Apr 13, 2022
The War in Ukraine and its Impact on Venture Firms and Startups
According to the UN, more than 3 million people have fled Ukraine because of the Russian invasion. Neighboring countries such as Poland, who have taken in over 1.8 million refugees, Moldova, Romania, Hungary and Slovakia, are already feeling the strain, struggling to supply enough beds, first aid and food, with many citizens volunteering aid, shelter and donating food and essential supplies. To help support Ukraine, we have included a few trusted charities organizing crisis relief funds for the people and animals of Ukraine.
Many startup founders and investors are wondering how the events in Ukraine will impact the venture capital landscape, and we want to address that here. We think there will be four main impacts:
- Rising interest rates will incentivize capital rotation into bonds rather than equities, therefore less capital will be allocated to venture (and startups as a result)
- The public market correction reduced price to sales multiples for publicly traded technology companies, and correspondingly startup valuations will decrease relative to the peak valuations of 2021
- Many Ukrainian software developers will leave the workforce for now, and this will translate to greater competition for hiring for software engineers
- The IPO market will slow down given macro uncertainty
Inflation, Interest Rates
The pandemic and Ukrainian conflict has left the global economy with two key points of vulnerability — high inflation and fragile financial markets. Since interest rates are rising, institutional investors will be putting more money into bonds instead of stocks. This means that less capital will go into the private market.
Rising interest rates will also decrease valuations in the public market due to public market valuation methodologies. This will translate into the private sector, since private sector investors use publicly traded companies as valuation benchmarks for comparable private companies. If these factors combine to create an economic slowdown, central banks will be unable to slash interest rates to stimulate growth or “print money” due to rising inflation, meaning we will have fewer levers to stimulate economic growth and dig ourselves out of a potential global recession.
Startup Valuations Will Decrease Relative to 2021
The impact of inflation, rising interest rates, geopolitical tensions and ever-lasting ripples of the pandemic has had an obvious effect on the public markets, and plunging markets are making it harder for firms to tap funds for investment. As such, we are already starting to see the impact on the private markets with the decrease in startup valuations. Ultimately, less money in the private markets means smaller funding rounds for startups.
Founder dilution will remain unchanging and constant, which means startup valuations will also decrease. Additionally, lower price/sales ratios in the public markets will mean startups will get smaller valuations relative to their revenue, and we’ve already seen venture funds re-trading term sheets at lower valuations.
It is clear that there is market pullback with decreasing deal flow and size as the private markets slow down, but this is not across the board. Large funds like Insight and Tiger have raised record-breaking amounts of capital, and still need to deploy this capital. There is also competition for startups with proven business models and traction will still be considerable, and valuations will remain founder friendly. For the unproven and earlier stage startups, however, we think fundraising will take longer and founders will likely have to take more restrictive term sheets. That being said, VCs are still deploying very aggressively into web3 companies.
Tighter Labor Market for Software Engineers
The Ukraine invasion disrupts a vital tech talent pool, made even more prominent with the current insatiable need for software engineers and developers. Ukraine is renowned for its growing hub for tech talents. One in five Fortune 500 companies, such as Microsoft, Google, Oracle, and Samsung, use Ukrainian IT services, and the Ukrainian IT development sector exported $6.8 billion in IT services in 2021. Now, startups such as Grammarly, Ajax, People AI and Preply, backed by some of the world’s biggest VCs, are scrambling to support employees and operations. Startup founders are mainly offering financial assistance to employees who are in Ukraine or neighboring countries. The cash is supposed to help with fleeing the country.
However, many tech workers and software developers do not have that luxury due to the ban on military-aged men leaving the country. This conscription will result in massive labor shortages in software developers for years to come. Fortunately, many Ukrainian startups have remote-first teams, limiting the impact on at least some of their employees. However, if the crisis continues without end, many firms will move their high-end tech needs to other locations such as Tallinn and Istanbul, which would be both a costly and difficult process.
IPO Market Slowdown
Historically speaking, geopolitical uncertainty and global conflict almost always negatively impact the stock market. So it is no surprise that the IPO market has significantly slowed down – Q1 2022 global IPO volumes fell 37% with proceeds down by 51% year-on-year. On Wall Street, there have only been 18 IPOs this year, raising a median amount of $27 million dollars, the weakest market for new flotations in more than 20 years. This slowdown is also due to price corrections in overvalued stocks from recent IPOs, stock market volatility, growing concerns about rise in energy and commodity prices, and the impact of inflation. The long-term impacts of the pandemic are also continuing to affect full global economic recovery.
Many private companies that are waiting to go public, like Instacart, Patreon, ServiceTitan, Databricks, etc. will probably suspend their IPO plans until the public markets stabilize. They may continue to raise more money from institutional investors and wait until valuations improve. There is a desire to be cautious and a new focus on public company readiness to give private companies the flexibility to capitalize and go public when the market conditions are more optimal.
Overall, the venture capital landscape is changing, and investors and founders alike are proceeding with caution until things stabilize. That being said, there is still a record amount of private capital sitting as “dry powder” in venture funds. This means that there is still plenty of funding to go around, but as venture capitalists become increasingly risk-averse, they will invest in startups with backing from name-brands like Y Combinator, into nascent protocols like Web3 that promise asymmetrical risk/return, and into startups that have proven business models with strong revenue growth. If you are a founder, you should expect to budget twice the amount of time for fundraising efforts – with savvy fundraising and solid fundamentals, you will get the capital you need. But it may come at a lower valuation than you expected, and the diligence process may take twice as long as you had hoped. The public market will also bounce back as it always has done and there will be an influx of companies going public after a backlog of companies waiting to go public.
Jan 21, 2022