The mythical “unicorn” startup valued at $1 billion is no longer a rarity. In a competition of egos, too many startups went after that $1 billion mark without businesses to back it up.
However, the investors who used to fund these excessive growth rounds at fear of missing out have started “sobering up” to realise they have invested in some bad business models at some huge prices, Social Capital’s Chamath Palihapitiya told Business Insider.
Things like terrible unit economics or high customer acquisitions costs were ignored because of some vanity metric that justified more money at a huge valuation, he said.
“But all those investors are now having to deal with the impending reality that there is no greater fool to then mark up the deal after them, that they may have in fact been the greatest fool,” he said.
That means startups that fall into the gushing money category are now faced with two options: find a bid at lower prices and do a downround, or they’re repricing their last fundraise at a lower price so there’s a future “upround” again.
“However you want to put the lipstick on the pig, that’s what’s happening now,” Palihapitiya said.
The falling valuations puts those venture capitalists who once thought they got a great deal in a bind. Venture capitalists are now having to revalue their portfolios to adjust for what Palihapitiya calls a “negative, protracted down cycle”.
“Now that deal that looked amazing looks barely break even or is now underwater,” he said.
Those sobering realisations will set off a chain of reactions, rippling from the venture community through to the limited partners, or LPs, that are the ones who fund them — everybody’s going to see these bad returns and suddenly be a lot more averse to risks. He estimates it will take four to six more quarters of poor returns before the investors in the big growth funds also “sober up to the fact that all the paper profits that they thought they had aren’t really there.”
That’s when, he thinks, these investors will start putting more of their money into early-stage funds like the ones run by Social Capital (naturally) and Benchmark.
“Because what they’re going to see is that they invested in a growth fund thinking that they were buying high quality business models, high quality revenue, predictable outcomes, 18 to 24 months of liquidity. Instead what they really did was make a series A investment but with $100 million instead of $10 million. That’s a really bad risk management.”
At the end of the day, Palihapitiya thinks going forward the tech industry will be seeing investors behaving differently now that there has been a reset of expectations on both sides of the table.
“They got really cute, they learned a lesson, they’re probably not going to be held accountable for that lesson, but they’re probably not going to repeat the same behaviour again,” he says.