• Mon. Dec 5th, 2022

‘We will see spectacular failures’: CEOs and investors on what the end of cheap money means for tech

BySwanzi010

Nov 15, 2022

Guillaume Pousaz, CEO and founder of payment platform Checkout.com, speaking onstage at the 2022 Web Summit tech conference.

Horacio Villalobos | Getty Images

LISBON, Portugal — Once high-flying tech unicorns are now having their wings clipped as the era of easy money comes to an end.

That was the message from the Web Summit tech conference in Lisbon, Portugal, earlier this month. Startup founders and investors took to the stage to warn fellow entrepreneurs that it was time to rein in costs and focus on fundamentals.

“What’s for sure is that the landscape of fundraising has changed,” Guillaume Pousaz, CEO of London-based payments software company Checkout.com, said in a panel moderated by CNBC. 

Last year, a small team could share a PDF deck with investors and receive $6 million in seed funding “instantly, ” according to Pousaz — a clear sign of excess in venture dealmaking.

Checkout.com itself saw its valuation zoom nearly threefold to $40 billion in January after a new equity round. The firm generated revenue of $252.7 million and a pre-tax loss of $38.3 million in 2020, according to a company filing.

Asked what his company’s valuation would be today, Pousaz said: “Valuation is something for investors who care about entry point and exit point.”

“The multiples last year are not the same multiples than this year,” he added. “We can look at the public markets, the valuations are mostly half what they were last year.”

“But I would almost tell you that I don’t care at all because I care about where my revenue is going and that’s what matters,” he added.

Rising cost of capital

Private tech company valuations are under immense pressure amid rising interest rates, high inflation and the prospect of a global economic downturn. The Fed and other central banks are raising rates and reversing pandemic-era monetary easing to stave off soaring inflation.

That’s led to a sharp pullback in high-growth tech stocks which has, in turn, impacted privately-held startups, which are raising money at reduced valuations in so-called “down rounds.” The likes of Stripe and Klarna have seen their valuations drop 28% and 85%, respectively, this year.

“What we’ve seen in the last few years was a cost of money that was 0,” Pousaz said. “That’s through history very rare. Now we have a cost of money that is high and going to keep going higher.”

Higher rates spell challenges for much of the market, but they represent a notable setback for tech firms that are losing money. Investors value companies based on the present value of future cash flow, and higher rates reduce the amount of that expected cash flow.

Pousaz said investors are yet to find a “floor” for determining how much the cost of capital will rise.

“I don’t think anyone knows where the floor is on the upper hand,” he said. “We need to reach the floor on the upper hand to then decide and start predicting what is the lower end, which is the long term residual cost of capital.”

“Most investors do valuations still to this day on DCF, discounted cash flow, and to do that you need to know what is the residual floor on the downside. Is it 2%, is it 4%? I wish I knew. I don’t.”

‘An entire industry got ahead of its skis’

A common topic of conversation at Web Summit was the relentless wave of layoffs hitting major tech companies. Payments firm Stripe laid off 14% of its employees, or about 1,100 people. A week later, Facebook owner Meta slashed 11,000 jobs. And Amazon is reportedly set to let go 10,000 workers this week.

“I think every investor is trying to push this to their portfolio companies,” Tamas Kadar, CEO of fraud prevention startup Seon, told CNBC. “What they usually say is, if a company is not really growing, it’s stagnating, then try to optimize profitability, increase gross margin ratios and just try to just lengthen the runway.”

Venture deal activity has been declining, according to Kadar. VCs have “hired so many people,” he said, but many of them are “out there just talking and not really investing as much as they did before.”

Not all companies will make it through the looming economic crisis — some will fail, according to Par-Jorgen Parson, partner at VC firm Northzone. “We will see spectacular failures” of some highly valued unicorn companies in the months ahead, he told CNBC.

The years 2020 and 2021 saw eye-watering sums slosh around equities as investors took advantage of ample liquidity in the market. Tech was a key beneficiary thanks to societal shifts brought about by Covid-19, like working from home and increased digital adoption.

As a result, apps promising grocery delivery in under 30 minutes and fintech services letting consumers buy items with no upfront costs and virtually anything to do with crypto attracted hundreds of millions of dollars at multibillion-dollar valuations.

In a time when monetary stimulus is unwinding, those business models have been tested.

“An entire industry got ahead of its skis,” Parson said in an interview. “It was very much driven by hedge fund behaviour, where funds saw a sector that is growing, got exposure to that sector, and then bet on a number of companies with the expectation they will be the market leaders.”

“They pushed up the valuation like crazy. And the reason why it was possible to do that was because there were no other places to go with the money at the time.”

Maëlle Gavet, CEO of startup accelerator program Techstars, agreed and said some later-stage companies were “not built to be sustainable at their current size.”

“A down round may not be always possible and, frankly, for some of them even a down round may not be a viable option for external investors,” she told CNBC.

“I do expect a certain number of late stage companies basically disappearing.”

Source : Sky.com

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