The start-up landscape has experienced a notable decline in valuations over the past 18 months, reflecting a range of factors influenced by the post-COVID economy, inflation, increased interest rates, and supply chain disruptions which have caused a greater focus on sustainability through either profitability or line of sight on profitability as opposed to pure growth at all costs.
I wanted to share some thoughts on a few potential reasons behind this decline. I also wanted to stimulate some thinking of three possible future scenarios that may shape start-up valuations in the next 18 months. Of course, I have no crystal ball, Just some thoughts:
Decline in Start-Up Valuations
1. Post-COVID Economic Challenges:
I know we are all probably all COVID outed. However, the impact will ripple for some time yet. We all know that the COVID-19 pandemic triggered significant economic disruptions, including lockdowns, reduced consumer spending, and decreased business activity. As a result, start-ups faced revenue declines and market uncertainty, leading to lower valuations. According to a report by Crunchbase, start-up funding dropped by 20% globally in 2020, reflecting the impact of the pandemic on valuations.
2. Supply Chain Disruptions:
Global supply chains faced severe disruptions during the pandemic, impacting various industries. Again, these issues are still yet to resolve, and with a new focus on a more distributed manufacturing base away from China, this will be an issue for the rest of the decade. Or at least a consideration. Start-ups relying on global manufacturing and distribution faced challenges in sourcing materials, fulfilling orders, and maintaining operational efficiency. These disruptions affected growth prospects, resulting in reduced valuations. The World Trade Organization's Trade Statistics show a decline in global merchandise trade during the pandemic, indicating supply chain challenges.
3. Inflation and Increased Interest Rates:
Inflationary pressures and rising interest rates have impacted start-up valuations. Three main reasons;
Investor Rate of Return: Investors can get a better rate of return with the banks at a much lower risk; and
Erosion of Purchasing Power: Inflation erodes the purchasing power of consumers, reducing demand for products and services.
Increased Borrowing Costs: Moreover, rising interest rates can make borrowing more expensive, limiting access to capital for start-ups.
These factors contribute to a more cautious investment environment and can lead to lower valuations. The U.S. Bureau of Labor Statistics and the Federal Reserve provide data on inflation rates and interest rate trends.
4. Focus on Profitability over Growth:
Due to more significant uncertainty, Investor sentiment has shifted in recent years, favouring start-ups with a clear path to profitability rather than just rapid growth. This shift in focus has led to a reassessment of valuations, with investors placing greater emphasis on sustainable business models. Start-ups unable to demonstrate a viable path to profitability may experience lower valuations. A CB Insights survey highlighted the increasing importance of profitability as an investment criterion.
So, if these are some of the things that are appearing, what might this mean for the future?
1. Gradual Recovery and Market Resilience:
Investor confidence may strengthen as the global economy gradually recovers from the pandemic's effects. Start-ups that can adapt to changing market dynamics and exhibit resilience will likely regain investor interest and witness improved valuations. Technology, healthcare, and renewable energy may present growth opportunities in recovery.
2. Increased Sector-Specific Investments:
Certain sectors may experience accelerated growth in the next 18 months, attracting increased investor attention. For example, clean energy initiatives, digital healthcare solutions, and sustainable technologies will likely receive significant investments as governments and consumers prioritize these areas. Start-ups operating in these sectors may benefit from heightened valuations.
3. Market Correction and Selective Investments:
A market correction in the start-up ecosystem can lead to more balanced valuations based on underlying business fundamentals. Investors may become more selective, favouring start-ups with proven revenue models, strong market positions, and sound growth prospects. This correction may result in consolidation, acquisitions, or closures of weaker start-ups. PitchBook's reports on venture capital activity provide insights into investment trends and market corrections.
The decline in start-up valuations over the past 18 months can be attributed to post-COVID economic challenges, supply chain disruptions, inflationary pressures, increased interest rates, and a growing focus on profitability. While the future remains uncertain, a gradual recovery, sector-specific investments, and market correction with selective The decline in start-up valuations over the past 18 months can be attributed to a combination of post-COVID economic challenges, supply chain disruptions, inflationary pressures, increased interest rates, and a growing focus on profitability.
About the Author
Adam Ryan is a Professor of Practice (Adjunct Professor) at Monash University and is a principal at Watkins Bay. Adam has over twenty years of start-up experience in Australia and the USA. An expert in Company Structuring for Innovation, Strategy, Mergers & Acquisitions, and Capital for early and growth-stage businesses.
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