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, they 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.

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.

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.

Jumia Technologies, the e-commerce giant that went public in 2019 at a valuation of $2.2 billion, has also experienced a valuation depression. The market capitalisation of the company, which is a major measure of valuation, has plunged from a high of $5.13 billion to $0.30 billion. Jumia’s financial results for the second quarter of 2023 showed it recorded a 1 percent drop in revenue, with other metrics also declining.

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.

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“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. They need much more education and a lot of infrastructure. They 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.”

5 Ways Startups Can Use Generative AI To Build A Competitive Advantage

Matt Carbonara, Managing Director, Venture Investing at Citi Ventures, investing in early-stage startups in the United States and Israel.

Generative artificial intelligence is having a moment. Tools like ChatGPT and GitHub Copilot have captured the imagination of people and enterprises around the world, and many venture capitalists—myself included—believe that GenAI may be the most transformative innovation since the dawn of mobile and cloud.

For entrepreneurs, this represents a major opportunity. The global GenAI market is forecast to reach $42.6 billion this year, according to PitchBook, and while VC investing overall remains in a slump, corporate VC funding for AI startups in Q1 2023 increased about 37% from 2022.

And that’s not the only good news. Much as Amazon Web Services lowered compute, storage and networking costs for startups, the rise of GenAI will likely cut costs as well by making coding, testing and customer acquisition less expensive.

But generative AI also poses challenges for startups. Its use has already become table stakes in the tech world, and VCs are increasingly considering potential investments with an eye on how AI may one day impact the markets and segments in which a startup operates.

Furthermore, incumbents like Salesforce and Microsoft are flipping the traditional, startup-led script of emerging tech adoption, rapidly incorporating GenAI into their existing solutions and partnering with leading firms such as OpenAI to build new ones. This could make it hard for startups to attract the investment they need to compete against incumbents who have preexisting brand recognition, tech stacks, customers, distribution and data—not to mention deep pockets.

Thus, despite the initial surge in venture investing, founders can’t rely on a “GenAI gold rush” mentality to secure funding. Instead, they will need to find a sustainable competitive advantage that will help their firm stand out in an increasingly crowded field. As every company becomes a GenAI company, startups must ask themselves: What sets us apart from their competitors? Where can they provide unique value to customers? What’s their lane?

Here are five potential answers:

The primary opportunity for differentiation in the age of generative AI is building your product around the tech from the ground up, rather than tacking it on to preexisting solutions or infrastructure. In this way, your company could re-architect current systems so dramatically that incumbents lose their advantages in data and distribution and/or existing products become irrelevant.

This holds especially true for traditionally manual processes and services. McKinsey estimates that “half of today’s work activities could be automated between 2030 and 2060,” with generative AI impacting knowledge work more than other types of work. For example, one of their portfolio companies builds software that uses GenAI tools to help companies manage contracts and draft legal documents more efficiently.

Startups can also build competitive advantage by adding value to foundational models—“AI systems with broad capabilities that can be adapted to a range of different, more specific purposes”—such as GPT-3.5. This could take place through prompt engineering (training AI tools to produce desired outputs); output chaining (refining large language models by stringing together outputs and inputs); improving a model’s user interface/user experience; and/or orchestrating foundational models (coordinating tasks within a workflow that’s driven by a foundational model.

One way startups might be able to add differentiated value to foundational models is by providing access to proprietary data that allows a firm to better train and use them for bespoke purposes. Another way may be through crafting guardrails and solutions for GenAI’s “black box problem”—the fact that AI engineers often have little or no idea how the tech makes decisions or why it can sometimes produce unreliable outputs such as chatbot “hallucinations.”

Many companies seeking to adopt generative AI-based tools lack the expertise to do so effectively. Startups that can support them will thus be well positioned to succeed. For example, MosaicML, a startup that helps enterprises build their own GenAI models, was recently acquired by enterprise software company Databricks for $1.3 billion.

Other avenues of opportunity include helping companies: manage and prepare their data for use in GenAI models; train models; and evaluate, experiment and put guardrails on models.

For startups that have already launched and are looking for their next growth inflection point, combining generative AI with other competitive advantages such as human expertise, an established customer base or superior distribution can help them take the next step. Using GenAI to, say, improve user experience can even kick off a virtuous cycle: a better UX could attract more users, who would produce more data, which could then be fed back into the foundational model to further improve the experience.

One of generative AI’s main benefits will likely be greater productivity via automation and the augmentation of human labor. This could help startups grow more capital-efficient—an especially important trait amid today’s high interest rates and rapidly cooling investment climate, particularly for “bootstrapped” startups. On the customer-facing side, firms can use GenAI to reduce sales, marketing, customer service and content creation costs; internally, the same holds true for bookkeeping, creating presentations, summarizing meetings, analyzing data, writing code and much more.

While the advent of GenAI presents startups with a range of new choices and challenges—open-source vs. closed-source foundational models, large foundational models vs. small models, building solutions vs. buying them, etc.—founders should not lose sight of the competitive fundamentals. Finding network effects, integrating with other products and technology, creating better workflows and user experiences, developing unique go-to-market approaches, building in switching costs to your product, etc. all continue to matter.

Indeed, at a time when an exciting new technology is fomenting the sense that all bets are off, the basics of sound business may prove more important than ever.

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