Startups’ Mortality Rate Seen Rising as Venture Capital Flows Tighten

After years of euphoria and multi-million-dollar valuations, companies are having to adjust to a new reality and tighten their belts to extend their runway and life expectancy, according to analysts

According to PitchBook, the number of venture capital-backed companies that have filed for bankruptcy or closed down globally has remained stable at 1,000 annually since 2016.
Last year, the number of venture capital-backed companies that went bankrupt or closed totaled 868, while in 2021 were 1,021 company closures.
February 13, 2023 | 02:03 PM

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Bogotá — Startups are going through a challeng stage in their young history after the rapid growth in recent years, with a boom in the emergence of new companies and multi-million-dollar valuations.

According to figures from financial data and software company PitchBook, the number of venture capital-backed companies that have filed for bankruptcy or closed down globally has remained stable at 1,000 annually since 2016.

Last year, the number of venture capital-backed companies that went bankrupt or closed totaled 868, while in 2021 there were 1,021 company closures.

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Meanwhile, the number of companies that captured their first venture capital funding fell from 16,501 in 2021 to 13,461 in 2022.

But, given the signs that the market is currently offering, PitchBook says “the years of low startup mortality are coming to an end,” according to the firm’s website.

Startups’ ‘mortality’ is currently supported by the fact that, given that “venture capital funds are investing less, they have to lengthen their runway and their profitability”, Maria Mercedes Agudelo, senior manager of transformation and innovation at KPMG, said in an interview with Bloomberg Línea.

“And many do not have enough money to last a year and a half, or two,” she added.

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She said this scenario could mainly impact those startups that “need a lot of cash flow to survive, that don’t have the capacity to be economically sustainable, and to raise capital, attract investors and sell”.

“The problem is that many startups started to grow rapidly without having a stable and sustainable business model, burning money and without having adequate customer retention. So these are the ones that could be more affected, they could be in the fintech, edtech or healthtech sectors, as there is no sector that is more affected,” she said.

How far will the runway reach?

Santiago Rojas Montoya, CEO of Cube Ventures fund, agrees, telling Bloomberg Línea that several verticals have been affected, but “the truth is that startups that raised capital based on FOMO (fear of missing out) are the ones that are being hit the hardest, regardless of the industry they operate in”.

“The challenge is going to be to transform their businesses into companies that extend their runway as much as possible, preferably with positive EBITDA, so that it is a theoretically infinite runway, and that continue to grow at high speeds,” Rojas said.

He added that, in the current context, investors are waiting for clear signs of increasing value of listed technology stocks in order to bet more heavily on startups, even if venture capital is not correlated to the public markets directly.

“This calculation of when investment in startups is going to increase will depend on when we start to see growth in these public markets,” he added.

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Students work at StartUp Lisboa Tech in 2015.dfd

In the opinion of Miguel Araujo, research and M&A manager at Brazilian fund Bossanova, despite the fact that the startup ecosystem is going through a spell of winter and venture capital has been feeling it, he said Bossanova “has yet to see a significant impact on the mortality rate of startups” in its portfolio, which includes companies in several Latin American markets.

“Because a good part of those startups were capitalized both in 2021 and at least in the first half of 2022, they are still capitalized, maybe they are going to hit an end-of-runway cycle in the middle of 2023 or by 2024. We may see one more impact for the first half of next year, but nothing significant”, Araujo said.

He added that some companie will survive due to them having greater flexibility, while other may end up suffering more in eventual value readjustments.

“Those that do not manage to be essential for the consumer. A nice-to-have product will probably be the first to be cancelled. It’s nice to have, but it’s not necessary to run a business. On the other hand, the must-have is that product that a business can’t do without, or a person can’t live without. So, more and more space is being squeezed for must-have products,” Araujo added.

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A changed landscape

Conditions have changed radically for startups, and companies are being forced to be cash-conscious, because “it is not time to be a rampant capital burner” without stabilizing finances and achieving the break-even point, he added.

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“It’s time to be more conservative, to have more cautious financial management, manage cash better, get some of that runway extended. To have margin to go through at least 12 months when the market tends to be less hot in order to have the best possible financial health,” he advised.

For his part, Cube Ventures’ Santiago Rojas Montoya believes that now is the time for companies to start standing out for being financially responsible, while continuing to grow rapidly, ensuring their financial capacity to survive at least this year, and preferably for two years, either through liquidity reserves and low monthly burn rates or, better yet, by being profitable.

“We must understand that we are in a cyclical phenomenon in which every eight to 10 years the economy contracts, falls into recession or crisis, liquidity is reduced and debt becomes expensive. Historically this happens after a boom and marks the beginning of the next cycle of economic growth until the next boom and crisis,” he said.

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And given that companies have seen a significant wave of layoffs, KPMG believes it is important for startups to increasingly plan their staffing, designing the positions and roles they require according to the sector in which each one is located.

It will be increasingly vital for “companies to project growth and development plans for their staff,” adds KPMG’s Agudelo.

This will involve reviewing the benefits that startups can offer compared to traditional companies in order to become more competitive in attracting talent, she said.

And within the planning, they must check that the balance of personal and professional life is adequate to meet the objectives.