Fernway DiarySM

Jul 01, 2022

In 2022, the global economy has become increasingly characterized by volatility and uncertainty. Supply chain issues that arose during the pandemic have become ongoing problems, and the continuing Russia-Ukraine war has resulted in sharply rising commodity prices. In the US, this month the Federal Reserve hiked its benchmark interest rate by .75{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in a bid to put the brakes on inflation, while the Dow Jones Industrial average fell below 30,000 for the first time since January 2021. With fears of recession growing, experts in the venture capital industry expect the pace of funding to continue to cool.

Last year was a record funding year, with tech startups raising $621 billion worldwide, according to CB Insights. The global unicorn (privately held startups valued at $1 billion or more) count also reached 959 in 2021, up 69{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} from the previous year. However, the first quarter of 2022 saw a decline in VC funding from the previous quarter, an early sign of the changing market. In another concerning development for tech startups, publicly traded tech stocks have taken a downturn as well, with the Nasdaq down nearly 32{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} since the start of the year and the BVP Nasdaq Emerging Cloud Index, which tracks publicly traded cloud computing companies, dropping over 40{d61ad4666dda706b731686a225909392f074403d16c1288901cab8f2cf34ab1f} in value.

While startup valuation is often held to be as much of an art as a science, the overall downturn in the public tech market is already starting to have an effect on the private markets. According to CNBC reporting, VC investors are beginning to hear about deals being renegotiated at lower values or term sheets being withdrawn. In the midst of stock volatility, dealmaking has also slowed considerably. Some VCs believe that the market may see a wave of “down rounds,” where a startup raises funds at a lower valuation than it had in previous rounds. They expect companies in later stages of fundraising to be harder hit than early-stage startups, and for the tight fundraising environment to put IPO plans on pause for many private tech firms. In cases where high valuations were based on comparisons to multiples in the stock market, private tech companies may need to adjust their share prices to be more in line with the falling share value of publicly traded competitors.

The sentiment among many investors is not that changing market conditions foretell another tech crash akin to the dot-com bust of the early 2000s, but rather that the VC ecosystem is undergoing a necessary correction after the rapid dealmaking of 2021. While companies can expect to see more conservative valuations, increased caution from potential investors, and a slower rate of investing, there is general agreement that there is still funding to be had. Nevertheless, experts warn that attracting investment during this period of extreme market turbulence may be very difficult.

Adjusting to Changing Conditions

How a startup should respond to a tougher investment market depends upon its individual position and stage of growth. For early or mid-stage startups with at least 12–18 months cash in reserve, the best course of action may be to proceed with business as usual, provided that their burn rate has been optimized to eliminate unnecessary expenses and strategically deploy spending in pursuit of necessary business goals. If this is not the case, startups may need to reevaluate and reduce spending to extend their existing runway rather than relying on being able to raise an additional funding round in the near term.

Going forward, heightened investor scrutiny should be expected in order to secure funding, making sound business planning, strong financials, and tax and regulatory compliance more important than ever. To effectively plan for next steps in challenging market conditions, startups need accurate financials and well-timed expert advice. Fernway Solutions offers a full range of advisory, corporate structuring, tax planning, compliance, and accounting services to ensure your startup has what it needs at each stage of its growth.

For more information, please contact your US tax advisory team at youradvisor@fernwaysolutions.com or visit us at www.fernwaysolutions.com.

Disclaimer:

The above content is intended to support the marketing of professional services and should not be construed as written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular tax situation. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this content is not intended to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Fernway Solutions assumes no obligation to inform the reader of any such changes.