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Bankruptcy

Startup life expectancy expected to fall

Company failure rate was extremely low during the last boom cycle. Investors expect that to change this year.

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Only one out of every 10 startups survives, said the old adage. But that was far from the case during the boom years of the last cycle when company failure rate was low—very low.

“VCs expected a certain percentage of their portfolio not to make it to the next round, but [company survival] has been off the charts,” said Miguel Luiña, managing director of fund investments at Hamilton Lane. He added that for certain managers, almost 100% of their companies raised subsequent funding during the capital-rich era that ended last year.

The number of VC-backed companies filing for bankruptcy or shutting down has hovered around 1,000 per year since 2016, according to PitchBook data. At the same time, new startup formation has increased, as measured by first VC financing, greatly exceeding startup failures.

 

But the years of low startup mortality are coming to an end.

Last week, Wyre, a nearly 10-year-old blockchain-based payments company, reportedly told employees that it is going out of business. A couple of days later, The Wall Street Journal reported that Genesis, a large crypto lender, is considering filing for bankruptcy protection.

While last year’s valuation correction has yet to force many companies to close their doors, investors expect the shutdown rate to shoot up dramatically in the second half of 2023 and into 2024.

“I think loss ratios will be triple—or some big multiple of what they’ve been,” said Micah Rosenbloom, a co-founding partner at Founder Collective.

The most severe ramifications of the slump are taking a while to manifest for several reasons.

Startups entered the downturn with a decent amount of cash that allowed them to continue operating, and investors did everything possible to help their portfolio companies stay alive by providing bridge financings or helping them secure venture debt.

But most venture capitalists won’t be as supportive of their weaker investments this year, as they seek to protect existing capital commitments.

“In 2022, [VCs] put money in a lot of companies that probably they shouldn’t have,” said Yash Patel, a general partner at Telstra Ventures.

Last year, there was still “hope” that many struggling startups could be kept alive, but now it looks like VCs may have been throwing good money after bad, Patel said. “Investors are going to get very strict about their reserve allocations, saving [funds] for the best winners.”

While the number of shutdowns is still low, high-profile closures are on the rise.

So far, the prominent shutdowns have been in the battered crypto space, but investors expect failures in other technology areas.

As to what kind of businesses will go under, VCs are not singling out specific verticals.

“I think it’s going to be companies that just either didn’t realize how hard this is going to get and could not get control of their burn rates,” said Rosenbloom of Founder Collective.

Featured image by ShutterOK/Shutterstock

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    Written by Marina Temkin
    Marina Temkin covered the venture capital ecosystem from 2021 to 2024, based in San Francisco. Previously with Venture Capital Journal, Marina wrote about the VC industry, and she was a reporter with Mergermarket in New York and San Francisco. She also has been a financial analyst and is a CFA charterholder. Marina received an economics degree from the University of California, Davis, and she attended the CUNY Graduate School of Journalism.
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