Start-up apocalypse? Cash crunch could wipe out venture-backed firms this year, Morgan Stanley warns
Start-ups backed by venture capital (VC) could be wiped out in droves this year as cash dries up and investors turn off the taps, analysts have warned.
The venture capital sector globally has been buffeted by rapid interest rate hikes and wild market gyrations in the past 12 months, with investors dramatically scaling back investment and companies slashing their valuations to raise money.
Venture investment in the fourth quarter of 2022 plunged to less than half of the frothy peaks recorded in the final three months of 2021, as firms raised just £75.6 billion across 7641 deals.
In the US, analysts at Morgan Stanley have now warned that “challenges abound” and the average VC-backed firm could face collapse this year.
“At current cash burn rates, the median VC-backed company will run out of cash in [the second half of this year],” the bank’s analysts said in a note yesterday.
“Broader impacts could be significant, VC-backed companies employ upwards of five million people, and drive revenue in important public equity segments,” they warned.
Limited partners, which back VC investors with funds, face over $500bn of capital calls at a time when portfolios had been marked down in value, they added.
The warnings come amid a tectonic shift in strategy for start-ups and VC investors, who have soured on the high-growth cash burn strategies that dominated for the past decade.
Investors have placed a premium on profitability and called for start-ups to rein in ‘growth at all cost’ business plans.
UK conservatism could shield VC-backed start-ups from collapse, analysts say
UK analysts told City PM that the more conservative strategy of UK firms could shield them from the same level of fall out this year.
“I think the US picture is quite different from the UK one,” Henry Whorwood, head of research and consultancy at investment data firm Beauhurst, told City PM
“The corollary of the accusation that UK firms are under-ambitious is that they’ve been more cautious with building up their burn-rates. And a lot of companies have spent the past couple of months doing what they can to lower those rates as well.”
He added that there would be “a crunch”, however, as firms that have been kept afloat by government support through the pandemic fail, and companies reach the end of their cash runways. LPs are also likely to struggle with capital calls, he said, causing an “uptick in companies going bust” and a potential disorderly fallout.
“If companies start going bust against a backdrop of further banking instability (or any other wider issue), then the processes will not be orderly,” Whorwood said.
Zuleika Salter, head of private growth capital at city broker and investment bank FinnCap, said, however, that a slide in conditions made cash-savvy firms an attractive bet for investors.
“Many companies and their shareholders are faced with either heavy dilution or significant cost cutting. We have seen companies and their VC-backers favouring the latter, resulting in job losses and deceleration of tech advancements,” she told City PM
“Under this pressure, some have creatively adopted more efficient business plans and are producing excellent growth metrics as a result. These companies will be very attractive growth-investment targets in the coming months.”