Startups could suffer deep cuts soon as investors re-rate and re-price

THE bloodletting in tech stocks and cryptocurrencies is starting to spill over into private markets, and startups could soon feel deep cuts as investors pull back hard on funding, valuations, and exits.

Investors are growing nervous about pricing their mid-to-late stage startups after years of record valuations and seemingly unlimited funding. And while waves of capital were still sloshing about in 2021, the tide is likely to reverse and contract.

“You don’t want to get into a company at a particular price and then it’s half the price in 6 months’ time. There’s a lot more caution in the market and many growth investors are talking privately about a slowdown in the investment velocity,” said Tushar Roy, partner at venture capital firm Square Peg Capital.

Investors and startups tracking the fortunes of South-east Asia’s first generation unicorns would now be wary of exiting via a public listing. Sea, Grab, GoTo and Bukalapak have all seen their stock prices plummet since the start of the year as markets re-rated growth stocks ahead of a looming economic downturn and as valuations of companies across the globe plunged.

The market capitalisation of Sea, which listed on the New York Stock Exchange in 2017, has shrunk by about two-thirds from US$124 billion on Jan 1 to US$42.2 billion on May 13. Sea last closed at US$75.40, compared to its 52-week high of US$372.70. Grab, which debuted on the Nasdaq in December 2021, has also dived in value, from US$26.7 billion on Dec 31 to US$10.8 billion on May 13. Grab closed at US$2.82 on May 13, against US$8.75, the highest it has traded after the business combination. Both companies are due to report financial results this week.

Startups at the pre-IPO and post-IPO stages are in for whiplash as investors swerve away from the chaos in global stocks, according to Chik Wai Chiew, chief executive officer of fund manager Heritas Capital.

“It could be a very short and sharp adjustment, but it also may be longer than what many people think in terms of these excesses wringing out the system,” he said. “The whole transmission effect is first hitting the pre-IPO investments and continues to flow upstream to the later stage growth rounds and earlier stage growth rounds.”

Square Peg’s Roy sees venture capitalists placing renewed focus on ensuring portfolio companies survive and come out of the market correction healthy, leaving them less time to do new things.

This means that investors may be less amenable to funding rounds at the growth stage, typically when startups are looking to scale their operations to gain a bigger slice of the market.

Fundraising for growth stage startups is about to get much tougher, and the region hasn’t seen the full force of it yet according to Rajive Keshup, investment director at venture capital firm Cathay Innovation. If a startup has an already-listed peer, the comparables to the value it has have changed significantly, putting a lot of pressure on the valuation.

“What that means is you'll start to hear more of employee letters being rescinded for offers that were out, term sheets being pulled on a more regular basis and less investment activity in the ecosystem,” he said.

There are likely to be more flat or down rounds – funding rounds where the valuation of the company remains the same or falls – rather than rounds to pump up the valuation. Bridge rounds, where money is raised just to ensure startups have cash reserves to continue operations, might be a more common sight. And these rounds may not be priced, meaning the convertible notes would not explicitly state the value of the startup, according to Square Peg’s Roy.

“I think that many growth investors are reluctant to price things. Because there’s so much uncertainty in the world, and if you do things like bridges or convertible notes, it kicks the can a bit further down until the market could possibly recover,” he said.

Some are already writing down their portfolio valuations, with the most notable being Tiger Global. And there’s likely more carnage down the road as startups find it tough to raise capital. Things will be even tougher if they run on business models that can’t scale economically or aren’t sustainable.

“You’re going to see a lot of startups perish and die as a result of that, all the downstream effects are going to be delayed from what we see now,” said Cathay Innovation’s Keshup.

The turmoil in stock markets has already led to fewer than anticipated exits for startups, according to Usman Akhtar, partner and head of Bain & Company’s South-east Asia Private Equity Practice, while special purpose acquisitions companies (SPACs) which were typical exit vehicles now face greater scrutiny.

“The SPAC market in the US wasn’t in a deep freeze like the way it is now,” said Akhtar.

It’s like a perfect storm, according to Chik: the world going through a war, pandemic and cyclical factors like rapid inflationary pressures, rising interest rates and geopolitical shifts. All these negative factors are aligned for some painful adjustments to markets both private and public.