This analysis was first published in SvD Näringsliv, in Swedish, on May 18th, 2022. This piece was translated from Swedish by Claude. Some phrasing may differ from a human translation.
The tech crash on the stock market is creating domino effects throughout the startup ecosystem. The hangover from the last few years of sky-high valuations is here — and the first wave of layoffs in Sweden has started.
The market sell-off in tech came fast and it was brutal. Zoom, Sinch, Peloton and Truecaller have all lost more than 40 percent of their market cap since the start of the year. Even giants like Apple, Google and Microsoft have shed roughly 20 percent. The hedge fund Tiger Global lost SEK 170 billion on its holdings — in the first quarter alone.
To understand what this means for tech companies, you have to look at how the ecosystem behind them works. When venture capitalists invest in startups, they classify their investments as “rounds”. It used to start with a “seed round” — the first money put into a company. You plant a seed that may grow into a real business. After that came Series A, B, C, and so on. Eventually, depending on how the company developed, you might reach the letter combination IPO — initial public offering.
But it quickly got messier than that. As competition intensified, venture capital wanted to get into the best companies earlier, and a new round appeared — “pre-seed”. On top of that, valuations in every other round kept climbing. An investment that used to count as big enough for a Series A might, in some cases, now arrive at seed.
Inflation hit the startup world early. But it’s only now it’s starting to bite, in combination with rising interest rates.
The big tech drop on public markets has forced a new, tougher environment for raising capital. It’s most visible among so-called cloud and SaaS companies (software-as-a-service), service businesses that sell via subscription. The Bessemer Cloud Index tracks how listed companies in this category are valued, and the curve shows a massive fall. One way to value these companies is to multiply their revenue to get a company value. In May last year, the median company traded at 14.38 times revenue. The equivalent figure this May is 6.46. Prices, in other words, have more than halved in a year.
The halving spreads to private companies too. The result of a tougher public market is increased pressure on later-stage startups — around Series B/C and up. Because they’re closer to either an IPO or a sale, public-market comparables become more relevant.
If you’ve taken in money at very high private valuations — as several large Swedish startups have — you can quickly find yourself in a bind.
They can’t go public, because the market climate isn’t favourable.
They can’t raise more money at a higher valuation than the previous round, because no one wants to invest on 2020–2021 valuations.
They can’t keep spending on unrestrained growth, because the money will run out.
So what do you do?
One option is to do what the digital clinic Kry has done and tighten the belt. On Tuesday, the company announced it would lay off around 100 people, about 10 percent of its workforce. “We need to react to the market dynamics and we need to be more careful with our capital,” CEO Johannes Schildt wrote in a memo. Getting to profitability faster is one way to absorb the shock.
Another option is to raise new money, but at a lower valuation than before. This creates additional dilution for existing shareholders, and so it’s not a popular one. Venture capitalists in Stockholm say many rounds are dragging on right now, and that valuations for later-stage companies have almost halved compared to a year ago.
The consequences of a lower valuation can also hit the employees of these companies. Many startups today have various option programs that let staff share in the company’s success as shareholders themselves. Options count as part of total compensation, alongside salary and other benefits. As long as valuations only went up, this has been very lucrative for many in the startup world. But at lower company valuations, the options may be worthless, and a large chunk of employees’ compensation disappears. The possibility of an option ending up worthless is, of course, part of how they’re designed — but many younger employees are experiencing this for the first time.
Over the past few years, a growing number of companies have reached unicorn status — a valuation above one billion dollars. It has been seen as a proof point and a milestone on the way to becoming a giant. After the tech crash, these unicorns are now wondering whether the valuation was worth what it may end up costing them.
A high valuation can turn into a yoke you have to bear. A weaker investment climate will force many companies to cut hard, to extend the runway before they need more money. But a turnaround takes time and can be expensive. If your timing has been unlucky, the cash cushion may be thin and there may be too little time to make big changes. Then cuts alone aren’t enough. Some unicorns probably won’t survive at all.
