- 2023 should curtail the current flow of bad startup ideas.
- Easy money and tech solutionism saw investors juicing everything from NFTs to dog-walking startups.
Lately, few ideas have proven to be too dumb for venture capital money.
VCs are in the business of betting on speculative ideas. The way it roughly works is to bet millions across lots of startups in the hope one of them blows up and returns that cash.
But a blitz in capital and a perhaps misguided faith in technology have seen VCs juice up everything from robot pizza makers to NFTs to dog-walking apps over the past few years.
VC silliness peaked this year in the public consciousness. Elizabeth Holmes, the fraudulent founder of venture-backed Theranos, was sentenced to more than 11 years in prison. Her downfall was portrayed in ABC News series "The Dropout." VC-fueled founder hubris also hit the entertainment mainstream through "WeCrashed", the dramatization of the WeWork saga, and "SuperPumped", which centers on Uber's enfant terrible Travis Kalanick. None of this is a good look for an industry that prides itself on funding innovation.
Still, a combination of reputational damage and a tightening monetary environment should mean VCs pull back from startups that clearly have no chance in hell.
Why bad businesses got so much money
Some gory details around recent startup collapses might make even the most financially unsavvy spectator ask how on earth so many investment professionals were happy to overlook obvious problems.
Take FTX, the crypto exchange led by disgraced founder Sam Bankman-Fried that collapsed with an $8 billion hole. Bankman-Fried was arrested in the Bahamas and awaits possible extradition to the US. At its peak, the exchange won investment from blue-chip names such as SoftBank, Lightspeed, and Sequoia — the latter once crowing about being won over by Bankman-Fried as he played 'League of Legends' during a pitch meeting.
Also in the recycling bin is Pollen, a British events startup founded by two brothers who, Insider reported Tuesday, were accused by staffers of running amok, lavish spending after raising cash, and sexual harassment. Representatives for the firm denied the allegations to Insider. The company imploded in August — and investors such as Backed, Molten Ventures, Northzone, and Kindred Capital have apparently quietly melted into the background.
Finally, the firesale of German rapid-delivery startup Gorillas to its rival Getir at about a third of its peak valuation marks the deflating online grocery delivery bubble in Europe. Gorillas was once valued at around $3 billion, but was snapped up by Getir for just $1.2 billion earlier this month.
One investor's take: FOMO.
"FTX is an example where it was all compounded — super hot space (crypto) where fundamentals don't even really exist, plus huge growth and hand-wavey metrics," said Rob Kniaz, London-based partner at early-stage investor Hoxton Ventures (which didn't back FTX). "Doubt that happens again for a while".
Kniaz contends the FOMO drove "less due diligence than usual lately."
A period of low interest rates saw cash flowing to investors who then made increasingly outlandish bets to try and return that capital. VCs were able to raise bigger and bigger funds as institutional backers, such as pension funds and endowments, gave them more cash. "Tourist" investors such as hedge fund firm Tiger Global also began indexing startups, essentially competing with VCs.
"Most folks had no choice" but to try and run to hot startups, said Kniaz, and they simply didn't have enough time to do the proper due diligence on founders and business models.
The subsequent markup in valuations means a correction is due.
'Fewer insane ideas'
We are no longer in a low-interest-rate market, meaning startup investors who could once rely on generous backers will have to be more cautious about how they spend their money.
They do have lots of money, with an estimated $290 billion of capital available to them in October, according to Pitchbook data. That money will need to go somewhere, but investors will be picking founders more cautiously, prioritizing profitability over growth — for now. In practice, expect more boring software deals and fewer dog-walking apps.
As the tide recedes, Kniaz is optimistic that there will be "a natural reversion to the mean where people can be more thoughtful in analysis."
There are signs that this is already in motion. European startups are on course to raise $85 billion this year, 17% short of last year's dealmaking across the continent, according to analysis by VC firm Atomico.
"I think when belts tighten you see fewer insane ideas and especially fewer models where the underlying economics don't add up," Kniaz said.
Some dumb ideas will doubtless persist: Venture capitalists don't need to make their fund performances public, and some will want to maintain wild valuations for startups already on their books.
But Kniaz senses a shift in motion: "This next year will show which emperor has clothes on or not. Lots of companies will get marked down, so fund performance will be adjusted quite a bit."