The recent bankruptcy of Silicon Valley Bank (SVB) has highlighted the risks associated with investing in startups, and the challenges facing venture capitalists, stockholders, and lenders. The collapse of SVB, the 16th largest bank in the US, was caused by its use of short-term deposits to finance investments in long-term bonds, stocks, and mortgages, a bet that interest rates would not rise. However, when the Federal Reserve started raising interest rates aggressively about a year ago to slow inflation, the market value of SVB’s long-term investments collapsed, exposing the bank’s weak balance sheet.
This raises questions about the wisdom of investing in startups that have been accumulating losses for years, which is a problem for venture capitalists, stockholders, and lenders. Many startups are little more than compelling stories and persuasive pitches, which has led to too much money being invested in companies that are unlikely to become profitable. The bankruptcy of SVB is a stark reminder that these investments are not without risk, and investors need to be more cautious.
One of the problems is that investors have been willing to overlook startup losses, which have been cumulating for years, in the belief that these companies will eventually become profitable. However, the reality is that few startups have been as successful as Amazon, which did not become profitable until its 10th year, when it had $3 billion in cumulative losses. At least 18 publicly traded American “unicorns” – companies valued at $1 billion or greater – have more than $3 billion in cumulative losses, of which three have more than $10 billion.
Moreover, most unicorns are far older than 10 years. The average age of America’s 144 publicly traded unicorns is 14 years. While Amazon’s $3 billion in cumulative losses were about equal to its revenues in year 10, almost 60% of publicly traded American unicorns have cumulative losses greater than their 2021 revenues, meaning that even if they become profitable – a big if – it will be difficult for them to overcome their cumulative losses.
This suggests that many startups are struggling to become profitable, despite the optimistic predictions of some venture capitalists. While some VC’s have claimed that startups are on the cusp of profitability, the facts suggest otherwise. The percentage of publicly traded American unicorns that are profitable rose to 19% in 2021 from 16% in 2020 and 12% in 2019, but fell back to 12% during the first three quarters of 2022. The end of the lockdowns not only meant the end of easy money; it also meant the end of high revenue growth for startups that provided services to people stuck in their homes.
This situation has been made worse by the fact that many privately held startups massage their profits, partly because they don’t have to release audited statements. For instance, Revolut, one of Europe’s top fintech startups, recently announced that it was profitable in 2021, apparently only the second European fintech to achieve profitability. However, it was later revealed that Revolut was only profitable because of lucky investments in crypto, and its auditor said it couldn’t verify those investments. With the value of bitcoin and other crypto falling more than half from their peak in 2021, it is likely that Revolut lost money in 2022.
The collapse of SVB should serve as a wake-up call for the global startup system. Too many venture capitalists, banks, and stockholders have invested too much in startups that are little more than compelling stories and persuasive pitches. Investors need to demand more, starting with audited financial statements from all private startups. If they refuse, their market value should be reported as zero.
The realities of startup losses are impacting companies with investments in privately held startups, including SoftBank, which has struggled in recent years. The company’s share price has fallen more than 50% from its peak in early 2021, and a recent Wall Street Journal article warned of further losses from its startup portfolio.
Another Wall Street Journal article published on the same day noted that $23 billion in value had been erased from Tiger Global’s holdings of startups around the globe, including TikTok parent ByteDance and payments company Stripe. The article also cited Harvard University endowment chief N.P. “Narv” Narvekar, who warned in his annual letter in October 2022 that venture managers were not trimming the value of their private investments sufficiently.
The collapse of SVB and the struggles of other companies with investments in privately held startups highlight the need for greater scrutiny of these companies, and for investors to demand more transparency and accountability. While it is true that some startups will eventually become profitable and provide handsome returns for their investors, the reality is that many others will not, and investors need to be more aware of the risks involved.
In conclusion, the collapse of SVB serves as a stark reminder of the risks associated with investing in startups. While some startups will undoubtedly become profitable and provide handsome returns for their investors, the reality is that many others will not, and investors need to be more cautious. The call for audited financial statements from all private startups is a good first step toward greater transparency and accountability, but investors also need to be more aware of the risks involved and be prepared to walk away from companies that are unlikely to become profitable.