Venture capitalists say the era of mindless money burning is over

Venture capitalists are singing a different tune amid a broad market crash. The blitzkrieg, the setting fire to money, and the delusions of grandeur vanished; Capital efficient, solid unit economics, boring business otherwise.

The effects of rising interest rates and fears of a recession have crept into the tech industry, as venture capitalists shy away from Libra strategies whatever the cost and exuberance that companies like WeWork and Uber became famous for in the 2000s. A new approach: find a business that can make money from what you spend.

“The world has transformed,” said Shel Mohnot, a San Francisco-based venture capitalist focused on early-stage startups. “We are now in the era of profitability.”

Moonhout said his company is now targeting companies that have a clear path toward positive cash flow and guiding his own portfolio companies toward sustainability. Others said the same. “For our part, we were more focused on the unit economy on day one when we invested,” said TX Zhuo, general partner at the Los Angeles-based company.

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Over the past decade, investors have reportedly invested $1.3 trillion in startup companies, many of which have been growing rapidly and exponentially but have yet to discover viable business models. The fast-flowing venture capital allowed a select group to distribute funds, acquire customers inorganically, and dump competitors in search of a monopoly that would eventually allow them to profit from the funds.

Subsidized rides from Uber, MoviePass allows people to go to the movies for almost nothing, and ClassPass connects customers by offering lower-than-market exercise classes. In the same way, massive funding has allowed WeWork to become the largest tenant in New York City and Uber and Airbnb to carry out a series of lawsuits as they try to undermine taxi laws around the world.

In the process, a lack of financial discipline is starting to permeate the tech sector. By 2018, money-losing startups were going public at the highest rates on record, according to data compiled by a finance professor at the University of Florida. In the two years since, it was reported that more than 90 percent of US billion-dollar startups were losing money.

“It created the ultimate hallway of weird dreams,” said Peter Atwater, a lecturer in economics at the College of William and Mary who studies trust-based decision-making.

This environment was largely driven by low interest rates in the wake of the financial crisis, which pushed cheap and easy money into the economy. From the point of view of venture capitalists, this made the cost of capital cheap enough to allow them to make large, long-term investments with less worry. It’s theoretically possible for any company to look like the next Amazon – an unprofitable company on the brink of dominance if given enough funding and time.

“Low interest rates mean you can bet on the future,” Moonhout said. Investors have bet big. Valuations and investments rose to record levels, which peaked last year. Entrepreneurs found themselves with new leverage in the negotiations, as investors competed with each other to go round, in the process offering fast, inflated deal terms and less diligence and oversight.

Then, last year, inflation started rising, and the Federal Reserve decided to tighten the noose by raising interest rates, which it hoped would calm the economy and stabilize prices. Just like this, the party in Silicon Valley seemed to be over. Layoffs hit, companies enacted hiring freezes, and venture capitalists suddenly started rethinking how they did their business. “Silicon Valley investor sentiment is the most negative since the internet crash,” said venture capitalist David Sachs wrote on Twitter in May. Volume increased by nearly half in the first quarter, and total number of deals for both fell by more than a third, according to stock management firm Carta, which tracks more than 28,000 companies. This pattern continued into the second quarter, according to early analyzes.

Late-stage startups have suffered the most so far, but higher interest rates have had a major impact on the kinds of startups early-stage venture capitalists target as well, they told Motherboard. “The accounts of what you invest in have to change,” Moonhout said. “There are some companies where this new world doesn’t really work.”

As a result, companies that looked attractive six months ago suddenly seemed like too much of a risk. Venture capitalists told Motherboard that unit economics, smart spending, and tangible business models have replaced theoretical promise and measurability through spending money as attributes worth targeting.

“Venture capitalists have rediscovered margins and cash flow,” Logan Bartlett of Redpoint Ventures tells me. “At the moment, high growth is discouraged, and capital efficiency is favorable,” said Frank Rotman of QED Investors, Dan Abellon of Two Sigma Ventures. , until the last few months.” And these are just a few of the comments I’ve heard from VCs.

Venture capitalists often see themselves as the smartest people in the room, a steady hand guiding founders with wisdom and clarity, so it’s no surprise that many of them say they are stable and haven’t changed their own approach, which they promise, has always been solid. “We are definitely in a better position than many other funds, or perhaps most funds,” Mohnot said. “But it’s possible for everyone to think that for themselves.”

But when they look outside, they are newly looking for signs of reason. Kat Wilson, managing director at Miami Angels, a Miami-based angel investor network, asked its members to pay extra close attention to companies that “have a path to profitability” and don’t rely too much on the next round of project funding. It’s looking for traceable metrics and signs of financial prudence, including cutting costs when necessary. These startups are often “boring” and “unexciting,” not experimental Web3 startups with unproven use cases, according to Wilson.

“Something that is good and powerful business is now more attractive,” she said. “Just show that you are a real business, not a business designed for finance.”

None of this means that venture capitalists suddenly view convenience stores as good investments. Their interest in profiting at the lowest possible cost is simply shifting to other – seemingly more stable – areas where the strong influx of cash gives enterprising investors more leverage. “Growth is still the name of the adventure game. But there will be a greater focus on unit economics, being careful with your money, and thinking about acquiring your customers,” said McIver Conwell, a Maryland-based venture capitalist.

In the new high-interest environment, many venture capitalists are targeting lean software companies that don’t “require expensive IRL logistics,” said Josh Konstein, an early-stage fund partner and former general editor of TechCrunch. . This means that companies that require a lot of money to operate – say, Peloton – are “losing their fortunes faster,” Hadley Harris of Eniac Ventures said. This could hurt companies trying to develop more complex but potentially transformative technologies. It also means that expensive companies that spend a lot to win customers will struggle quickly, as has already been the case with fast-delivery startups like GoPuff.

“In a world full of dynamism for 2021, you could burn a lot of money on clients,” Mohnot said. “In 2022, it’s a completely different story.”

Sustainable companies become more enticing in periods of economic uncertainty due to the opportunity of a lack of funding to keep an unprofitable startup in existence, a question that few have asked in the past year, some said. In such an environment, venture capitalists wonder if the company can continue without receiving funding every six months to a year. “They didn’t ask that question even a year or two ago,” said Richard Lyons, chief innovation and entrepreneurship officer at UC Berkeley and former dean of the business school. Four venture capitalists said they are asking startups if they can support themselves through the end of 2023 without additional funding.

One of them is Conwell, who said he suggested the founders raise money that gives them 24 months to get out of this period of turmoil. But the founders don’t always agree. He recently got into an argument with one of the founders who said they planned to drain available funding in months and then come back again, as has been the practice in recent years. “I don’t think that’s the best plan,” Conwell told the founder.

However, the money is there, and investors have to invest it.. “A lot of venture capital funds have the money to spread it out,” said Megan West, venture capitalist at Lerer Hippeau and founder of Gen Z VCs. For her part, Loyst has tried to assure entrepreneurs that her company has plenty of money to distribute, even if they are also “going back to basics” by focusing more on valuation and metrics. “There is a lot of fear in the market right now,” she said.

The sources said that the new situation has already benefited the owners of capital. By last year, the large amount of money in the startup ecosystem had pushed many venture capitalists to compete with each other to invest in startups, giving them increased leverage for entrepreneurs, who sometimes felt they could name a number and get that amount of funding. Now, that is starting to shift as venture capitalists become more selective.

“Things that are easy for the entrepreneur and being very friendly with the founder won’t be the norm anymore,” said Conwell, who predicts that the transition will be difficult for young entrepreneurs who have grown up in the age of easy money. “It would be really annoying for them.” According to Carrie Smith, an Austin-based venture capitalist, entrepreneurs are “a little more interested, which is good, because that gives us more leverage. And that’s always a good thing from a business point of view.”

Money is at the core of the problem, as is always the case in the enterprise industry, and Conwell said a renewed focus on unit economics is essential in the new world, where money is more expensive and investors everywhere will look closely for cracks in the business.

“We can’t afford not to have a good economic unit, and we miss out on getting returns,” Conwell said.