The era of free the money is now officially behind us: the US Federal Reserve raised its benchmark policy rate by 0.50%, or 50 basis points, this week.
Startups have long basked in the sun of zero-cost money. Following a historic period of low rates, the comparative attractiveness of investing in bonds and other safer and even lower-yielding assets was reduced, meaning investors around the world were looking a place to park funds and have a chance to earn material income.
Technology performed well during the period, with tech startups taking an even bigger hit in the arm. The mechanism is simple to understand: low rates have led to an influx of capital into more exotic investments, such as venture capital funds. These funds then grew in size and number. The result of this influx of cash to investors has been an explosion of funds for startups.
More capital pools with more funds have led to competition for access to deals, putting founders in the driver’s seat when it comes to valuations and terms. Another factor at play was the COVID-19 pandemic which boosted the value of public tech companies, while many other concerns took a hit due to travel restrictions and other related economic changes.
Crossover funds piled up in public and private tech companies, with the latter leading to a flurry of funding events that stretched valuation multiples to the moon.
Now we see the rubber band going back. As interest rates rise, the funding available to venture capitalists shrinks, and crossover capital has already left the stage to lick its wounds. Meanwhile, other investments – think bonds – are simply more lucrative than they used to be.
More so, pandemic-era tech trading has faded, leaving public prices for startups far from their peak valuations. It creates a unique shitty moment in which startups struggle with what must look like a capital drought at the same time as investors become more conservative. and releases are limited due to depressed prices in the public market.
It’s a mess for startups that have only known the summer. Winter does not come; it’s here.
The risk reaction
Venture capitalists are speaking publicly about climate change, a change from earlier this year when such commentary was scarce. Whether it’s due to more short-term pain in the market or VCs simply finding their voice, the comments are now strident and regular.