“It may be the best time for any type of company in any industry to raise money for all of history, like since the time of the ancient Egyptians,” an excitable Stuart Butterfield, CEO of Slack, told Farhad Manjoo. The New York Times in 2015.
That wasn’t an exaggeration. While interest rates remained near zero, venture capital funds raised more money than ever and liquidated their investments at some of the highest valuations ever seen.
The glory days of VC are over, and judging by history, the tech bust is expected to last until 2024 and beyond. In other words, the venture capital bust has just begun.
Extremely low interest rates have benefited venture capital in several ways. Low returns on conventional investments attracted investors to Silicon Valley, which promised outsized returns. Between 2016 and 2021, venture capital investments in the United States tripled. Ultra-low rates compress the dimension of time, making the future appear closer than it is. It’s no surprise, then, that a large number of extremely outlandish start-ups have been funded: luxury space travel, flying taxis, autonomous vehicles, and so on. Due diligence took a back seat. Sam Bankman-Fried’s failed cryptocurrency exchange, FTX, has attracted a roster of blue-chip investors, led by Silicon Valley luminary Sequoia Capital.
The valuations of startups, whose profits lay in the distant future, were hugely inflated by easy money. After battery developer QuantumScape merged with a SPAC in 2020, its market capitalization surpassed that of General Motors, even though the company did not expect sales for many years. Easy money has also fueled market liquidity, helping venture capitalists exit their investments. Never before have so many unprofitable companies traded at such high valuations. More than a thousand IPOs arrived on the US markets in 2021, more than double the previous record.
The punch bowl was removed from the VC party after the Fed began raising interest rates in 2022. QuantumScape’s stock is down more than 90%, but at least, unlike many other startups, it’s still in business . Bankman-Fried is in prison, awaiting trial. The IPO market has dried up. New entrants to the world of venture capital have fled. Others are facing large capital calls from the venture capital funds they committed to during good times. Starving for fresh funding, many startups are facing a bleak future. WeWork, which describes itself grandly as an “office solutions company” (sounds better than “rentals”) and once boasted a valuation of nearly $50 billion, is the latest to fall.
The Nasdaq index of technology stocks has seen a strong rebound in the first half of 2023. There is great excitement around artificial intelligence: NVIDIA, whose graphics processing units are used for artificial intelligence, is valued more than a trillion dollars. Large speculative bubbles, however, take years to unravel. Bear market rebounds, otherwise known as “idiot rallies,” are commonplace. After the dotcom bust, it took the Nasdaq a year and a half to bottom (and more than 15 years to regain its peak). The IPO market has seen little action for years.
The bear market in tech stocks is likely to return in 2024, with the Nasdaq index set to hit a new multi-year low. More and more startups will fail and venture capital funds will continue to see negative returns. As for Nvidia, it’s worth remembering what happened to Cisco Systems. During the dotcom bubble, Cisco, whose servers powered the Internet, was briefly the most valuable company in the world. Its shares traded at nearly 40 times sales before plummeting. More than two decades later, Cisco’s stock price remains well below its bubble peak. Valued at about 35 times sales, Nvidia could suffer a similar fate.