Market history says a recession could result in the next Airbnb or Slack

Layoffs, rising interest rates, skyrocketing valuations – this is a tough time for startups.

Amid the broader economic slowdown and bear market in technology stocks, investors have been preferring profitability — or at least a reasonable way to get there — over the promise of future growth.

This has been a hard sell on the ability of the VC-funded startup market to monetize innovation, at least in the short term.

According to the recently released annual review of mutual fund trends from PitchBook and the National Venture Capital Association, one of the biggest takeaways in 2022 has been the “slow” exit pace. A total of $71.4 billion in exit value was generated, down 90.5% from the 2021 record of $753.2 billion. It was the first time that the value of exits fell below $100 billion since 2016, and late-stage companies were the hardest hit. Public offerings of VC-backed companies have fallen to a level not seen since the early 1990s, with only 14 listed in the fourth quarter.

We’ve been here before.

As the economy thawed in 2008, legendary venture firm Sequoia published the infamous “RIP Good Times” memo, announcing to startups that “cuts are a must” along with “the need to become cash flow positive.”

More than a decade later, those who heeded that advice have turned out to be game-changing tech giants, including CNBC Disruptor 50 Companies. blockAnd pinterestlumber twilioand Cloudera.

One in particular has gone on to reach a market cap of over $50 billion, despite going public in a volatile environment: Airbnban eight-time Disruptor 50 company that shares the same distinction with only one other company in the history of the annual list – Stripe.

Airbnb signs on an electronic screen during the company’s initial public offering (IPO) at the Nasdaq Market site in New York, U.S., on Thursday, December 10, 2020.

Victor J Brown | bloomberg | Getty Images

Stripe topped the Disruptor 50 list for 2020 that was released shortly after the Covid crash. Months earlier, Sequoia had published another widely read note, “The Black Swan,” which pointed to persistent inflation and geopolitical conflicts that would limit capacity for “quick fix” policy solutions such as rate cuts or quantitative easing.

Last year, Sequoia Partners admitted that they underestimated the monetary and fiscal policy response to the Covid crisis. Two months later, we got an idea of ​​the market correction they were referring to when Stripe cut its internal valuation by 28%, from $95 billion to $74 billion, which was one of many private company haircuts seen in 2022. This week, This was reported by The Information that Stripe cut its valuation again, by 11% to $63 billion.

Stripe was founded in 2010, just as the US economy and job market was beginning to recover from the financial crisis and its turbocharging during Covid. “We were very optimistic about the near-term growth of the Internet economy in 2022 and 2023 and underestimated the potential and impact of a broader slowdown,” its founders wrote in a recent layoff note.

“The world is now turning again. We are facing stubborn inflation, energy shocks, higher interest rates, lower investment budgets and less startup financing… We believe that 2022 marks the beginning of a different economic climate… Today this means building differently for smaller times.

“In times like these, investors continue to invest in innovation,” said Kyle Stanford, senior analyst at PitchBook. But he added that this is most evident in the difference between seeds and project growth in the late stage.

Seed rounds generated record deal value in 2022, and valuations have continued to grow even as late-stage project companies near the public market have taken a hit. Meanwhile, with revenue multiples of up to 150x in 2021 and now down to 10x in publicly traded peers, investors view companies close to the public markets as a penalty that “those valuations can’t be paid” because investors “wouldn’t,” Stanford said. You get it when you come out in the next year or so.”

That huge gap and funding struggles will continue for many of those companies, especially with the opportunistic investors who flocked to them — cross funds, private equity funds, sovereign wealth funds — backing out because they can’t get the quick exit dividends at the high multiples that were in abundance in 2021.

Smaller tech bets are becoming bigger

Despite the environment and lack of public deals, venture capital financing is still going strong. Venture funds raised a record amount of money in 2022, closing $162.8 billion across 769 funds, according to PitchBook and NVCA. This was the second consecutive year with more than $150 billion. Smaller companies get more money. In 2022, early-stage venture capital deals raised $68.4 billion, close to the 2021 figure, albeit with the first half of the year accounting for more than 60% of the funds. Meanwhile, investors ran out of late-stage venture capital deals, with a fourth-quarter deal value of $13.5 billion at a five-year low.

Previous recessions eventually gave rise to dominant technology companies, including such famous names as Hewlett Packard, Microsoft and Electronic Arts. During the 2008-2009 recession, specifically, a tech unicorn with a total value of $150 billion was created, according to Startup Genome, including 24 Disruptor 50 companies. Among them are Airbnb, Block, Pinterest, Slack, and WhatsApp. .

It won’t be any easier for the largest venture-backed companies in the short term.

“The project is in a late stage in a difficult place,” Stanford said. “But going public on a downward spiral won’t end these companies. We’ve seen companies struggle as public companies and then go up really quickly, so a lower IPO isn’t the end of the road.”

But where investors are really looking inside the nearly 3,600 closed-end investment funds in the US in the past four years is among the many funds (about 1,650 of them) under $50 million that focus on making deals in seed and pre-seed companies. “There is a lot of capital for new ideas and emerging technology,” Stanford said.

Tough times also mean better offers from founders and better-run companies. Building a company during a downturn requires a business plan for more sustainable growth, and today’s startups will need to make more elaborate and elaborate pitches to investors. “They need to be in the best shape to get capital now,” Stanford said. “But when you can create new market share in a challenging market, when the market shifts, they’re ideally positioned to get more market share and customers.”

Whatever Airbnb and Uber have been through a decade of frothy valuations and emerging “grow at any cost” business models, it was through being companies stuck in hard times that they began to seize on ideas that were noisy.

“Investors should pay special attention to companies emerging from this downturn,” said Julia Burstyn, CNBC’s chief media and technology correspondent and creator of the Disruptor 50, in an appearance on CNBC’s “Squawk Box” earlier this week. . “Lean times can force new kinds of precarious innovation,” Borstein said.

CNBC is now accepting nominations for its 2023 Disruptor 50 list – our 11th annual look at the most innovative venture-backed companies. Learn more about eligibility and how to apply by Friday, February 17th.

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