Investors are regaining the upper hand in Silicon Valley startups

For years, venture capitalists have lavished money and power on company founders as the value of startups rose. Investments now come with strings attached.

The widespread rout in tech stocks has prompted venture capitalists to cut spending in recent years. In the new environment, some investment firms were able to add stringent conditions to funding rounds.

Such terms were rare for startups during much of the tech bull run, as low interest rates created an easy fundraising environment for founders and investors flooded the private market looking. of yields. Some fund managers have started raising new funds targeting so-called structured deals in recent months, a sign that there is more to come.

Tonal Systems Inc., a developer of fitness equipment, earlier this year entered into a financing agreement that allows investors to double their investment before other shareholders in the event of a sale or bankruptcy, according to a company filing in Delaware. The company declined to comment.

Investors also condition funding on the companies’ future performance. In July, investors brokered a deal to invest in Israeli artificial intelligence software startup Ayyeka Inc. that gave them the right to lower their stock price if the company misses certain financial metrics over time.

Structured deals differ from standard funding rounds, where investors buy seed stocks without covenants that guarantee returns or tie investments to financial performance. A spokeswoman for Ayyeka said the company had suggested the structure of the deal to investors and remained extremely confident that it would achieve its goals.

Investors say the growing prevalence of structured deals shows how power in Silicon Valley has returned to them after a record amount of capital poured into the startup ecosystem over the past decade. The pandemic heightened the investment frenzy as interest rates plummeted, creating a freewheeling fundraising environment where popular founders negotiated funding deals that limited external oversight of their businesses, investors say. capital risk.

Investors say the hottest startups will still have access to unconditional funding, thanks in part to the record amount of capital that has been raised for venture capital investments.

But some companies with more fragile finances that rose to lofty valuations last year are already struggling to find willing backers, forcing them to offer painful concessions in return for new funding, investors say. The fundraising market for traditional public listings, another source of capital for mature startups, is on track for its worst year since 2009, according to Dealogic.

Klarna recently raised new funding at a valuation of $6.7 billion, an 85% discount from its previous funding round.


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Hollie Adams/Bloomberg News

Matt Murphy, a partner at venture capital firm Menlo Ventures, said last year that startups in his portfolio typically turn away investors with structured deals because of the large amounts of capital available elsewhere. Now, some founders may have no choice but to accept the harshest terms, he said.

“Terms and structure are going to be much more mainstream over the next 12 to 24 months as businesses are going to struggle to scale up,” he said.

Structured deals could help some startups avoid raising new capital at a lower share price, which is often a blow to business morale and a negative signal for future investors, according to venture capitalists. risk.

Fintech startup Klarna Bank AB raised new funds last month at a valuation of $6.7 billion, an 85% discount from its previous funding round. This could be the start of a downward trend in valuations over the next few months, investors say, as many startups that have raised large sums of money in the past year could have fundraising needs in a very different environment.

In a sign of the changing times, the investment firms that helped drive up valuations during the pandemic bull market are raising funds dedicated to structured equity trades that guarantee a return for investors. Coatue Management LLC, one of the most active seed investors last year, is raising a $2 billion fund to invest in structured seed rounds for public and private companies, according to an investor presentation from May View. by the Wall Street Journal and someone familiar with the matter. At the time, the company had already raised $1.2 billion in capital for the fund.

In the presentation, the company mentioned the scarcity of capital available through private rounds and traditional public listings as one of the reasons startups might want structured capital. He also said that structured finance rounds have historically outperformed standard finance rounds during market crises.

Viking Global Investors LP, which manages private equity funds that invest in startups, is also looking to raise at least $1 billion for a structured capital fund, according to a person familiar with the matter. Bloomberg News earlier announced the new Coatue and Viking funds.

“Investors are thinking more about downside protection,” said Rick Heitzmann, a partner at venture capital firm FirstMark Capital, referring to clauses that try to guarantee fund managers a profitable return even if their bets turn. wrong.

Startups are also starting to take on more debt instead of selling stocks at lower prices. Venture capital-backed startups in the United States raised nearly $15.9 billion in debt in the first seven months of this year, compared to around $13.3 billion in the same period of 2021 , according to data from Crunchbase Inc. The increase came as global venture capital funding fell 18% over the same period, the data showed.

Mr Murphy of Menlo Ventures said debt funds struggled to compete with other types of funding last year, although they were already coming back into vogue with startups as a way to raise funds.

Even companies that were able to raise money at higher valuations during this year’s tech rout are trying different fundraising strategies. HR management startup Personio GmbH raised convertible debt in June where investors’ loan would turn into shares at a discount to a public listing price, according to people familiar with the matter. Personio also sold shares at a valuation of $8.5 billion for the round, up from its last valuation of $6.3 billion.

As part of the deal, investors negotiated the right to receive interest that could also be converted into shares at a discount, known as an in-kind loan, in part to protect investors from a market crash. , the people said.

Write to Berber Jin at berber.jin@wsj.com

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