Nowadays, with the proliferation of venture capital, the new digital markets and the volatility of the markets at the macroeconomic level; it seems that everyone is talking about the startup bubble. As funding dries up and unicorns lose their magic, founders around the world are asking: what’s next?
The startup bubble
But first let’s remember a little what happened in 2018, just before the pandemic broke out. According to the venture capital database CB Insights, there was a 40% drop in the number of deals made in the third quarter of 2018This compares to the third quarter of 2017, when $13 billion was invested in startups through nearly 900 deals. In fact, according to PitchBook, the fourth quarter of 2018 marked the lowest amount of capital raised by venture-backed companies since 2016. Investors were seen to be very cautious with their money and checks got smaller. Founders around the world felt the pressure.
The explosion in 2019
But 2019 arrived and startups in Latin America grew exponentially. According to Statista, the nThe number of venture capital transactions in Mexico was 95 and rose to 100 in 2020. This represents an increase of 5.3% in one year, showing that this losing streak had been overcome. In recent years, the number of venture capital transactions in the country has ranged between 95 and 156 transactions. This is how Mexico saw the birth of its first unicorns.
Between 2016 and 2022, a total of $1.6 billion of investment capital was invested, raised primarily by the Mexican startup company Kavak.
For its part, between 2014 and 2022, Bitso, a company that operates in the cryptocurrency sector, announced seven investment rounds, reaching a total of 378 million dollars. During 2019 and 2021, fruitful times were experienced for all of Latin America, with a strong injection of capital.
and the fall
But a significant drop in the price of shares of companies in the technology sector, rising inflation, increases in interest rates and a war, make the entire financial ecosystem nervous today and therefore to investment injections. Under the new market conditions and given the losses reported by large international funds such as SoftBank, Tiger Global and a16z among others, equity funds will be much more selective and cautious in their interventions. Focusing mostly on efficiency and cash flow rather than on the expansion or innovation strategy.
Which will definitely generate a slowdown, but this does not mean a bad thing. However, it will be the most consolidated companies and those startups that have a better structure and strategy management that will survive. A complicated outlook is expected in the next 12 to 18 months.
How do startup bubbles occur?
The startup bubble is often referred to as a period of exuberant investment in early-stage companies, leading to an unsustainable amount of money and thus an increase in startup valuations, which is traditionally followed by of a correction period. This bubble was created by a combination of factors, including the advent of online marketplaces, decreased investment risk, increased non-dilutive funding, and increased total capital available for investment. Investor interest in startups has been evident since the late 1990s and early 2000s, as the Internet plays a significant role in the growth of technology-based companies. Especially in the early 2010s, when digital marketplaces like Amazon and Alibaba began to emerge, and global economies began to recover from the 2008 financial crisis.
How to deal with a slow market?
As the startup landscape changes, founders need to be more cautious with their fundraising. Startups must be prepared to pivot, downsize, or even downsize. Founders need to make sure they have the right team and that the company has good cash flow. To avoid raising too much money too soon, startups need to be clear about their product and marketing plans. They should also focus on getting customers to start spending money as quickly as possible and building a scalable business model.
Consider that on average 16 months pass between a seed round and a Series A. So it is a priority to do more with less and today it is worrying to have a high-performance work team. At Hitch, we are surprised that despite the current limitations, the human resources area is one of the first to lose its budget, since the main challenge in Mexico City is to find the ideal talent. There is information that indicates that 42% of foreign entrepreneurs have difficulties accessing talent. The speed and precision to find collaborators has a great value for any company. Therefore, paying attention to the attraction, selection and development of the task are paramount.
Investors demand more for less
The startup bubble created a new normal for early-stage companies, as investors demand more for less. With the recent decline in capital, investors are now focusing on higher quality companies. They look for founders who have a proven product, recurring income, and great growth potential.
Investors ask, “Why should I invest in a company if they are just going to take my money and then go to the next investor and get more money?” They want to see companies with a path to profitability. Increased investor due diligence, coupled with declining capital, means founders will have to be more careful with their fundraising. They will need to show investors a clear path to profitability, and investors will be eager to see a return on their investment.
As the market corrects, expect to see more convertible notes, where the valuation is lower but the shares have a higher strike price. This will be done to protect the investments made, as the larger the round, the more likely the shares will go underwater if the company fails or is acquired at a lower valuation. The investors they are also diversifying their investments and looking for more investment opportunities. They are also becoming more flexible with their terms, allowing founders more time to achieve success. This means founders have more options and the startup world has room for everyone.
What happens if the bubble bursts?
The startup bubble is a natural progression in the evolution of new companies and new ideas, which has always been present in the markets and which are part of the economic development of this type of company. It starts with the excitement of new ideas and the enthusiasm of investors for those ideas. It continues with the inflow of money from investors in those companies. This enthusiasm and money flowing into the market often create a bubble.. When the bubble bursts, it does not mean that the market has completely collapsed. On the contrary, it means that the market has become more demanding and that investors are now more careful about where their money goes. This is good for the market as a whole, as it weeds out companies that don’t have what it takes to succeed and gives more opportunities to those that do.
My recommendations for entrepreneurs in this period are that they seek to optimize the monthly expense of their operation, try to monetize and increase their income organically and extend the months of life through a more stable cash and financial situation, including if that means stop growing at the rate at which they were doing it. If they find themselves in need of raising capital, they probably have to make sacrifices and the conditions of their investment injections are not the most favorable, the ideal is to try to find, as far as possible, a win/win with their investors. Probably the use of investment instruments such as convertible notes and SAFEs is ideal, so as not to penalize the company’s valuation so much in this period.
Jordi Greenham Asensio I have learned great lessons during my entrepreneurial journey. There are three values that have helped me overcome many obstacles: being humble, being a good listener and being fully committed. make things happen!