This analysis was first published in SvD Näringsliv, in Swedish, on June 24th, 2022. This piece was translated from Swedish by Claude. Some phrasing may differ from a human translation.
In a matter of months, Sweden went from one of the world’s hottest countries for startups to dark headlines about layoffs and cutbacks. A deeper look shows that what has crashed, above all, is a particular way of building companies.
“AI will affect us all. Get to know it and get to know your path forward.”
In a foreword to a book from 2018, Marcus Wallenberg reflected on the phenomenon that would reshape industries and revolutionise business: AI — artificial intelligence.
The book was written by Luka Crnkovic-Friis, CEO of the AI company Peltarion. On its shareholder register you’d find Wallenberg’s holding company FAM, which alongside EQT invested SEK 110 million in the company that same year. The vision was to build a platform for AI that other companies could use, and so accelerate that transformation of society.
The headlines were big and the customer list impressive. The company was one of Sweden’s most hyped.
Even before Peltarion had even launched its product, NASA, Tesla and General Electric were said to be customers. The company took part in seminars in the Swedish parliament on the opportunities and challenges artificial intelligence could bring to Sweden. The future looked bright — for Peltarion, and for Swedish tech more broadly.
Then came 2022.
The market’s enthusiasm turned abruptly. Tech companies that had listed in 2021 had already started falling in the autumn, and the slides kept coming. Many companies have now lost more than 70 percent of their market value.
Old memes — joking internet phenomena — resurfaced talking about “buy the dip”, buying assets in a downturn. Except now with the pitch-black addition that “the dip keeps dipping”. The declines don’t seem to stop.
And from sending out press releases about helping social services deal with vulnerable children, or building platforms for the education of the future, came a different kind of news. Peltarion had been acquired. The buyer was the games company King, the company behind the mega-hit Candy Crush Saga.
Instead of revolutionising society, they would now build their AI into King’s mobile games. The artificial intelligence — which was supposed to help digitise and transform society — will make sure more candy gets swiped.
What actually happened?
If you listen to the company itself, it is “a monumental chapter in Peltarion’s history” and “King’s scale and reach […] are a good match for our technology”.
Becoming an AI division for a global games company isn’t a bad outcome for a business. But in an interview with Dagens industri in 2018, Crnkovic-Friis said that even if they had tens of thousands of customers on their platform, it would be “a drop in the ocean compared with the companies that could benefit from it”.
The shareholder group had written down the value of their investment significantly in the years before the deal. No price tag has been disclosed either, which usually suggests it wasn’t as high as had been hoped.
Whatever happened behind the scenes, you can tell a big shift has taken place. And it’s probably no coincidence that it’s happening right now.
A lot of startups are in exactly the same situation. The surrounding conditions have suddenly changed. Companies like Peltarion — and many others — may have to pivot on short notice.
Let’s take a quick look in the rear-view mirror.
In 2000 the dot-com bubble was a fact. You could call it a business-model crisis. Many of the companies simply had no real revenue to speak of, and therefore very limited profitability. The companies’ valuations reflected a belief in the future that suddenly went up in smoke. With a weak business model at the core, there was no saving them.
In 2008 came the financial crisis. It had nothing to do specifically with tech companies, except that the whole of society got dragged down in a dark spiral. In hindsight, that period became the start of an enormous boom for tech. One that accelerated further around the Covid crisis in 2020, when central banks printed money like never before and interest rates were at record lows.
Now, in 2022, startups in Sweden and around the world face a funding crisis. The situation is serious, but markedly different from 2000. Today, most companies have more realistic business models at their core. But they may have become overvalued, and forced a type of growth the company can’t quite sustain.
After more than ten years of huge venture investments in growth-at-all-costs, the tap has now been turned off. And it has happened very quickly.
A new report from the investment bank GP Bullhound shows that in the second quarter of 2022, barely half as much money was invested in large venture rounds as just three months earlier.
The IPO window is closed too. In 2021, companies went public for $46 billion. Half a year into 2022, the equivalent figure is one (1) billion dollars. The outlook for the rest of the year doesn’t look much brighter.
What the market is seeing is the effect when very strong momentum turns. Picture a rubber band that can be stretched and expanded. At some point it can’t go any further, and the rubber band flies off in the other direction — or snaps entirely.
In a recent podcast interview, Aswath Damodaran, professor of finance at NYU Stern School of Business in New York, talked about exactly this phenomenon.
“Momentum is the strongest force in the market, much bigger than earnings, cash flows or any other fundamentals. As a trader you live on momentum, but you die with it too. That means you make money when momentum is with you, but if you don’t get out in time, the momentum that was your friend suddenly becomes your enemy.”
The funding crisis companies now face is the effect of momentum that has turned. Over ten years — and the last two years in particular — of access to highly risk-tolerant capital, many companies optimised for the conditions that prevailed. Growth was what was rewarded, and as fast as possible.
The business models may be better this time around, but many need more time to play out. There’s talk of “growing into your valuation”, meaning you need to live up to the promises you made when you took in your investment. But valuations of young companies are highly subjective. Many entrepreneurs are now stuck between the expectations of their previous valuation and the now-sober view the market offers.
LinkedIn co-founder and investor Reid Hoffman published a book in 2018 called “Blitzscaling”. The title referred to growing your business so fast that competition simply couldn’t keep up. It could be expensive and complicated, but once competition was out of the picture you’d catch up.
The clearest example of blitzscaling is the transport company Uber, which grew enormously fast but has also been saddled with enormous losses and big problems around working conditions and regulation. On the surface, though, they’ve been a success. Uber has come to represent a kind of on-demand economy and was used as a reference in thousands of startup pitches. “We’re like Uber, but for X” could be heard in hundreds of meeting rooms around the world.
To be able to “scale” fast, you need lots of staff. Uber was rumoured to send employment contracts to developers before even meeting them, to save time. Even in Sweden, people looked towards Silicon Valley and saw those methods as the ones leading to success, willingly financed by venture capital firms. So they started hiring lots of people and taking bigger risks. Maybe a bit too much — but now the business was going to scale up, and it needed to happen fast.
The difference between the dot-com bubble and now is precisely this. Look at Klarna, for example: they were profitable and growing up until 2019. After that, the growth rate accelerated sharply and losses grew large. A profit of around SEK 560 million over 2016–2018 flipped quickly to a loss of over SEK 9.3 billion between 2019 and 2021.
What has happened now is that venture capital no longer wants to finance this kind of strategy. The same investors who urged speed in growth are now urging speed again — this time in pivoting to profitability. Klarna recently announced it wants to cut ten percent of its roughly 7,000 employees. The online doctor service Kry is doing the same.
Turning around a business that is bleeding money is hard, and takes time. It’s therefore quite possible that ten percent in layoffs won’t be enough. And that the cuts should perhaps have been done differently.
Apple’s former chief evangelist, Guy Kawasaki, put it in the simplest possible way back in 2006:
“Cut deep, and only once.”
Kawasaki argues that companies often start with smaller cuts, believing the wind will turn. But it often doesn’t — or at least not as fast as the company’s leadership hopes. Then you have to make more cuts, which can result in low morale among the employees who remain.
If you can’t turn a company profitable in time, you either have to sell or shut it down.
The tech world doesn’t move in a vacuum — it’s very much influenced by the world economy at large. How inflation, interest rates and the broader business cycle develop will affect how deep, and how long, the industry’s crisis becomes.
But already now you can say with reasonable confidence that the startup world is facing a number of major changes because of what has happened.
To begin with, several industries will face a large consolidation wave. Having eight different e-scooter companies in Stockholm much longer is unlikely. Just this week, one of the market leaders, Voi, announced it’s cutting staff at its head office. The competitor Bird has — since its SPAC listing in November last year — lost over 93 percent of its market value. There will be acquisitions, mergers — and surely a bankruptcy or two.
The funding crisis is most visible among the biggest companies. When the stock market’s valuations set the benchmark, it’s the companies closest to a potential IPO that get hit first.
Brand-new companies that need capital probably have seven to ten years ahead of them before they reach that kind of size, and the market may well have turned again by then. The smaller you are, the less you feel this crisis.
For the somewhat larger companies, timelines get stretched. Blitzscaling is expensive to execute, but it often works in the sense that development happens fast. If the financing for that isn’t there, you have to choose an alternative, probably slower, path forward.
It may therefore take considerably longer to become a unicorn — a company valued at over a billion dollars — now than a few years ago. The next Klarna may well lie a fair distance into the future.
Look one step further back, before companies are even founded, and the sentiment may shift too. Entrepreneurship as a career choice looks different in a downturn, and probably attracts fewer people.
As company valuations fall, more option programs become worthless. The money that previously flowed to startup employees was in part invested in new, smaller companies. The total pool of money for early-stage startups is likely to shrink, and starting a new company may become harder than it was a couple of years ago.
A more positive reading is that the companies being built now will be more resilient. Founders have to choose business ideas that don’t only work in a world of low interest rates. You’re forced to chart a path to more independent financing — and to prioritise it — from day one. You know, the way ordinary companies have always had to do?
A funding crisis is hard to live through, but for the next generation of unicorns it may turn out to be the best thing that ever happened.
