Chicago tech startups face a funding crisis

“We tell companies to be careful of any new hires,” says Chicago Ventures partner Stuart Larkins, though he says a number of his investment companies are ahead of forecasts and still growing rapidly. .

Venture capitalists worry about how their businesses will fare if customers cut spending on products due to rising interest rates and other costs, or if a broader recession sets in . But they also worry about a rapid change in the funding environment.

“Until recently, the cost of capital was effectively zero,” says Molly Bonakdarpour, a partner at Drive Capital in Columbus, Ohio, who has invested in several Chicago startups. “When you see the cost of capital going up, the math changes. Every entrepreneur, every board has conversations about how to adapt to an environment where capital is more expensive. »

Venture capitalists review budgets with management teams, looking for ways to cut costs, preserve cash, and achieve profitability faster. Some have circulated manuals with how-to guides on managing layoffs, tracking weekly rather than monthly cash flow, cutting outside consultants, and renegotiating deals with wireless or cloud service providers.

“As a management team, we spend a lot of time discussing what it will take to achieve profitability on a sustainable basis . . . which is a departure from where we all were a while ago. just six months,” says David Rabie, CEO of Chicago-based Tovala, which sells high-tech countertop ovens and meals to go with them.

It’s not just the possibility of a recession that worries investors. Valuations of venture-backed companies, which largely follow the public markets, had been skyrocketing for years. But with tech stocks down about 25% this year, and worse in specific sectors, those valuations are falling fast. Falling tech stocks reduce opportunities for VCs to withdraw funds from existing deals, dampening the likelihood of IPOs and reducing the value of mergers and acquisitions, making them less attractive. The number of exits fell 42% in the first quarter compared to the fourth quarter, and the value of those transactions fell 79%, according to PitchBook.

More mature private companies, which have raised larger amounts than early-stage startups, are seen as particularly struggling. An influx of cash by spendthrift giants such as Tiger Global and SoftBank led to a wave of more than $100 million in funding that sent valuations soaring last year.

The pace of deals over $100 million in Chicago has slowed sharply, with three deals in the first half of this year, down from a record 17 in 2021, according to PitchBook.

Companies that raised funds at high valuations in late 2020 and 2021 will struggle to raise more at similar prices. Some will be forced to accept lower valuations, a ‘slip’, giving up more shares in exchange for less money than previous investors have paid, something companies are loath to do.

“We tell our companies a flat lap is a win, a higher lap is a home run,” Larkins said.

Amount, a Chicago fintech company that was valued at $1 billion in 2021, recently turned heads when it raised new funds at an equal valuation. He then cut 18% of his jobs, or about 100 positions.

Travel software startup Journera closed a $10 million funding round in April. CEO Jeff Katz said “software company valuations have been crushed, and we felt it”, although he declined to disclose the valuation. Chicago-based Journera is taking advantage of the post-COVID travel recovery and is hiring. But he won’t be hiring as aggressively as expected.

“We want to keep our costs as low as possible,” says Katz, who founded Orbitz after the dot-com crash. “Everyone is talking about more lead and profitability rather than growth as a key metric.”

The irony is that venture capital funds are sitting on record amounts of cash. They raised $129 billion last year, more than double the previous record, according to PitchBook. Companies raked in another $100 billion this year.

Early-stage companies will also feel the impact of falling valuations. PitchBook says early-stage deal valuations are down more than 50%. And that’s for companies that can grab the attention of investors. While venture capital funds are worried about their existing investments, they are less interested in new deals.

Jim Dugan, managing partner at Chicago-based OCA Ventures, said he was attending a conference with hundreds of venture capitalists in California ahead of Memorial Day. “Most VCs are internally focused, not looking for new deals, sorting through their portfolios,” he says. “Everyone goes through it.”