Prominent venture capitalists are concerned about skyrocketing valuations and returns on startups, raising alarms that the market is overheated.
The number of new venture-funded startups is relatively flat in 2021, Wall Street Journal reported. However, valuations have surged, with more money coming in. Investors pumped a record-breaking $93 billion into seed- and early-stage U.S. startups through Dec. 15. The median valuation for such companies funded in 2021 was $26 million, up from $16 million in 2020 and $13 million in 2016, according to PitchBook Data Inc.
Blank Street Coffee, a Brooklyn-based early-stage startup with 15 small-format specialty shops in New York, has received commitments for its third funding round in a year. A $35 million investment comes just three months after the fledgling company received $25 million, according to CEO Vinay Menda.
“We live in a world where capital is available,” said Menda, a 29-year-old former venture capitalist who co-founded the coffee company in 2020.
A record of 249 firms achieved $1 billion “unicorn” valuations in the first half of 2021, according to CB insights — almost double the number of unicorn valuations during 2020.
However, some of these valuations could be inaccurate and artificially inflated without regard to their intrinsic value, according to Bharat Kanodia, the founder of Veristrat, a valuation and advisory company.
This could explain why WeWork, which was valued at $47 billion in January 2019, fell to $12 billion in September the same year when it planned its IPO, Kanodia wrote in a column for Inc.com.
Venture capitalists are not looking to invest in numerous companies and run them in perpetuity. Their business model is to invest in numerous companies, double down on the ones that do well and sell them for a big payday.
The only way this model works is when VCs’ portfolio companies are successful in raising capital at higher valuations in each subsequent funding round.
There have been a few investment rounds in which companies were valued at $100 million before they had a sustainable business model, according to Fred Wilson, a partner at Union Square Ventures and early backer of Twitter and Coinbase.
The investors “are being delusional, comforted by the likelihood that someone will come along and pay a higher price in the next round,” Wilson said. “The numbers just don’t add up.”
In order to compete, many venture capitalists say they have spent less time on background checks and other research before investing. A recent rout of high-growth tech stocks have investors particularly on edge, as startup trends often follow the public markets.
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