“We’re Seeing the Beginning of a Liquidity Crisis” in the Startup Boom, Suddenly

Stock markets have been volatile recently, plunging and soaring alternately on vertiginous slopes, sometimes the same day, and now folks that supply the juice to the startup ecosystem – VCs, pension funds, mutual funds, hedge funds even – are getting nervous.

They need to know where this market is going. They need to know if they can exit at a big profit, or if their investment and hopes will get dragged down with these startups when it all falls apart.

“Periods like this are pretty much your worst nightmares,” Sam Hamadeh, CEO of private-company financial intelligence provider PrivCo, told the LA Times. “There are literally meetings across Wall Street, where road show schedules were being planned, that are now about thinking, ‘Can we get late-stage funding to raise capital?'”

Big bucks are at stake. In the US, 76 venture-funded startups have “valuations” of over $1 billion. Uber sits at $50 billion, Airbnb at $25.5 billion. Palantir, intelligence and law-enforcement darling funded in part by the CIA, reached $20 billion; revenue-challenged Snapchat $16 billion. And so on.

“Valuations” in quotes because they’re negotiated by a handful of people behind closed doors. Tidbits are then leaked to the Wall Street Journal for the sole purpose of hyping the startup to investors. The WSJ tracks these leaked tidbits. No one put that much money into the companies. Actual investments are a small fractions of these valuations. But nevertheless, it’s been crazy out there.

Or was – until the stock market went haywire.

“If broadly speaking, public investors are resetting valuations, then the private market has to follow,” Eric Liaw told the LA Times. He’s a partner at Institutional Venture Partners, which invested in Snapchat, among others.

The stock market, after going nowhere for a year and then jumping up and down like mad, might actually, after all these years, give up its bullish ghost and head south. That would imperil the entire startup scene. It happens after every boom.

Funding would become scarce. The next round, if there is one, might be a down round, with lower valuations than prior rounds. Some investors and employees might have to watch their gains go up in smoke – without being able to sell. If there is an IPO or a buyout, it too might be a disappointment. And employees who broke their backs for these startups would realize just a how demoralizing the process can be.

But those are the lucky ones.

Until the stock market’s direction becomes clearer, after the violent ups and downs, investors in startups are likely to drag their feet before putting money into new deals. Now all eyes are on whether this is, according to Mark Terbeek of Greycroft Partners’ Los Angeles office, “a fundamental change or just a nervous day.”

“The new fear is you’re going to have a lot of companies valued ahead of what they can get on the public market,” he said. Startups that are burning a lot of cash and have high valuations “will be most vulnerable.”

On the other hand, startups that are loaded with cash, like Uber and Snapchat, have time to adjust to the new era and figure out how to get through a downturn, and they might be able to raise more money at stable valuations, he said. It would be a while before they meet, as he put it, “the day of reckoning.”

Much of the recent funding for late-stage rounds at mega-valuations came from mutual fund companies such as Fidelity and T. Rowe Price. They’re new to this, and the threat of a downturn in the stock market could spook them, and they could simply close their wallet.

The LA Times:

If the market keeps declining, companies that have quickly spent initial investments will feel the most pain. Such corners of the start-up world include app companies that provide services such as assistants and food with a tap of a smartphone. The start-up tracking firm CB Insights recently identified 12 on-demand food delivery companies, some of which have launched in several cities, that “might be at risk of overextending themselves in the race to gain market share in the top metros.”

Ha, over the past four months, I have received in my mailbox – the antediluvian mailbox, not an electronic one – eight glossy fliers from food and drink delivery startups. Those flyers are expensive. They’re part of a constant flow of glossy flyers from startups that are blowing investor money on marketing firms (um, they’re also startups), mail-outs, and the United States Postal Service. These outfits are a dime a dozen.

And what should startups do that are hoping to go public? Kathleen Smith, Principal of Renaissance Capital, which tracks the IPO market, told the San Francisco Business Times: “Batten down the hatches.”

“Returns are the fuel that drives the IPO market, and the returns in the tech IPO market have been generally bad,” Smith said, but added that the pain hasn’t been just in tech. About 53% of all IPOs so far this year are at or below their initial price. Half of last year’s are underwater, and 48% from 2013 are in similar shape.

“We are seeing the beginning of a liquidity crisis,” she said. “If you are running a business that is losing money and needs investments to survive, you are coming up to hard times.”

It’s a good deal for everyone. Until it isn’t. Read… The Last Two Times This Happened, Stocks Crashed

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.

  15 comments for ““We’re Seeing the Beginning of a Liquidity Crisis” in the Startup Boom, Suddenly

  1. MC says:

    There’s one company in the startup field that has been bugging me for a while now: jet.com .
    As we know, jet.com is brazenly taking on the 300lbs silverback pack leader of Internet shopping: Amazon.
    Amazon makes very little money on everything it sells (I’ve heard their average profit is a minuscule 0.84%) and isn’t above losing money just to gain market shares.

    Jet.com takes things to the next level: the company itself declared it’s making money only on the $50/year subscription fee, and sells everything at cost or even at a loss. They plan to be profitable once they reach 15 million subscribers which they predict will happen in 2020.

    This means that even if jet.com doesn’t run into any snag and growth procedes exactly as planned, it will burn through investor’s cash for five years straight without turning even the most minuscule profit. That’s an awfully long time, even by modern startup standards, and to make matters worse the company obviously needs to heavily invest in marketing just to make itself known. The first ad campaign is running in eleven US cities and will cost the company a coll $100 million.

    But there’s more. As Paula Rosenblum shrewdly noted on Forbes, if jet.com manages to break even by having its 15 million subscribers, a retailer war is sure to break out, and it won’t be limited to Amazon and jet.com. “Brick and mortar” chains such as Walgreens and Walmart are sure to reply in kind, just to wrest market shares from their online opponents: the once almighty US consumer is stretched very thin and there isn’t just enough growth left in the system (at least short and mid term) to accomodate yet another retail heavyweight, even if ailing outfits (Macy’s, J.C. Penney etc) start dropping dead by the roadside through sheer exhaustion.

    A little help may come from China’s legendary excessive capacity in all sectors: just to shift bicycles, sweaters and tablets and keep the factories open, the central planners in Beijing will be ready and willing to cut prices, thus allowing retailers to breath a little easier. This, of course, if Chinese online “retailer” colossus Alibaba doesn’t join the fight itself: in Europe Chinese companies have already started a very aggressive expansion of their brick and mortar stores, competing for stagnating or contracting market shares.

    This cannot and will not end well but in the meantime letìs console ourself this war allows us a little respite from that inflation that officially doesn’t exist.

    • Wolf Richter says:

      I didn’t mention it in my post: jet.com was one of the many companies that sent me a glossy big flier. That’s a pretty desperate measure for an internet retailer.

      • Gil Obrero says:

        Deflation, deflation deflation.
        This is the new normal.
        Manila is just a couple of days from HK GZ and SZ.

        Already the street sellers are flogging SZ made smart phones, You can get octa core or quad core 16 or 32 Gb from $25 to $35.

        Smart TV.s are coming in t4o some online stores at 43″ under $100 and even 63″ under $450.

        They are dumping already sock is getting liquidated fast in Guangdong province as friend of mine in Guangzhou explained as he buys from the private traders and exports to the local Asia region.

        With shipping costs so low now, and everyone desperate to turn some cash over, he predicts this is just the beginning as it will spread to higher and higher value goods and then out to the rest of the world from Asia.

        He does not believe for one second that most of the producers will go bust, they will carry on borrowing from the state banks and produce even if it meant losing 50 % of cost.

        They just shrug and say whatever happens happens, but whatever it is that happens never happens forever.
        We just wait, he says,, things will be fine,, things go different way one day. Its no matter, we still drink and eat good food and if family ok we don’t worry

    • Vespa P200E says:

      I think jet.com may become another internet retail bagholders from early 2000 like etoys.con, homegrocer.con, etc. as internet retail is brutal place.

      But hey I remember the wild west Yahoo msg board back in early 2000 where loons who became the bagholders said “profit is for pussies” and only metric that matter is growth/revenue rate.

      • MC says:

        Jet.com bagholders may include some pretty big names, such as Google and Goldman Sachs. So far the company has raised $220 million, of which a cool hundred has already gone into sending flyers to the likes of Mr Richter. ;-)
        This means that as of right now the company has $120 million of working capital to build up a logistical juggernaut to cater to millions of customers purchasing everything from diapers (Mr Lore’s original line of business) to iPhone’s. Marc Lore aims at raising $600 million before even going public, which is a more reasonable figure but given how nervous venture capitalists are getting right now (friendly advice: do not mention the word “biotech” when one or more is in the room) it may prove a Herculean task.

        If we want to turn the knife into the wound another name: Zulily.
        At one time this ecommerce startup was valued an astounding $9 billion.
        Using the mechanism of flash sales (also known impulse purchases), for a short time it seemed like it would be able to take on the combined might of eBay and Amazon.
        But Zulily committed a fatal mistake: it espanded its line to include items commonly available on eBay and, far far worse, directly sold by Amazon. To makes matters worse purchasers were put off by Zulily’s long delivery times: many bought one time and then got back to Amazon and/or eBay.
        End result: Zulily was sold to QVC for $2.4 billion, nothing to complain about but still lower than its IPO value and has been on a declining slope ever since. Caught in a war between Walmart, Amazon and jet.com, with eBay catering to more and more impulse buyers, the writing’s on the wall.

    • Winston says:

      “jet.com is brazenly taking on the 300lbs silverback pack leader of Internet shopping: Amazon”

      A. Because that model is doing so well?
      B. Or to make a killing on an overvalued IPO and then, eventually, bail?

      It can’t be ‘A.’

  2. Vespa P200E says:

    No surprise as liquidity can dry up pretty quick when the market tanks…

    I worked for biotech start-up that botched IPO 2 days before going listing on Nas due to dispute between CEO/BoD (VCs) and underwriters led by Jefferies over offering price. Tried to go public again but no investment banksters would touch us, considered reverse takeover/IPO (buy listed unrelated company), etc and company gave up the Nas symbol to get $1.5 mil back due to dire financials. Anyway tried to get any kind of funding back in 2008 and there was absolutely NO liquidity available.

    The VCs who invested in 3 rounds (raised about $175 mil) would not give any more money even with prospect of huge dilutions. Company ended up getting bridge loans from SUCKERs who were dumb enough to give loans with 10% int rate to dying company and at the end they became the bagholders of worthless papers.

  3. Vespa P200E says:

    The money spigot gets dried up pretty quick in 2008 when the market tanked…

    Maybe a its a good thing for SF real estate market (for buyers) and flush out the countless BS sharing economy quixotic start-ups. But alas their young clueless unemployed employees without work may have to move in with the parents and stop paying back student loans which results in…

  4. howard minsky says:

    every time a new company hits the jackpot a million kiddies run out and raise capital and more capital and investors give it to them cause nobody knows what stupid idea might become the next uber, facebook, airbnb, etc….

    they look at the kid entrepreneur and if the idea makes even the smallest of sense they give them money.

    Uber goes public —- Airbnb goes public —- and every greedy investor will be giving out money like there is no tomorrow

    yes the game will one day run out and money will be hard to get but that is not now

    that wont be till after companies like UBER and AIRBNB are not going public and when these stories stop lighting up the world

    yes maybe only 1 out of 100 business ideas will work… but that aint stopping nobody from rolling the casino internet dice.

    the VC’s have raise so much money and now the PE guys are in the game with more money…. every kid in college is dreaming up some mostly stupid ideas and they will be funded

    again, nobody knows whether it will work or not

    who would ever believe all these businesses could work? You could never have convinced me that any of these businesses would work.

    I wouldnt have believed Facebook could have the $16 billion in revenues it will have this year

    the party will end but it aint over any time soon

  5. c1ue says:

    Nice article.
    Another factor I consider a potential major issue is the Chinese laundry during the gold rush. The joke is that 2 Chinese laundries opened up during the Gold Rush in San Francisco, but late. When the boom collapsed, they switched to doing each other’s laundry and made a fortune.
    I really wonder how much of these companies’ business is selling to each other: the food delivery, ride sharing, car sharing, app, online massive shopping, etc – a major demographic are the relatively few millenials with decent jobs – i.e. the ones working for the unicorns as well as the smaller but well funded startups.
    When the Internet 1.0 collapsed – it took down not just the companies that made little or no money, but a huge swathe of service businesses that had sprung up to sell to HTML programmers and the like. This time around, instead of one gigantic Webvan, we seem to have a dozen or more with aggregate funding actually more than Webvan sucked up. Amazon and Ebay survived the Internet 1.0 bust, but hundreds of their competitors did not. E-commerce was the buzzword in Internet 1.0 – this time around it is ride sharing and social.
    Even companies that did grow and were profitable suffered. Cisco was the first company that was to hit the $1T valuation post 2000.
    15 years later, their valuation is a fraction of what it used to be despite their revenues and profits having increased steadily over most of that period. PE multiple shrink is a bitch…
    It will be interesting to see how (not when) this goes down.

    • Petunia says:

      Before the financial crisis it was obvious to me that the big box stores that were expanding rapidly were making all their money on Wall St. and not from revenue. The Florida town I lived in, 100K population, had too many home improvement stores, too many office supply stores, too many of almost everything. This was before the bust, even after, they were all still open and mostly empty.

  6. Shawn says:

    As a Techy living in SF, I would say most of the startups in the bay area are based on bad ideas, no ideas, copied ideas, little or no business model and little or no product development. They exists solely to keep to executive and their cronies employees employees. There is a lot of arrogance and ego involved in this business. And with reputation, ego and arrogance, if you can talk the talk without having to walk the walk, they getting 50 to hundred million dollars from some dumb investor is a piece of cake.

    As in every bubble, when the money dries up, things unwind very quickly given the degree these startups burn money. My question is, when the layoff start, how is this going to affect the SF Bay Area housing market?

    • c1ue says:

      Internet bubble 2.0 popping won’t affect the housing market as much as you’d think. SF turnover is extremely low – in no small part due to Proposition 13. The prices ostensibly will drop, but not nearly as much as they will in the surrounding areas because of this lack of liquidity.
      Only when we see interest rates going back to historic averages will there be a significant chance in US overall, and SF eventually, prices.

Comments are closed.