Hello and welcome you are listening to Patrick Boyle on Finance, a podcast exploring ideas from quantitative finance, examining events occurring in markets right now and financial history to see what lessons can be taken away, including interviews with some of the most interesting people in the world of finance. To learn more about the podcast, visit on finance.org. Big start-ups are shutting down.
According to Pitchbook, more than 3000 private venture backed start-ups failed in the last year. Of the start-ups raising money, 19% were funded at a lower valuation than in prior funding rounds, 38% of VCs disappeared from deal making last year, and more than 1/4 of a million workers at tech companies were laid off over the same period.
US corporate bankruptcy filings closed out 2023, with the most filing since 2010. The year has been described as a mass extinction event for startups in the press. Hyperloop One, which was supposed to reinvent transportation, was shut down after wasting $450 million. It's like a tube with an air hockey table. Swear it's not that hard. Bird, the electric scooter rental company which was also supposed to reinvent public transportation, filed for Chapter 11 bankruptcy
protection. It was the fastest startup to ever land a billion dollar valuation and at its peak was worth 2 1/2 billion dollars. It was delisted from the New York Stock Exchange in September after failing to maintain a market cap of above $15 million for 30 consecutive days. Who would have thought that renting scooters to drunk people for a dollar who would then throw them in a canal on their way home would be a money losing business?
Bird ran up more than $1.6 billion in net losses from 2018 before finally running out of money. Smile Direct Club, which was supposed to revolutionize the oral care industry by selling 3D printed clear aligners direct to customer, was valued at $8.9 billion when it went public in 2019. But the stock fell in value over time as the company proved to be unprofitable year after year. The company shut down last month $900 million in debt.
The health tech startup All of AI, which reached a peak valuation of $4 billion in 2020. Driven by the need for automation in healthcare during the pandemic, the company raised over $900 million from investors In 2022. The company began laying off staff, citing tough economic conditions. The company was allegedly trying to raise money when it abruptly shut down in November. Going out of business in 2023 was particularly surprising for
a company with AI in its name. Zoom, the Robot pizza delivery company, which had raised $445,000,000 in VC funding, the majority of which came from SoftBank in 2018 at a two and a quarter billion dollar valuation, shut down this summer. The writing was on the wall for quite some time with Zoom. In 2020, they announced that they were shutting down their robot pizza delivery business, and we're shifting their focus to food packaging, production
and delivery systems. Who did they think would invest in that? Investors want robots making and delivering pizza that should be obvious to everyone. Yo, I haven't got all day. What kind of pizza do you guys
want? We work who set out to revolutionize office real estate by having an app which I'm told didn't work very well, and Free beer on Tap filed for bankruptcy in November. Wework and its founder Adam Newman were the poster boys of how a blitz scaled business model led by a charismatic founder could apply a veneer of technology to an old business idea and attract venture capital funding to achieve a multi billion dollar valuation. At its peak, Wework was valued in private markets at $47
billion. SoftBank alone invested $16 billion into the company. Masayoshi Son, Softbank's founder, allegedly invested his first $4.4 billion in the shared office space company after Newman gave him a 12 minute tour of Wework in 2016. With such a short tour, it's unlikely that the free beer even had an impact. SoftBank, run by Masayoshi Son Japan's Kathy Wood, was one of the biggest startup investors in the last decade.
They invested in all sorts of non tech companies that were made to look like tech in order to attain sky high valuations. According to Bloomberg, the SoftBank Vision Fund alone lost $53 billion over the last two years on startup investments. So why are startups failing now? How much money has been lost? Why did people ever invest in some of these crazy business models and how might this affect the broader economy?
We've seen a very difficult period for startups over the last year or two, but it comes in the wake of probably the best period for VC backed startups in decades. During the decade from 2011 to 2021, VC investment in private startups grew more than sevenfold, from $46 billion in 2011 to $345 billion in 2021. In 2022 when the Federal Reserve began hiking interest rates, this money began drying up as investors lost their taste for unprofitable but high growth
investments. The flood of money into venture capital over that 10 year boom period was driven by two main factors. Firstly, low interest rates, which meant that a dollar of earnings that was expected to come in 10 years time was worth almost as much as a dollar of earnings due to arrive the next day. This meant that you could focus more on growth than near term
cash flows. Secondly, a recent history of profitable exits from VC funded startups like Facebook, Google, WhatsApp and Snap meant that investors were suddenly paying a lot of attention to tech startups. Hoping to repeat those successes. Venture capital went from being a small asset class run out of offices on Sandhill Road that had burned investorsinthe.com bubble to a massive global asset class like hedge funds or private equity. The big names in VC became
household names. During the lockdown period of the pandemic, people around the world began adopting new technologies at a faster rate than ever before, and there was a feeling amongst investors that a sea change had occurred and that the future belonged to working from home companies like Zoom and Peloton. People were using apps like Uber and DoorDash for food delivery and booking rentals on Airbnb to get out of big cities now that they no longer had to turn up in
the office. While the prior wave of profitable high growth tech stocks had been one way or another in the advertising space or businesses like cloud computing, the new wave of startups had untested business models. Gig economy businesses which attracted a lot of competition and might never flip to profitability, or robot made pizza which would be cooked on
route to a customer's home. As it turned out, a lot of these new business models didn't really work, especially when interest rates started going up and investors wanted to see positive cash flows. Investors over the period of the tech stock bull market had started taking a lot of risk.
A lot of new investors were young and had never seen a rising interest rate environment and they expected that a lot of the new business ideas that they saw, including during the pandemic, would continue on forever. There was a lot of optimism around technology and high growth startups back then amongst retail investors who didn't really worry about valuation. Startups do fail all the time. So what makes these bankruptcies
any different? Well, many of these firms were worth billions of dollars in the private market until very recently. The investors in private markets are supposed to be more sophisticated than retail investors, but the qualification to invest in private investments like these is just that you have a lot more money to lose.
A lot of the VCs possibly believed in many of the questionable investments that have since gone bust, but a venture capital fund isn't really there to hold on to these investments until the underlying business flips to profitability. They invested the idea stage with the goal of selling these businesses onto the public when the hype is at its peak.
They did manage to unload a number of the biggest flops, like We work, but not at the valuations they were hoping for, and have found themselves holding the bag on a lot of investments that they bought into at peak valuations. Historically, by the time a company had reached a billion dollar market cap, having raised hundreds of millions of dollars in funding, it had mostly sorted out its business model. If not already profitable, it was firmly on the road to
profitability. This was not necessarily the case for many of the companies now failing. The huge valuations many of these companies were attaining in the private market may have been more of a function of how much money had flowed into the private tech startup market since 2011, rather than necessarily reflecting the quality of these companies and their business models. So how much money has been lost in these startups?
Well, according to Erin Griffith at the New York Times, $27.2 billion in VC funding had gone into the 3200 venture backed companies that went out of business in the 1st 11 months of 2023. That number was based on data from Pitch Book, which they put together for the New York Times, and they said that the data was not comprehensive and probably under counts the total because an awful lot of companies go out of business quietly without any big announcement.
That $27.2 billion number excluded many of the largest startup failures that went public like we work, or that found buyers at much lower prices than VC investors had invested at. Aaron gives the example in her article of hoping. I'm hoping I pronounced that correctly. A startup that raised more than $1.6 billion in VC funding was once valued at $7.6 billion and recently sold its main business for just $15 million. That's a big loss and a lot of money burned.
The hype around AI that we've seen in the last year has masked a lot of the losses in the tech space. Meta was up 178% last year due to a combination of AI hype and cost cutting within their core business. This covers up the $46.5 billion lost on the Metaverse, which no one will venture into for fear that they'll run into Mark Zuckerberg. AI was the only bright spot for startups last year, which according to Bloomberg received almost $18 billion in VC funding.
So should we expect these startup shutdowns to affect the broader economy? Well, there are job losses associated with these business failures. As I mentioned in the intro, Bloomberg reports that more than 1/4 of a million workers at tech companies were laid off last year. But the job losses are happening in an economy that's otherwise doing just fine. The labor market has been very tight, meaning that the people who lose their jobs should find replacement jobs easily enough.
As bad as the stories of these firms shutting down might sound, we have to keep in mind that the stock market is at all time highs right now, with the gains driven by mega cap tech stocks like Meta, Microsoft and NVIDIA, all of whom closed at new all time highs on Friday. According to the New York Times, some VCs have been encouraging founders in their portfolio companies to consider walking away from struggling businesses.
Rather than waste years grinding away, some of these companies have been able to wind up and return some money to their investors. One of the negative economic effects of startup shutdowns is that in such an environment, it becomes harder for founders with good business ideas to get
funding. According to Pitch Book, the number of active investors in US venture capital, which was defined as firms that made two or more deals in the last year, plummeted by 38% in the 1st 3/4 of 2023 compared to the same period the prior year. That translates to 2725 fewer firms making deals. According to S&P Global. US corporate bankruptcy filings rose last year, hitting the
highest level since 2010. the FT reports that corporate insolvencies in England and Wales climbed to their highest level since the global financial crisis in the six months to September last year, as businesses grappled with high borrowing costs and slowing demand.
A new paper by Bruno Albuquerque and Roshan Iyer, The Rise of The Walking Dead Zombie Firms around the World, argues that some of the increase in recent business failures is a catch up effect, and that many of the companies that failed in the last year were zombie companies that had been propped up by low interest rates and pandemic relief measures. These were businesses that would have likely collapsed earlier without the support they received, which has now mostly
been withdrawn. The failure of bad business models is just part of the creative destruction of the capitalist system and is necessary for a healthy economy. The paper defines zombie firms as firms that are risky, unproductive and unviable, but that managed to avoid immediate default, often thanks to banks, investors, or government support in light of misaligned incentives.
Their research shows that the share of zombie firms, both listed and private, has steadily grown over the last 20 years, initially growing in the wake of the global financial crisis. After a downtick from 2016 to 2019, the share of zombie firms resumed its upward trend, likely driven by the unprecedented policy support and easy financing conditions made available to businesses as pandemic relief.
The paper finds an increase in zombification over the last 20 years for both listed and private firms, with zombie firms accounting for over 10% of all listed firms in 2021, up from 6% in 2000. And for private firms the rise has been from 1% in 1997 to over 5% in 2020. The authors find that the presence of zombie firms in an industry dampens investment, productivity and employment for
healthy firms. They find that healthy firms who find themselves competing with zombie firms are less able to access credit, and that non zombie firms in industries heavily populated with zombie firms tend to exit the market at a faster rate than average, and that new competitor entry rates in those industries are significantly lower.
The paper argues that the policies that led to zombification, while well meaning, might delay an important creative destruction in the global economy, harm healthy firms and have negative consequences for long term productivity growth. No one wants to see firms going out of business, especially startups which are often the most exciting and innovative firms.
But if a business model makes no sense or only works in a zero interest rate environment, then it's disappearance means that capital can again flow in the direction of the best businesses. Thanks for tuning into this week's podcast and a special thanks to my supporters on Patreon who make all of this happen. Have a great week and talk to you again soon. Bye. If you enjoyed this episode, be sure to subscribe so you're notified when a new episode is
posted. Thank you to everyone who is supporting this content on Patreon. If you enjoyed this content, you can find more like it on YouTube on the Patrick Boyle on Finance channel or follow us on Twitter at Patrick E Boyle. Thanks for listening. Bye.