Global interest in high valuation startups dampens

Until the global economic meltdown that started last year, high valuation was always an important part of a funding deal for high-growth focused investors.

But a recent report from Carta, an ownership and equity management platform, shows investors are taking a different approach to funding tech companies.

Investors are shifting interest to companies with lower valuations. According to Carta, nearly 19 percent of all primary funding went to this category of startups, making it the third straight quarter in which that has been above 15 percent. It is also the three highest rates of down rounds since at least the start of 2018.

“The past 2.5 years of down-round data paint a clear picture of how the valuation landscape has shifted. Between Q1 2021 and Q1 2022, the venture funding market was flourishing, the down-round rate declined for four straight quarters. After that, when the market entered a downturn, the down round rate increased for five straight quarters,” the report said.

The Carta report is corroborated by the new half-year report from Briter Bridges, which also tracks startup funding across Africa.

“Within the downturn, we are seeing a shift in focus from the growth stage, where many startups are stuck with high valuations from the peak 2021 and 2022, to the late and early stage,” the report said.

As a result of the drought in the funding market, many startups have been forced to take write-downs on their valuations and make deep cuts to their teams. The Briter Bridge report said that with regard to deals valued at $100 million or more, startup funding in Africa has seen a decline to $1 billion during the first half of 2023, compared to $1.5 billion in the second half of 2022 and $1.8 billion in the first half of 2022.

The economics of high valuation

A startup valuation describes the worth of the business – its idea, the product or service and so on. To know the valuation of an established business, you need to calculate the market value of the business, using tangible metrics and assets, such as revenue, profits, and customers.

The higher a business’ revenue, the stronger the company’s profit margins; the higher its bank balance, and the more promising its future, the higher its valuation. Startups that push for a higher valuation often do so because it helps them to raise the required amount of money without losing a lot of equity.

Also, having a lot of valuation makes it easier to borrow money, if the company is private. If the company is public, a high valuation leads to a high share price opportunity for the shareholders. A high valuation also means a big payday for the founders or shareholders, if the company is acquired.

The valuation of a startup can rise significantly if people or investors believe it has bright prospects. Just as well, any sign of trouble decreases the valuation of the company. This explains why some of the tech companies monitored by Briter Bridges have to take valuation cuts.

High valuation slashes are real

This is presently the case of Chipper Cash, the Kenyan fintech company that had a valuation of $2 billion in November 2021 when it raised $150 million from investors. The company has since hit hard times, mainly due to the collapse of FTX and Silicon Valley Bank. Recently, the company reportedly saw its valuation slash by 37.5 percent – from $2 billion to $1.25 billion. It also precipitated a team slash of over 175 employees.

What the investors say

Jasiel Martin-Odoom, African investment lead at Accion Venture Lab, said the current investment climate has shown that investors are heavily interested in ideas that have been derisked.

“Investors used to be ‘founder friendly’ to secure their spot in funding rounds. But those days are behind us. In 2023. Investors are including terms that heavily favour them. Founders need to gauge the impact of these terms on their future,” said Martin-Odoom.

Experts have also recently pointed out that investors are increasingly hesitant in investing in high-valuation startups because of concerns that the fundamentals of the companies may not be worth the investment. For example, startups backed by Y Combinator (YC), the US-based global accelerator, are seen as having absurdly high valuations.

Ihar Maniock, managing partner at Geek Ventures, a pre-seed capital venture firm, said founders have more to lose by raising funds at too high valuations, especially when they are not able to grow into the valuations.

“Founders have very little to lose by raising at low valuations, while investors have lots to lose. Raising at a $10 million vs $20 million valuation will be a 2x multiplier difference for a fund; in the case of a successful company, it could be a 50x vs 100x multiplier or a difference between a successful fund and a lousy one.

For a founder, raising $10 million vs $20 million means losing a few percentage points, which in the case of a multibillion exit means the difference between a life-changing extremely large amount of money and a life-changing extremely large amount of money plus a few million,” said Maniock.

Osaretin Victor Asemota, growth partner at AnD Ventures and Africa partner for Alta Global Ventures, believes that as profitable as high-growth startups with high valuations are, they are not the solution to Africa’s problems.

“We need widespread employment and economic growth. We need much more education and a lot of infrastructure. We also need better planning,” Asemota said.

However, investors like Paul Graham say high valuation should not affect the decision to invest in a startup.

“As happens every single YC batch, investors complain that the valuations are too high, and the startups raise anyway,” said Graham. “Some investors just cannot grasp the implications of the fact that all the returns are concentrated in the big wins. The top-tier investors get it though; you’ll rarely lose them over price.”