Here’s a sign of how much things have changed in Silicon Valley in the past six months.
Tech startups, which once eagerly scooped up VC funding just because they could, are now practicing a form of fund-raising abstinence and going to pains to not raise money — even if they actually need a fresh infusion of cash.
According to Merus Capital’s Sean Dempsey, later stage tech startups are increasingly doing everything in their power to avoid going back to the well and taking money from investors.
“A lot of companies are trying desperately not to have to raise money. They know that if they have to go back to the market it’s going to be a bloodbath,” Dempsey tells Business Insider.
Why would a company deprive itself of capital that it needs?
The funding climate has changed and many startups know that if they raise money now it will be at much less generous terms than their previous funding. That could mean doing a down round, or a flat round, in terms of the company’s valuation. Or it could mean accepting unfavorable “ratchets,”which are conditions that put investors’ interests ahead of the startup’s interests.
“Many of these rounds were done at valuations that got ahead of the fundamentals, certainly in the case of most unicorns. So knowing that market sentiment has shifted and investors have become more fearful than greedy, companies are pushing out fundraising as long as possible,” Dempsey explains.
One example of such unfavorable conditions was cited in a recent report by The Information, which noted that some investor term sheets include the right to veto a startup’s IPO if the price isn’t to the investor’s liking. According to the report, the number of highly valued tech firms that raised new rounds of funding in the first quarter fell by 63% compared to a year earlier.
The fear of raising new money means that startups are being forced to “extend the runway,” stretching their existing cash reserves as long as possible by cutting back on hiring, slashing costs, and looking for other creative ways to tighten the belt, says Dempsey.
“The hope being that they can become profitable or at least grow into the valuation and/or investor sentiment improves (not likely anytime soon) when they raise the next round,” Dempsey says.
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