Tech sell-off has VCs worried about a drop in startup valuations

After a blockbuster year for venture capital deals, some investors worry the boom times may not last much longer. 

Tech start-ups raised a record $621 billion in venture funding globally in 2021, according to CB Insights, up more than double from a year earlier. The number of privately-held “unicorn” firms valued at $1 billion or more rose 69% to 959.

Private companies such as Stripe and Klarna saw their valuations swell to the tens of billions of dollars, aided by a flood of cash as a result of ultra-loose monetary policy and the acceleration of digital adoption during the Covid-19 pandemic.

Now, with the Federal Reserve hinting at plans to hike interest rates in a bid to cool rising prices, investors in high-growth tech firms are getting cold feet. The Nasdaq Composite has fallen over 15% so far this year as fears of tighter policy has led to a rotation out of growth stocks into sectors that would benefit from higher rates, like financials.

In the private markets, panic over the tech sell-off is starting to set in. VC investors say they’re already hearing about deals being renegotiated at lower valuations and even the withdrawal of term sheets. Later-stage companies are likely to be the hardest hit, they say, while some firms’ plans to go public could get put on hold for the foreseeable future.

“It’s definitely trickling through to the private markets and the later-stage rounds,” said Ophelia Brown, founder of Blossom Capital. “Term sheets are being renegotiated. Some term sheets have been pulled.”

The shift in tone echoes negative sentiment on start-up investing around the start of the Covid pandemic. In March 2020, Sequoia warned founders of “turbulence” in a blog post reminiscent of its 2008 presentation “R.I.P. Good Times.” For a brief period, the Silicon Valley firm was right: a number of start-ups saw their valuations slashed initially, while others had term sheets pulled.

But what followed was a banner year for start-up investment, with companies raising $294 billion in 2020 globally. Hedge fund giant Tiger Global became a significant driving force in the market, backing tech firms at much earlier stages than before as traditional investors sought out returns via alternative assets.

Brown thinks some of the reaction in both public and privately-traded tech stocks has been overdone, however, and that most start-ups should be able to weather a changing economic cycle given the mountain of cash available in private markets.

“There is still so much dry powder for new funding rounds,” she said. “Most companies have been very well funded that, unless they were being completely reckless with the cash, they should be able to see this through.”