It is becoming more apparent that American startups are facing a bad year, and financial relief is far from coming.
Higher interest rates, a shaky U.S. economy, and the recent banking crisis have led to a shortage of funds for capital-hungry startups in their early stages, along with less opportunity for those in late-stage development to cash out and exit.
Despite that investors remain optimistic due to rising stocks on Wall Street and positive corporate earnings reports in the second quarter, the news has not benefited aspiring new companies.
Startups across the country, particularly in Silicon Valley, which was hit hard by the collapse of key regional lenders, are expected to face lean times.
Established tech giants such as Apple, Amazon, Alphabet, and Microsoft are able to handle the recent losses in the tech industry, but many of their newer peers in the sector are struggling to survive.
For decades, tech startups have a major factor in the growth of the U.S. economy, but many experts think that a massive wave of failures in Silicon Valley will soon hit the industry.
Tom Loverro, general partner at venture firm IVP, said in a May tweet that “the Mass Extinction Event for startups is underway. It is a news footnote most of the time. Don’t be fooled. The market has changed.”
He added that startups were quickly becoming shutdowns and that “funding announcements get lots of headlines. Bankruptcy filings … less so.”
Higher Interest Rates Hit Loan Markets
Much of the pain facing startups can be blamed on the Federal Reserve’s strategy to raise interest rates to fight inflation, which has made loan rates skyrocket.
The current federal funds rate is at its highest level since July 2007.
The spike in interest rates “is one of the clearest symbols of change in the market,” according to the “Q2 2023 PitchBook-National Venture Capital Association Ventures Monitor” report from PitchBook.
“This shift in the landscape has impacted all sectors and stages of the venture ecosystem with deals, exits, and fundraising all well below the high-water marks set in the past few years.”
The impact on lenders with the collapse of Silicon Valley Bank in March have also led to a drying up of credit available to startups.
As many banks attempt to reconfigure their operations in the wake of the recent failures, many have become more reluctant to lend capital to new companies due to heightened risk.
Venture Capital for Startups Declines in 2023
Venture capital funding for startups halved in the first six months of the year worldwide, said the Pitchbook report.
The report, which takes a pessimistic view of the situation, said that the lack of capital would have been worse without the massive surge in investment in artificial intelligence startups.
Over 400 companies have not been able to raise any new money since 2021, according to Pitchbook, while almost 95 percent of tech startups worth more than $1 billion have failed to generate profits.
“Lingering uncertainty has morphed into a heightened fear about the economy. The recent collapse of Silicon Valley Bank and regional bank failures spell tighter financial conditions for all, with repercussions cascading through the small and medium-sized business (SMB) ecosystem,” Hicham Oudghiri, co-founder and CEO at Enigma, told PYMNTS.
Tech startups are facing a serious culling that will likely continue for some time.
Only 19 percent of venture capital deals with startups were recorded in Silicon Valley this year, down from 22 percent in 2020.
“The deal count decline is the continuation of a decadelong trend that has accelerated since 2021,” said PitchBook.
Fresh capital for new tech companies have dried up significantly in recent months, as Pitchbook reported that “the market could quickly hit a cliff if economic conditions worsen.”
Startup Firms May Face a Culling
There are currently more than 50,000 U.S.-based venture capital backed firms, which is twice the amount from 2016, but many are facing a shortage of capital. This could lead to a fresh culling of failed firms.
However, the decline of fresh available capital meant that companies in their early stages saw their funding value decline by 26.3 percent in the second quarter from the first quarter of the year, while even some of the more well-developed startups faced a harder time raising money.
Startup companies in the first half of the year generated only about $12 billion in value from 588 exit events, which is when shareholders are able to cash out through an acquisition, IPO, buyout, or a merger.
The report said that the lackluster results may mark 2023 as the lowest earning year in a decade for late-stage startups.
“An immense amount of capital remains trapped in late-stage and venture-growth-stage startups hesitant to gamble on whether their financial performance can withstand the intense scrutiny of the public markets,” said the report.
Merger and acquisition activity has also been drying up since 2022, as companies are increasingly hobbled with rising interest rates and fear of a recession.
Investment banks like Goldman Sachs and Morgan Stanley have both reported substantial drops in revenue and earnings from conducting company mergers.
Meanwhile, worries over a softening economy and market volatility have caused initial public offerings (IPOs) to decline to single digits.
Last year, the U.S. IPO market fell 94.8 percent, to $8 billion, a 32-year low, and has only continued to decline.
The total capitalization of new stock in the first quarter of 2023 has fallen by 60 percent from last year, reported the Center for Research in Security Prices.
Although many startups are still technically worth a lot on paper, they tend to be concerned they would come up short of that number if they attempt to cash out at this difficult time.
