A chill has descended onto the global startup market, albeit not evenly. Venture capital totals are sagging in most geographies, and falling share prices for tech companies large and small have soured sentiment on the future value of high-growth and often cash-hungry startups.
The end of the lengthy startup boom that first formed in the wake of the 2008 financial crisis and largely powered through until the final months of 2021 is shaking out, changing how the market views certain entities.
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Every business cycle has winners and losers, heroes and villains. Some earlier winners turned out to be losers. Tiger, the mega-crossover fund, has evolved from a market-dominating change agent in technology financing to a bag holder. SoftBank’s various Vision Fund efforts are suffering. And some crypto investments that looked to be massive wins have sputtered.
Torben Friehe, CEO of Wingback (YC W22), told TC earlier this year that many founders that he has spoken to have decided to hold off on fundraising in the current climate, adding that other founders from “across the ecosystem” are saying “that if you have to fundraise right now, you basically have to cut whatever you’d planned to raise back in January in half.”
The winners and losers scorebook isn’t that hard to draw up. But the heroes and villains ledger is a bit more difficult. But with the startup market so changed, so quickly, whiplash is setting in among the investing class. And some are pointing the finger not just at late-stage capital pools that poured too much liquidity into the startup market — some startup players are irked at accelerators, Y Combinator in particular. Let’s talk about it.
The return of fear
The latest missives from venture players are once again downturn letters. We last saw a round of these notes when COVID-19 first hit the world outside of China, leading to economic calamity and lockdowns. Investors warned startups to buckle up for bad times. But, as we now know, the bad times never came for most of them.
Instead, ironically, the pandemic became an accelerant of sorts, pushing more business toward tech companies that helped other concerns operate remotely; an accelerating digital transformation was another tailwind bolstering the tech sector, giving startups a shot in the arm.
The most recent round of warnings from venture capitalists appears more frequent than we saw in 2020, leading our own Natasha Mascarenhas to note over the weekend that “everyone is drafting their own startup Black Swan memo.” Among the various firms that sent advice to their portfolios was Y Combinator.
Y Combinator, or YC for short, is the world’s best-known accelerator. Its expanding cohort sizes, twice-yearly cadence and “standard deal” made it a trendsetting startup program; one that has sufficient heft to influence the overall direction of the early-stage market for funding upstart technology companies. And, after starting life offering “about $20,000 for 6% of a company,” YC raised its terms in 2020 to “$125,000 for 7% equity on a post-money SAFE,” along with reduced pro-rata rights “to 4% of subsequent rounds.”
That changed again in early 2022, when YC added a $375,000 note to its deal, offered on an uncapped basis but with most-favored-nation status. In essence, YC conserved its ability to collect 7% of startup equity early, with extra capital provided to its portfolio companies to put to work.
Over the last few years, YC has raised the valuation bar for its startups, from around $333,333 (6% of a company for $20,000) to $1.79 million (7% of a company for $125,000). Even more, the additional capital it now offers on an uncapped basis likely worked to cement early-stage startup expectations that their accelerator valuation was market valid.
Abhinaya Konduru, an investor at Midwest-focused venture fund M25, told TC that her firm has “been skeptical of a couple of national accelerators’ valuation practices from an investing standpoint even before the last couple of years,” adding that changes to early-stage valuations from select accelerators — she did not call any program out by name — “made it even harder to consider those companies for an investment to the point where [M25] stopped looking at them.”
