Encouraged by runaway successes, investment has been easy to come by for tech start-ups, But the party might now be over
If you were starting up a tech company in the last few years, money was the last thing you had to worry about. Venture capital investors seemed enthusiastic to back almost any tech company with a decent idea and growing user base. The one in 10 in their portfolio that made it big would more than make up for the nine that flopped. Because tech is such an unpredictable field with a ‘fail fast’ ethos, hedging your bets, at least up until recently, made sense.
But this year, venture capital for the start-up community has been far harder to come by. As far back as 2012, PwC was tracking the amount of venture capital investment in the US through its quarterly MoneyTree report. After deals surged between 2013 and 2015, 2016 has been much quieter. In Q2 2015, venture capitalists invested a total of $17.4bn in US start-ups. In Q2 2016, the most recent data, only $15.3bn was invested. This was accompanied by a decrease in the total number of deals being done. MoneyTree recorded 1,231 deals for Q2 2015, compared to a mere 961 deals done in Q2 2016 – the lowest number in a quarter since 2013. Confidence among venture capital investors has clearly been dented.
The problem for tech companies in particular is that a number fail to reach the scope and scale they aspire to. Many are chasing an economy of scale wherein a spectacularly large number of users will allow them to turn a profit from many small fees. This usually means running a company at a loss while a user base forms and grows – a strategy popularised by Uber. Investment is critical to getting these kinds of companies where they need to be.
Unfortunately, many have failed to reach their lofty targets. The goal of many start-ups is to reach the stage where they can launch an IPO or be purchased by a larger company, thus generating a return for early investors. However, the number of companies reaching that stage has been steadily decreasing.
The problem for tech companies in particular is that a number fail to reach the scope and scale they aspire to
According to a recent report from CB Insights, the number of technology start-up exits worldwide in the first half of 2016 was down 17 percent from the same time in 2015. The report also indicated the purchase price for these companies has also been quite small: in the period, 53 percent of companies exited for less than $50m.
This is fuelled by the fact some of the darlings of the tech start-up world have not managed to successfully reach their anticipated heights. Uber, with many questions surrounding its profitability, has so far not yet made an IPO. Spotify has also not yet been able to make the transition to public trading either. Twitter launched its IPO in 2013, and has struggled with its business model ever since. The success of Facebook, it seems, may have been the
exception rather than the rule.
Aside from the struggles of big stars, there have also been many serious high-profile failures that may have made investors more cautious. The UK’s Powa Technologies, a payment company that once claimed to be worth $2.7bn, fell into administration in February 2016 after it squandered its money.
The current climate is not dissimilar to that surrounding the burst of the dotcom bubble in 2000, when overvalued internet companies with flawed business models experienced rapid devaluation. While the market is considerably more mature now, investors are clearly becoming choosier about which start-ups they are willing to give the benefit of the doubt to. In an increasingly uncertain global economic environment, it seems, more and more start-ups are proving they just aren’t worth the risk.