In a 51-page note, the venture capital firm said loose monetary policies globally in the past two years had led to negative interest rates, making fundraising effortless for growth companies and driving up valuations. Now, with interest rates rising, “money is no longer free”, which can have massive implications for valuations and fundraising, it added.
The fund called the downturn a “crucible moment”, one that would present “challenges and opportunities” for many of its portfolio founders.
“We foresaw some of this when we first published our Black Swan memo at the start of the Covid in early 2020. What we got wrong was the monetary and fiscal policy response that followed and the distortion field that created,” Sequoia wrote in a confidential advisory note to the founders of companies where it invested in. “Sustained inflation, and geopolitical conflicts further limit the ability for a quick-fix policy solution. As such, we do not believe that this is going to be another steep correction followed by an equally swift V-shaped recovery, like we saw at the outset of the pandemic,” added the note, which ET has seen.
US tech publication ‘The Information’ first reported about the Sequoia advisory on May 24.
Sequoia said the valuation swings currently seen were a reflection of uncertainty about demand, changing labour market conditions, supply chain uncertainties and war. These are factors that ultimately affect business, it said.
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“We expect the market downturn to impact consumer behaviour, labour markets, supply chains and more. It will be a longer recovery and while we can’t predict how long, we can advise you on ways to prepare and get through to the other side,” Sequoia added.
Several other prominent investors, including Lightspeed Venture Partners and Y Combinator, have also warned their portfolio companies of the turbulent times ahead. SoftBank founder Masayoshi Son said earlier this month that the Japanese investor would likely cut down on investments significantly this year.
Tech slowdown and expensive capital
While 2021 was a seminal year for fundraising for Indian startups, the first half of 2022 has seen late-stage rounds getting delayed on account of higher diligence from investors, as well as disagreements on valuations and investment terms.
“When capital was free, the best performing companies were capital consumptive. As capital has gotten expensive, these have become the worst performing companies,” Sequoia said in its advisory.
The shift for global investments now is towards companies which can show profitability and near-term certainty.
“With macro uncertainty around inflation, interest rates and war, investors are relooking for companies that can produce near-term certainty. Capital is getting more expensive … leading to investors de-prioritising and paying up less for growth … The focus on near-term momentum is often shifting toward companies who can demonstrate current profitability,” Sequoia added.
It added that belt-tightening would have a domino effect with “second-and-third-order” effects, as “one company’s cost represents someone else’s revenue or purchasing power”.
Sequoia also said the US was experiencing the third largest Nasdaq draw down in the last 20 years, with an increasingly volatile tech market in the last six months. Further, 61% of all software, Internet and fintech companies are trading below pre-pandemic 2020 prices, it said.
“The era of being rewarded for hypergrowth at any costs is quickly coming to an end,” the venture firm added.
Who survives?
According to Sequoia’s note, the survival of companies depends on “who moves the quickest” and “will have the most runway to avoid the death spiral”.
“Do the cut exercise (projects, R&D, marketing, other expenses); it doesn’t mean you have to pull the trigger, but that you are ready to do it in the next 30 days if needed. In 2008, all companies that cut were efficient and better. Don’t view cut as a negative, but as a way to conserve cash and run faster,” said Sequoia in the letter, advising founders to take a conservative view of the situation.
Sequoia’s global advisory comes at a time when three of its prized portfolio companies in India and Southeast Asia — social commerce venture Trell, fintech BharatPe and ecommerce technology company Zilingo —
have undergone internal audits on allegations about corporate governance issues and financial fraud.
Due to an audit in its portfolio company, Sequoia India has postponed the closure of its $2.8 billion India and Southeast Asia funds,
ET reported on May 18.
