Start-up investors are warning of dark days ahead as boom times are ‘unambiguously over’

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  • Major venture capital firms are asking their portfolio companies to start cutting costs and looking for ways to reduce their cash position.
  • This is in contrast to last year, when IPOs were raising record amounts of cash, valuations were skyrocketing and venture firms’ wallets were wide open.
  • Y Combinator said companies need to “understand that the poor public market performance of tech companies significantly affects VC investments.”

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Slow down your recruiting! Cut Marketing! Expand your runway!

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The venture capital missives are back, and they’re heating up.

With tech stocks on their way through the first five months of 2022 and Nasdaq on pace for the second worst quarter since the 2008 financial crisis, start-up investors are telling their portfolio companies they will not be spared in the fallout, And that situation could get worse.

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“It will be a long recovery and until we can predict how long we can prepare and advise on ways to go the other way,” said Sequoia Capital, the venture renowned for early bets on Google, Apple and is firm. WhatsApp wrote in a 52-page presentation titled “Adapting to Endure”, a copy of which was obtained by CNBC.

Y Combinator, the start-up incubator that helped spawn Airbnb, Dropbox and Stripe, tells founders in a E-mail Last week he added, “It needs to be understood that the poor public market performance of tech companies significantly affects VC investments.”

This is in stark contrast to 2021, when investors were rushing into pre-IPO companies at high valuations, deal-making was happening at a frenzied pace and connoisseurs of buzzy software start-ups were commanding 100 times revenue, That era reflected an expanding bull market in tech, with the Nasdaq Composite profiting in 11 of the past 13 years, and venture funding in the US reaching $332.8 billion last year, up seven times from a decade earlier. . according to National Venture Capital Association,

The sudden change in sentiment is reminiscent of 2008, when a collapse in the subprime mortgage market infected the entire US banking system and dragged the country into recession. At the time, Sequoia published the infamous memo titled, “RIP Good TimesDeclaring “need to become cash flow positive” as well as to start-ups that “need to cut”.

However, Sequoia has not always tracked the timing of its warnings. In March 2020, the firm called the COVID-19 pandemic the “black swan of 2020” and called on founders to pull back on marketing, ask clients to cut spending and evaluate whether “you can do more with less.” can.”

As it turns out, demand for the technology has only increased and Nasdaq had its best year since 2009, thanks to lower interest rates and increased spending on products for remote work.

This time around, Sequoia’s words look like the emerging conventional wisdom in Silicon Valley. The market started to turn in November, with companies starting to start 2022 to stop making public blunders. Crossover funds fueled a boom in the private market, as they grapple with historic losses in their public portfolios, it said. Dina ShakiroA partner of Lux Capital, which has offices in New York City and Silicon Valley.

‘Ready for winter’

“Companies that have recently raised valuations at very high prices at the height of inflation are grappling with high burn rates and the near-term challenges of growing those valuations,” Shakir told CNBC in an email. “Others that were more vulnerable to dilution and elected to lift less may now need to consider avenues of extension of the runway that a few months ago seemed unsuitable for them.”

In its first-quarter letter to limited partners, Lux reminded investors that it had been anticipating such trouble for months. The firm cited its fourth-quarter letter asking companies to conserve cash and avoid putting money behind unprofitable growth.

“Our companies heeded that advice and most companies are now winter ready,” Lux wrote.

Relentless rise in fuel and food prices, the ongoing pandemic and raging geopolitical conflicts have collided in such a way that investors now fear spiraling inflation out of control, rising interest rates and an all-in-one recession.

What’s different this time around, according to Sequoia’s presentation, is no “quick policy resolution.” The firm said what it missed in early 2020 was the government’s aggressive response to keep lending rates artificially low by pouring money into the economy and buying bonds.

“This time, many of those tools are gone,” Sequoia wrote. “We don’t believe this is going to be another sharp correction, followed by an equally rapid V-shaped recovery as we saw at the start of the pandemic.”

Sequoia told its companies to look for opportunities to cut costs in projects, research and development, marketing and elsewhere. The firm said companies need not pull the trigger immediately, but should be prepared to do so over the next 30 days, if needed.

Job cuts and recruitment freezes have already become a big story inside major public tech companies. Snap, Facebook, Uber and Lyft have all said they will slow hiring in the coming months, while Robinhood and Peloton announced job cuts.

And among the companies that are still private, Klarna and . There is a staff cut in cameowhile instacart is Allegedly Slowing down appointments ahead of the expected initial public offering. Cloud software vendor Lessworks announced staff cuts on Friday, six months after venture investors valued the company at $1.3 billion.

“We have adjusted our plan to increase our cash runway through profitability and strengthened our balance sheet significantly so that we can be more opportunistic around investment opportunities in a macro environment and the uncertainty of the weather,” Lessworks said. said in one blog post,

tomasz tunguzuThe managing director of Redpoint Ventures told CNBC that many start-up investors are advising their companies to hold enough cash for at least two years of potential pain. This is a new conversation and it goes along with the tough discussions around valuation and burn rate.

Shakir agreed with that assessment. “Like many, we at Lux are advising our companies to think longer term, extending the runway to 2+ years if possible, very close on reducing burn and improving gross margins. Take a look from now on, and start setting expectations that funding in the near future is unlikely to look like what they expected six or 12 months ago,” she wrote.

one in Post On May 16, with the title “The Upside of a Downturn”, Lightspeed Venture Partners began by saying, “The boom time of the last decade is clearly over.” Among the sub-headings, one reads, “Cut non-essential activities.”

“Many CEOs will make painful decisions to put their companies in the waters of the twilight,” Lightspeed wrote. “Some people will face trade-offs that just a few months ago seemed strange or unnecessary.”

Lux highlights one of the painful decisions he hopes to see. For many companies, the firm said, “the people have to be sacrificed before they can sacrifice valuation.”

But venture firms are eager to remind founders that great companies emerge from the darkest of times. Those who prove that they can survive and thrive when they are short of capital, the idea is that they are in a position to thrive when the economy booms.

Sequoia said that for companies that can add talent today, more is available because of hiring freezes at some of the largest companies. And Lightspeed notes that regardless of what’s happening in the market, the technology will continue to advance.

“Despite all the talk of doom and gloom, we remain optimistic about the investment opportunities and creation of generational technology companies,” Shakir said. “We are delighted to see our CEOs exchanging notes and suggestions with each other, at once excited and humbled by these changing circumstances.”

WATCH: ‘Startup valuations are still highly attractive’, says Jim Breyer, an early Facebook investor

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