Nothing ventured until startups offer more gain

Dropping valuations send fund managers to the sidelines “Right now, we don’t really know what things are worth”

Once driven by the fear of missing out on the next Uber or Airbnb, venture investors have begun to sit on their money, waiting to see how far the tech market will fall. Dropping valuations often kick-start a fresh round of dealmaking, but anemic initial public offerings and billion-dollar markdowns for the likes of Snapchat and Dropbox have helped lead to a broader retreat.

“Right now, we don’t really know what things are worth,” says Mike Volpi, a partner at Index Ventures, a firm that’s holding on to $1.3 billion tagged for startups. “When you don’t know what something’s worth, you don’t know whether you are getting a good deal or a bad deal, so the obvious thing to do is, not much.”

The pullback in startup investing began late last year. Venture firms invested 30 percent less money in the U.S. during the fourth quarter of 2015 than in the previous quarter, and there were 15 percent fewer deals, estimates researcher CB Insights. The company says its preliminary data from the first quarter of this year show investors remain reluctant to pursue deals.

For most venture capitalists, this is a pause, a reset—not a meltdown, says Dan Townsend, managing director of Top Tier Capital Partners, a fund of funds that seeds thousands of startups through its investments in more than two dozen venture firms. “There are some very high private valuations that may come off and some business models that will be questioned,” he says.

Venture firms typically invest on a timetable of 7 to 10 years, so taking a quarter or two off may not seem like much. But startups are often trying to launch products or reach growth goals every few weeks and rely heavily on momentum. For them, waiting an extra three to six months for money can mean death.

Bitcoin company Bonafide and news site Pixable are among the startups that have shut down because of lack of funds in the past few months. A few years ago, investors might well have put in more money to turn things around. Instead, the startups were left to die. It’s no longer a question of how much but whether a company will get continued support, says Greg Becker, chief executive officer of Silicon Valley Bank. SVB counts among its customers 65 percent of U.S. VC firms and half of all VC-backed companies.

Companies such as Foursquare and Jawbone have been able to woo new investors but only by accepting

harsh terms. Both raised down rounds, meaning they took fresh money at lower valuations than in the past. Among other things, this diminished the value of shares owned by employees and earlier investors. Both Foursquare and Jawbone declined to comment.

Even growing startups are scaling back their ambitions. In September jobs-listings site Thumbtack settled for a $125 million round of financing valuing the company at $1.3 billion, roughly 40 percent less than the original asking price. In November online retailer Jet.com closed new funding at a valuation of $1.4 billion, down from $3 billion in a summer sales pitch. In January used-car marketplace Beepi said it raised $70 million, valuing the company at about $500 million—a fraction of the $300 million and $2 billion that CEO Ale Resnik predicted last year. “What happened to us happened to a lot of companies as they were trying to raise in the latter part of 2015,” Resnik told Bloomberg TV in February.

Of course, there are always exceptions. Last month, Chinese ride-hailing app Didi Kuaidi closed on an oversubscribed round of at least $1 billion, raising its valuation above $20 billion. Messaging startup Slack is expected to close a significant funding round at much better terms than the $2.8 billion valuation it commanded last year. And Uber continues to raise money at better and better terms. “When you have a fund, there’s a real pressure to put the money to work,” says Steve Kaplan, a professor at the Chicago Booth School of Business who specializes in VC and entrepreneurship.

For smaller companies VCs are preaching caution and urging them to build revenue models sooner rather than later. “There is no making up on volume when you lose money on every transaction,” says Ben Narasin, a partner at Canvas Ventures. “Growth at any cost is not a valid model. There was a time when it was rewarded, but that time is gone.” �Lizette Chapman, with Selina Wang

The bottom line Many venture firms are waiting for cash-hungry startups to offer better terms than both sides have been used to of late.