April 5, 2022

We’re out of cheap money

Observing current market trends, we’re witnessing a resurgence of the traditional economy. Garage workshops and amateur radio clubs are the future of Silicon Valley’s high tech startups and Europe’s leading accelerator hubs.

The “golden age” of inflated capitalization of high tech startups is over worldwide. This time for a long time.

Of course, financiers are to blame for the startup economy becoming another bubble and Ponzi scheme 20 years after the dot-com crash. Everything went on as usual: the best projects and ideas were PR’d, attracted investors, went public, expanded, then went up in value again and turned from a business into an abstract financial derivative. No one cared about profits: the founders thought they were superheroes and rulers of the new digital world, bankers and venture capital fund owners got their first-hand shares, investors got dividends, consumers rejoiced at the availability and price of the new services (as in the case of Uber). An entire ideology and culture of the new age emerged that impacted the entire civilization.

End of the Unicorn Era

Rivian, an electric car startup, saw a significant surge in its market value after going public in 2021 with a whopping $86 billion. Sadly, their stocks suffered a decline of 50% within the first three months of 2022 and this brought Amazon, their main investor, to a loss of $7.6 billion.

Uber and Lyft faced a similar fate when they were evaluated to be worth $120 and $150 billion respectively before their IPO. Both companies were unprofitable, with Uber accumulating losses of around $4 billion in 2018. Common profitability standards were overlooked, with user count seen as an alternative measure for the projected returns on investments. The likelihood of the model failing was known, however, when this never happened, there was rejoicing from those involved. The pandemic of 2021 had an overall positive impact on high-tech companies, as it was a record year for the number of IPOs in the US.

But the upswing was followed by a fall.

The decline of the global IPO market is staggering, with only 321 deals recorded in Q1 2022 worth a mere $54.4 billion—half of what was seen in the same quarter of the previous year. CB Insights report that global venture capital financing experienced a 19% decrease in the first quarter of 2021, affirming this bleak reality.
Furthermore, companies that emerged during 2007—2012, such as Netflix and Peloton, have suffered a tremendous 70% and 60% decline in their stocks, respectively, and Deliveroo and Spotify fell 58% and 61%, respectively. Most web 2.0 businesses dependent on user engagement, content monetization, subscriptions and advertisement revenues are no longer feasible. Even those who managed to secure significant funding are at risk of going under soon.
The traditional American approach of “turning on the printing press” to issue cheap loans and help investment banks, however, cannot rectify this situation worldwide. Ray Dalio’s Bridgewater Associates, a notable hedge fund, bet over $5.7 billion in a decline of European stocks—further highlighting the gloominess of this scenario.

All will suffer

While it might be easy to assume that the current economic situation is impacting only Internet companies and related services, the reality is that traditional business models are not immune to changes brought about by the increasing prices of energy. It becomes increasingly difficult to bring about innovative ideas, such as “smart farms” and AgroTech, due to the inflated cost of fertilizers and fuel which can make up more than half of the crops cost.

It becomes incredibly challenging to secure the funding needed for the transition from experiment to a functional prototype to measure commercial viability and scalability, given the present climate.

The rules of the natural world are unwavering, and nations have already put an end to subsidies of electric transportation and green energy initiatives (e.g., the UK and Japan). Even in rural areas of the US, government support of wind farms is dwindling.

Moreover, the world of fintech, an area once rife with potential investment, is feeling the effects of these developments as billion dollar companies such as Klarna, Bolt, and Fast suffer extensive layoffs. As a result, market analysts are warning of a drastic devaluation of unicorn investments. For those who have poured their resources into such projects, this news comes as a discouraging reminder that there is no room for miracles.

What do we do?

Compared to traditional companies, startups tend to take a different approach to economic growth. Profitability is not an immediate expectation. It develops through the acquisition of more capital. The priority for investors is either to cash out prior to a steep fall in the startup’s worth or remain invested until the startup develops into a traditional enterprise with secure gains.

The fundamental challenge in startup economics lies in devising the right metrics and KPIs. With a business model that is heavily reliant on customer acquisition cost (CAC) and lifetime customer value (LTV) data, there is no place for traditional methods of assessment. A great emphasis is placed on advertising budgets and measures such as brand strength and awareness are used to derive more meaningful conclusions.

Startups often miss the nuances of their target audience. Their first customers are usually risk-takers, who don’t always fit the definition of a “mass audience”. When the product launches, it quickly becomes apparent if the proper promotional strategies were implemented, or not. Unfortunately, if the latter is true, startups don’t make it past this stage.

Recently, the trend has been that venture capital firms will switch back to traditional assessment approaches. Hampus Jakobsson, the head of Pale Blue Dot, remarked that not one of the startup entrepreneurs he met was familiar with the discounted cash flow technique before their Initial Public Offering. This reveals that when assessing startups, the two essential elements are growth and monetization, with monetization still being the main consideration.

Startups should take the time to understand the fundamentals of economics and develop practical strategies for analyzing their business. Start by examining and streamlining cash flow processes. Figure out which areas need investment and always ensure sufficient funds are allocated for them.

For a startup founder, it is essential to remain focused on their unique selling proposition (USP) and concentrate on what consumers are looking to buy right now, not in the distant future. It is a known fact that customer buying habits have drastically shifted considering the pandemic, which makes prior customer knowledge now obsolete. As the market continues to evolve, it is essential to acquire and implement new knowledge quickly and efficiently if the business is to succeed in this climate.

Maximize cash flow and keep a close eye on settlements. Find creative ways to minimize unnecessary costs, consider automating standard operations, and remember that cash flow is the cornerstone of your business. Cash flow is essential and should be treated as such.

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