“It might be the best time for any kind of business in any industry to raise money in all of history, like since the time of the ancient Egyptians,” an enthusiastic Stuart Butterfield, CEO of Slack, told Farhad Manjoo in a 2015 interview.
This statement was not an exaggeration. With interest rates hovering near zero, investment funds raised unprecedented amounts and exited at some of the highest valuations ever recorded.
However, the favorable conditions for venture capital have ended, and if past events are any indication, the current downturn in the tech sector may last well into 2024 and beyond. This marks the beginning of a venture capital contraction.
The period of ultra-low interest rates provided numerous advantages to venture capital. The low returns on traditional investments drew investors to Silicon Valley, which held the promise of substantial gains. Between 2016 and 2021, U.S. venture capital investments tripled. Low rates made the future seem more immediate, leading to the financing of numerous extravagant startups, such as luxury space travel and autonomous vehicles, while due diligence suffered. Sam Bankman-Fried’s unsuccessful crypto exchange, FTX, attracted high-profile investors, including the prominent Sequoia Capital.
Startups, many of which had profits projected far into the future, saw their valuations soar due to easy access to capital. After battery developer QuantumScape merged with a SPAC in 2020, it achieved a market cap greater than General Motors, despite not anticipating sales for several years. Easy capital also enhanced market liquidity, allowing venture capitalists to exit their investments. Never before had so many unprofitable companies been listed at such lofty valuations, with over a thousand IPOs hitting U.S. markets in 2021—more than twice the previous record.
This favorable environment shifted dramatically when the Federal Reserve began raising interest rates in 2022. QuantumScape’s stock plummeted over 90%, yet it remains operational, unlike many others. Bankman-Fried now awaits trial in jail, and the IPO market has all but vanished. New investors in venture capital have retreated, while existing ones face significant financial demands from funds they committed to during better times. With fresh capital dwindling, many startups are facing a grim outlook. WeWork, which once boasted a valuation near $50 billion, is among those struggling, rebranding itself as an “office solutions company” rather than focusing on rentals.
The Nasdaq index of technology stocks showed a strong recovery in the first half of 2023, largely fueled by excitement over artificial intelligence—NVIDIA, known for its AI graphic processing units, is valued at over a trillion dollars. However, speculative bubbles can take years to deflate. Historical bear market recoveries, often referred to as “sucker’s rallies,” are frequent occurrences; for instance, after the dotcom bust, the Nasdaq took nearly a year and a half to reach its trough and more than 15 years to regain its previous high. The IPO market remained stagnant for years thereafter.
Looking ahead, a return to a bear market in tech stocks seems likely in 2024, with expectations that the Nasdaq index will reach a new low. More startups are anticipated to fail, and venture capital funds are expected to report continued negative returns. In the case of Nvidia, it’s worth remembering the trajectory of Cisco Systems during the dotcom bubble, when it briefly became the world’s most valuable company with shares trading at nearly 40 times sales before experiencing a significant crash. More than 20 years later, Cisco’s share price still trails well below that peak. Valued at around 35 times sales, Nvidia could encounter a similar downturn.