The pace of startup shutdowns, fire sales and sharp business-strategy changes is picking up.
Fresh capital from venture investors and bank loans is scarce and expensive. Going public is near impossible. Some business models that worked when cash was cheap are unsustainable now. That means venture-backed startups are running out of money and facing hard choices.
“The Mass Extinction Event for startups is under way,” said Tom Loverro, general partner at venture firm IVP, in a recent tweet. Loverro said in an interview that none of his portfolio companies has shut down recently, but it is early days in what could be a wave of startup failures. “It’s like the entire industry went out drinking and is now suffering the consequences,” he said about the venture boom of 2021 that he believes is heading for a bust.
Some venture investors see the impact already.
“It is hitting now,” said Elizabeth Yin, co-founder and general partner of pre-seed investment firm Hustle Fund.
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Of her firm’s first fund, only about 60 of the original 101 portfolio companies are around. There were roughly 90 active startups a year ago.
“I had modeled out before that at least half of them would die in the first three years and that didn’t happen,” she said, adding she believes the frothy market boosted survival rates before the current downturn.
Yin said that she isn’t concerned that the wave of closures will have a serious negative effect on her fund’s returns. That is because the companies that recently folded were never marked to a high value in the portfolio, she said.
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Larger shutdowns could put further pressure on venture returns that have been falling overall. The yearly internal rate of return for venture firms was negative 7% in the third quarter of 2022, the lowest value since 2009, according to PitchBook Data.
In recent months, several companies that raised significant venture funding have folded, including biotechnology company Goldfinch Bio, wine business Underground Cellar and fintech company Plastiq.
California startup Zume, which was developing a robotic pizza maker and was once valued at $2.25 billion, recently entered a wind-down process handled by Sherwood Partners, a restructuring firm, according to Sherwood’s co-founder and co-president Martin Pichinson. Zume representatives couldn’t be reached.
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Sherwood’s business increased by 50% through April 30 this year compared with the same period last year, Pichinson said. “And the storm hasn’t even started,” he added.
The venture-capital boom in 2021, as well as pandemic-era government funding to small businesses, likely kept businesses alive for longer than they would have otherwise, some observers believe. Now that those funding sources have dried up, the failures are coming in.
“Most of the companies we are handling now frankly deserved to have gone out of business a year or two ago,” said Barry Kallander, president of KallanderGroup, which provides corporate restructuring and dissolution services.
Venture-backed businesses in the U.S. raised $346 billion in venture capital in 2021, according to the PitchBook-NVCA Venture Monitor report. Many are still surviving on that for now, investors and founders say. Some hope that they will be able to get through to a time when the market rebounds and they can consider tapping public markets. Technology stocks have started strengthening with the Nasdaq Composite Index up more than 26% for the year as of Thursday afternoon.
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The venture market, meanwhile, has been declining. Startups in the U.S. raised $37 billion in the first quarter of this year, down 55% from the first three months of last year. The longer the venture market stays depressed, the closer many startups get to the moment of truth.
Real-estate startup Watson Living closed shop and was taken over by a wind-down specialist on Dec. 31, said Andrew Firestone, co-founder and former chief operating officer of the company.
In 2021, Watson Living found traction with a few customers and raised $2.5 million in seed financing at a valuation of about $15 million. Yet its product that offered financial rewards to good tenants was too complex and didn’t add enough value to sell quickly to apartment operators, Firestone said.
“The market shifted and that time window where we had time to figure it out shrank significantly,” he said. Watson Living returned less than 10% of the capital to investors, he said. Firestone has started a new business in another industry.
Historically, data on the number of startups that ceased operations is hard to track, researchers say. Successes, though, are rare.
About 45% of some 1,100 companies that raised a seed financing round in 2017 never raised follow-on funding, according to Carta, a provider of software to venture-backed companies that analyzes its clients’ aggregate data.
Getting to a successful outcome is even more rare. Roughly 16% of companies have had a successful acquisition or went public within seven years of raising their first venture capital funding, according to data on close to five thousand U.S. companies that raised first funding between 1995 and 2013. That research was conducted by Honggi Lee, of the University of New Hampshire, Tel Aviv University’s Lia Sheer and Matt Marx of Cornell University.
Failure rates may increase during downturns, Lee said. “If startups don’t have money then they cannot operate,” he said.
Samantha Ettus, founder and chief executive at fintech Park Place Payments, which had raised $4 million in venture funding, had to act fast when the largest investor of a planned financing failed to send the check last September. Ettus cut expenses, raised $440,000 in bridge funding from existing investors, and hired an investment bank to sell Park Place.
“When I first started the company, we said we will build this [into a] billion-dollar company. I had never intended to sell so early,” Ettus said. Publicly traded
Logiq
acquired Park Place in April in an all-stock deal valued at more than $6 million, allowing Ettus to continue building her business with the resources of a larger company.
Some startups find a way to pivot.
Last year, a debt provider for fintech startup Upfront toughened the terms on a pending loan. “The covenants made the business plan not viable,” said Marc Escapa, the company’s co-founder and co-chief executive.
The company had just raised a $6 million equity round but could no longer pursue offering auto loans as it planned, Escapa said. It pivoted and is now selling loan-origination software under the name Fuse Finance.
Escapa said he’s glad that his startup hit on a new business direction that is working well. Yet the experience also showed him how macro trends out of control of the startup can make an idea unfeasible.
“The fundamentals of what you were going to build are not true anymore,” he said.
Write to Yuliya Chernova at yuliya.chernova@wsj.com
