25 Aug Hot Tech Start-Ups May Face a Long and Bumpy Fall
SAN FRANCISCO — As stock markets have tumbled, public company shareholders were not the only ones wondering what would become of their portfolios. Venture capitalists also began fretting about whether the plunge — which resulted last week in the worst week for American stocks since 2011 and a renewed sell-off on Monday — would cool the heady market for shares of private companies, especially in Silicon Valley.
There is reason to worry: The number of start-ups valued at $1 billion or more has jumped to at least 131, up from fewer than a dozen in 2010, according to the research firm CB Insights. The total amount of venture money invested has also more than doubled, to $50 billion in 2014, from $23 billion in 2010, with venture funding in the second quarter exceeding $17 billion for the first time since the end of 2000, according to the National Venture Capital Association. That has some wondering if it’s time for Silicon Valley’s heat to cool off.
Yet those anticipating a collapse in start-up land will probably have to wait. Any adverse effect on venture-backed companies is likely to be uneven and more complicated than a straight bust. Instead, the effect of a stock market rout is set to move slowly across the start-up landscape, creating a gulf between well-run companies with achievable business plans and those that were funded as part of the back-everything frenzy that began earlier in the decade. But once negative sentiment takes hold, a more widespread downward spiral could quickly unfold.
The reason that there will most likely be no uniform start-up deflation is rooted in the pricing of private company stocks. The prices for start-up shares, which are closely held by small groups of investors, generally reset only when the founders go into the market to raise money. (In contrast, public stock prices rise and fall every day in response to a company’s performance and market sentiment.)
Over the last few years, start-up share prices have gone up nearly every time a private company has raised money. Investors were largely optimistic and generous because they assumed that a variety of factors — including low interest rates, a strengthening American economy and the growing Chinese middle class — would keep the markets positive. Spending more to help a start-up grow into a huge company seemed like a reasonable bet.