“We’re Seeing the Beginning of a Liquidity Crisis” in the Startup Boom, Suddenly

Stock markets have been volatile recently, plunging and soaring alternately on vertiginous slopes, sometimes the same day, and now folks that supply the juice to the startup ecosystem – VCs, pension funds, mutual funds, hedge funds even – are getting nervous.

They need to know where this market is going. They need to know if they can exit at a big profit, or if their investment and hopes will get dragged down with these startups when it all falls apart.

“Periods like this are pretty much your worst nightmares,” Sam Hamadeh, CEO of private-company financial intelligence provider PrivCo, told the LA Times. “There are literally meetings across Wall Street, where road show schedules were being planned, that are now about thinking, ‘Can we get late-stage funding to raise capital?’”

Big bucks are at stake. In the US, 76 venture-funded startups have “valuations” of over $1 billion. Uber sits at $50 billion, Airbnb at $25.5 billion. Palantir, intelligence and law-enforcement darling funded in part by the CIA, reached $20 billion; revenue-challenged Snapchat $16 billion. And so on.

“Valuations” in quotes because they’re negotiated by a handful of people behind closed doors Tidbits are then purposefully leaked to the Wall Street Journal for the sole purpose of hyping the startup to investors. The WSJ tracks these leaked tidbits. No one put that much money into the companies. Actual investments are a small fractions of these valuations. But nevertheless, it’s been crazy out there.

Or was – until the stock market went haywire.

“If broadly speaking, public investors are resetting valuations, then the private market has to follow,” Eric Liaw told the LA Times. He’s a partner at Institutional Venture Partners, which invested in Snapchat, among others.

The stock market, after going nowhere for a year and then jumping up and down like mad, might actually, after all these years, give up its bullish ghost and head south. That would imperil the entire startup scene. It happens after every boom.

Funding would become scarce. The next round, if there is one, might be a down round, with lower valuations than prior rounds. Some investors and employees might have to watch their gains go up in smoke – without being able to sell. If there is an IPO or a buyout, it too might be a disappointment. And employees who broke their backs for these startups would realize just a how demoralizing the process can be.

But those are the lucky ones.

Until the stock market’s direction becomes clearer, after the violent ups and downs, investors in startups are likely to drag their feet before putting money into new deals. Now all eyes are on whether this is, according to Mark Terbeek of Greycroft Partners’ Los Angeles office, “a fundamental change or just a nervous day.”

“The new fear is you’re going to have a lot of companies valued ahead of what they can get on the public market,” he said. Startups that are burning a lot of cash and have high valuations “will be most vulnerable.”

On the other hand, startups that are loaded with cash, like Uber and Snapchat, have time to adjust to the new era and figure out how to get through a downturn, and they might be able to raise more money at stable valuations, he said. It would be a while before they meet, as he put it, “the day of reckoning.”

Much of the recent funding for late-stage rounds at mega-valuations came from mutual fund companies such as Fidelity and T. Rowe Price. They’re new to this, and the threat of a downturn in the stock market could spook them, and they could simply close their wallet.

The LA Times:

If the market keeps declining, companies that have quickly spent initial investments will feel the most pain. Such corners of the start-up world include app companies that provide services such as assistants and food with a tap of a smartphone. The start-up tracking firm CB Insights recently identified 12 on-demand food delivery companies, some of which have launched in several cities, that “might be at risk of overextending themselves in the race to gain market share in the top metros.”

Ha, over the past four months, I have received in my mailbox – the antediluvian mailbox, not an electronic one – eight glossy fliers from food and drink delivery startups. Those flyers are expensive. They’re part of a constant flow of glossy flyers from startups that are blowing investor money on marketing firms (um, they’re also startups), mail-outs, and the United States Postal Service. These outfits are a dime a dozen.

And what should startups do that are hoping to go public? Kathleen Smith, Principal of Renaissance Capital, which tracks the IPO market, told the San Francisco Business Times: “Batten down the hatches.”

“Returns are the fuel that drives the IPO market, and the returns in the tech IPO market have been generally bad,” Smith said, but added that the pain hasn’t been just in tech. About 53% of all IPOs so far this year are at or below their initial price. Half of last year’s are underwater, and 48% from 2013 are in similar shape.

“We are seeing the beginning of a liquidity crisis,” she said. “If you are running a business that is losing money and needs investments to survive, you are coming up to hard times.”

It’s a good deal for everyone. Until it isn’t. Read… The Last Two Times This Happened, Stocks Crashed