After a year in which free-flowing capital fueled unprecedented growth in so-called technology “unicorns,” the sector is bracing for a slowdown which could thin the herd.
Unicorns — a term coined for the usually rare billion-dollar, privately funded startups — have been proliferating in the US, China and elsewhere as venture capital investors bet on the next Google or Facebook Inc.
However, the prospect of a “bear market” where prices are falling, combined with other factors, could send unicorns running for cover, observers who follow the sector said.
Some warnings have already appeared.
Venture-backed startups internationally saw a 30 percent drop in funding in the fourth quarter to US$27.2 billion, a survey by KPMG LLP and research firm CB Insights said.
A separate survey by 451 Research found more than half of tech investment bankers predict venture funding is expected to tighten this year compared with last year, the most bearish outlook since the 2008 to 2009 recession.
Some unicorns have seen their value slashed by investors aiming to put a fair market evaluation on their holdings. Mutual fund company Fidelity Investments last year marked down the value of its holdings in Snapchat Inc by 25 percent.
In this scenario, cash-hungry unicorns are likely to face a harder time getting fresh capital, said David Erickson, a senior fellow at the University of Pennsylvania’s Wharton School and former Wall Street banker, who led technology share offerings.
A weak stock market could impact private firms, potentially forcing a delay of initial public offerings. If they need to raise cash, it would likely be “down rounds” with a lower valuation than previous funding efforts.
“Valuations will typically come down,” he said.
Since the “softness might be prolonged, venture capital firms will be focused on protecting the value in their existing investments rather than spending too much time investing in new names,” he said.
Erickson said there are some similarities to the tech bubble of 1999 to 2000, even if the new firms have more developed business models.
“While the companies are more seasoned, the issue similar to 2000 is that many are burning tonnes of cash,” he said. “If they need to have enough cash to break even and if they can’t access capital either through the public markets or private markets, then they face more difficult decisions.”
Erickson added that “we are not quite at that dire stage now,” but that if capital dries up it might mean that promising startups would either need to sell themselves or “hit the wall.”
The unicorn population — estimated by Forbes this month at 173 companies worth a collective US$585 billion — is still alive, but some are hurting.
CB Insights chief executive Anand Sanwal said he expects to see “some wounded unicorns,” but that there is still capital available from private equity and corporate venture funds.
“Some of those companies that got ahead of themselves on valuation are going to have difficult conversations. You can’t just keep selling your dream and your business model can’t be raising venture capital,” Sanwal said.
Brooklyn Bridge Ventures Charlie O’Donnell said many of the unicorns are likely to face a “down round” if they need new capital, because investors are more cautious.
“It’s not that they’re concerned that the world will implode and that startups won’t still be a good bet over the long term,” O’Donnell said in a blog post. “They’re just... busy taking care of their wounded.”
A report by KPMG and CB Insights found that last year was a blockbuster year for startup venture funding despite a cooling in the fourth quarter. For the year, the report found US$128 billion in venture funding for startups, up 44 percent from 2014. The number of funding rounds was more than 7,800.
However, it noted that some companies which went public “fell short of recent private valuations, no doubt rattling VC [venture capital] investor confidence.”
The most prominent in the group was mobile payments startup Square Inc, led by Twitter Inc cofounder Jack Dorsey. Square debuted with a market value of a little more than US$4 billion — well below the US$6 billion value assigned by private investors in its latest funding round. The firm’s value has since fallen to less than US$3.4 billion.
Most stock markets are in a “correction,” which means a drop of 10 percent from their peak.
However, some Asian bourses are in “bear” territory, with a drop of 20 percent or more and the tech-heavy NASDAQ has neared that level.
Unicorns, analysts said, might not fare well if the bears come out in force.
“If indeed venture firms start keeping their money in their own bank accounts — rather than investing it in entrepreneurs — that could well put startups under pressure, resulting in slower growth rates and lower valuations for those that survive tighter times, as well as dramatic flameouts for those that don’t,” 451 Research analyst Brenon Daly wrote in a blog.
Daly said the message has not yet reached the unicorns.
“Most money-burning startups continue to run their businesses as if there’s an inexhaustible supply of money,” he said.
“But at some point this year, startups will almost certainly have to make different decisions than they’ve made up to now,” he added.
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