Venture capitalists see an ‘R’ word coming for tech – and it’s not just the recession

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As tech workers face mass layoffs for the first time in more than a decade, venture capitalists foresee a “time of pain and opportunity” and believe it might be time for the industry to reset.

Tens of thousands of software engineers and other tech workers have lost their jobs so far this year, but VCs see silver linings in economic downturns: the potential for more people creating their own business. In discussions with MarketWatch after the announcement of job cuts at powerful technology companies such as Amazon.com Inc. AMZN,
-1.84%
and Facebook’s parent company Meta Platforms Inc. META,
-3.29%,
some VCs said they expected the downturn to last about a year — as is typical of recessions — as the tech industry, which they said was overheated, undergoes some adjustments.

According to data compiled by Challenger, Gray & Christmas, around 59,000 layoffs in the tech industry have been announced so far this year.

Now, a common statement among VCs is the “R” word: reset, not just recession.

“There’s a reset happening, which is absolutely necessary,” said Chris Cunningham, founding partner of Connecticut-based C2 Ventures. “Companies with no solid business were overvalued too high and with too much risk capital.”

Venture capital has been instrumental in the tech industry, providing startup founders with private capital to build companies and grow industries that have become some of the largest and most influential in the world, in exchange for a slice of the pre-public pie. Venture capital investment made Silicon Valley what it is – resulting in the first success story of Apple Inc. AAPL,
-0.83%,
dot-com baby boomers like Google GOOG,
+0.27%

GOOGL,
+0.42%
and mobile-focused startups like Uber Technologies Inc. UBER,
-4.85%
The region has become known for its entrepreneurial spirit, risk-taking, high wages and world-class benefits – and its boom and bust cycles.

Busts can be profitable for venture capitalists. Several venture capitalists have said they expect successful startups to emerge from this period and young companies in growth mode to continue to attract investors.

David Blumberg of San Francisco-based Blumberg Capital said “Layoffs make it easier for startups to attract top talent, and many top companies are born during downturns.” These include those founded in 2008 and 2009, during the throes of the Great Recession: now public companies like Uber, Airbnb Inc. ABNB,
-2.41%
and PIN Pinterest Inc.,
-3.54%,
as well as acquired companies like Venmo (now owned by PayPal Holdings Inc. PYPL,
-3.14%
), Slack (now owned by Salesforce Inc. CRM,
-4.29%
) and WhatsApp (now owned by Meta).

“People who are laid off, some of them are going to be the next great entrepreneurs,” said Spencer Greene, general partner of TSVC, a Silicon Valley startup venture capital firm.

The question of the day is, will venture capitalists continue to fund them even when other investments have yet to bear fruit due to a slowdown in the IPO and acquisition market? Greene said “we’re just as active as we’ve been,” and the data shows that’s mostly the case, although there are signs of a slowdown in some segments.

PitchBook’s third-quarter report showed seed and start-up valuations “remained at the high levels reached in 2021.” But median and average late-stage venture capital valuations took “a big hit” in 2022, according to the report, which also said that “late-stage backup is even more affected by companies’ inability to exit “.

In addition, data from PitchBook shows that “the number of late-stage deals also declined significantly – down more than 20% from the first quarter of 2022 – although still well above observed numbers. before the COVID-19 pandemic”.

These data points suggest that older startups may struggle to find funding to stay private, as they also face a dry IPO market and large companies are targeted by antitrust regulators. But it also suggests that laid-off tech workers could find funding for the next big thing.

Eugene Zhang, founding partner of TSVC, offered some advice for young tech workers and newcomers to the industry, who may not have been through its ups and downs yet.

“You have to understand that this is normal,” Zhang said. “It’s just the last 13 years, there was a lot of exuberance…it was a special time. This is the first reset you need to do.

The changing environment means that “European businesses will thrive even more: they operate in a market where capital has always been scarcer and so they already have the lean muscle,” said Erika Batista, general partner at On Deck in San Francisco. “But the broader economic instability is deterring investors in many cases. I see companies with incredible traction in Asia and Africa struggling to grow.

Meanwhile, “the best companies are investing during downturns and doubling down on capital,” said Lisa Lambert, chief technology and innovation officer at British multinational utility National Grid PLC NG,
+0.80%
and founder and chairman of its venture capital arm, National Grid Partners. She said it was normal for companies to reduce their workforce if necessary, but continue to invest in capital for long-term growth.

Lambert said she mainly sees the resilience of investments in energy technologies and that there remain “massive amounts of capital” on the sidelines. Still, she said that “if it becomes a deep recession,” it will affect her venture capital firm’s portfolio. It depends on whether the Federal Reserve’s interest rate hikes — which affect lending and investment — go “too far…they’re definitely lowering demand on purpose,” she said.

When it comes to the length of lean times, venture capitalists’ predictions range anywhere from the next few months to the next two years.

“It will be a two-year period of pain and opportunity for emerging startups during the recession,” said Boston-based Nextview Ventures partner Rob Go. “There is not much reason to believe that these difficult times will end soon.”

As for “large publicly traded companies, there’s this pressure for profitability,” said Max Gazor, general partner at CRV Partners in Palo Alto, Calif. “We are looking at six months of caution to spend efficiently.”

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