianoo Adrian, a managing director at Teachers Insurance and Annuity Association of America. When the money manager launched its online retirement checkup tool last year, customers were initially unsettled by how fast the website estimated their projected lifetime incomes.

“We got some feedback during our testing that individuals would say ‘Well, how did you know that already? Are you sure you took in all my responses?’ ” she said. The company found that the delay increased credibility with customers, she added.

For others, a delay might not be enough to break undesirable habits.

More people have been seeking treatment for day-trading addictions in recent years, said Lin Sternlicht, co-founder of Family Addiction Specialist, who has seen an increase in cases since the start of the pandemic.

“By the time individuals seek out professional help they are usually experiencing a crisis, and there is often pressure to seek help from a loved one,” she said.

She recommends people who believe they might have a day-trading problem unsubscribe from notifications and emails from related companies and change the color scheme on the trading apps to grayscale, which has been found to make devices less addictive. In extreme cases, people might want to consider deleting apps entirely.

For Perjan Duro, an app developer in Berlin, a 20-second delay wasn’t enough. A few months after he installed One Sec, he went a step further and deleted the app for his retirement account.

“If you don’t have it on your phone, [that] helps you avoid that bad decision,” he said.

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