Silicon Valley start-ups explore sales as funding runs dry

Cash-strapped tech start-ups are exploring sales to bigger companies in order to survive a funding crunch, as a series of takeovers of artificial intelligence companies lure buyers back to Silicon Valley.

In recent weeks, software group Databricks acquired generative AI start-up MosaicML for $1.3bn, Thomson Reuters paid $650mn for legal services AI group Casetext, Robinhood bought credit card start-up X1 for $95mn, and finance automation company Ramp acquired Cohere.io, a start-up that built an AI-powered customer support tool. 

The flurry of deals involving AI start-ups were a positive signal for venture-backed companies after 18 months of gloom in a tech downturn that crashed valuations and led to mass lay-offs.

But they are also a signal that start-ups that grew quickly during a pandemic-fuelled tech boom are increasingly seeking to sell themselves to larger companies or are under pressure from their venture backers to merge with a rival. Many face running out of cash as their venture capitalist backers have retreated and as markets have soured on initial public offerings of start-ups.

“There is a wave of consolidation coming in tech and particularly software,” said Ryan Nolan, global co-head of software investment banking at Goldman Sachs. He said many of the approximately 1,000 unicorns — tech start-ups valued at more than $1bn — are “stuck without a clear path to liquidity”. 

Josh Wolfe, co-founder of venture fund Lux Capital, said many large start-ups in his portfolio were now acquiring smaller rivals to boost growth. He said $8.5bn defence tech group Anduril and $3.6bn biotech firm Eikon Therapeutics “are now acquiring companies and assets and talent and further cementing their market share”.

“I think that wave is just beginning,” Wolfe added.

Large public companies are making acquisition plans. In June, Salesforce doubled the funds it has earmarked for investment in AI start-ups to $500mn. Arjun Kapur, managing director at Forecast Labs, a unit of Comcast’s venture arm, said large tech groups were now “more aggressively” approaching start-ups, including in his portfolio.

Last year, Forecast Labs merged its virtual healthcare business Nurx with competitor Thirty Madison. “A lot of these acquisitions . . . are about two individual organisations lacking certain value that can be merged to create a more valuable business,” said Kapur. “Those deals are happening more frequently.”

More activity is expected, particularly if regulators in the US and Europe push through a trio of big tech deals currently held up over antitrust concerns: Microsoft’s $75bn purchase of Activision Blizzard; Broadcom’s $61bn acquisition of VMware; and Adobe’s $20bn takeover of Figma. “The regulatory outcome for the largest tech deals will have a significant impact on large strategic buyer activity,” according to Goldman banker Nolan.

Microsoft’s deal took a major step forward this week after a federal judge denied the US competition regulator’s attempt to block it and UK authorities said they were open to a restructured deal. Broadcom’s purchase of VMware was cleared by the EU this week, but still faces regulatory hurdles in the UK, US and China.

If successful, the planned IPO of SoftBank-backed UK technology group Arm in September would also be a valuable sign for larger tech start-ups that the window for listing has opened.

Until then, especially in capital intensive sectors such as robotics and battery making, founders are rapidly depleting their cash runways and running out of options. Their positions have worsened as debt capital has become more expensive as interest rates have risen, and after Silicon Valley Bank, a crucial provider of loans to small start-ups, collapsed in March.

There have already been some notable start-up collapses.

In May, payments start-up Plastiq declared bankruptcy. The company had previously raised more than $200mn from investors including Khosla Ventures and Kleiner Perkins, most recently last year at a valuation close to $1bn, according to PitchBook.

Zume, a robot pizza delivery start-up that raised about $500mn from investors including SoftBank, shut down in June. 

Venture capital firms have cut spending in the past 12 months. They have invested just $80bn into start-ups this year so far, with that number largely reflecting a string of blockbuster generative AI deals. Last year venture investment totalled $246bn, down from $347bn in 2021, according to PitchBook.

After the collapse of SVB, high-profile investors including Y Combinator president Garry Tan predicted an “extinction level event” for US start-ups. There is early evidence that could already be under way.

“The percentage of our clients who are failing is double what it was 12 months ago,” said Healy Jones, vice-president at Kruze Consulting, an accountant to more than 800 venture-backed start-ups. So far only a small percentage of clients were effected, he added, but the increase was “flashing a dangerous sign on the health of the venture market.” 

Valuations of tech start-ups have begun to fall more closely in line with their publicly listed counterparts, according to venture capitalists. There have been a string of down rounds — in which companies are forced to raise capital at lower valuations — at late-stage start-ups, such as fintech firms Stripe and Klarna, and security group Snyk. The value of preferred equity in start-ups — shares typically held by venture investors — has plunged by a quarter since early 2022, according to research by Carta.

Founders and investors fear the crunch could ultimately be as brutal as the dotcom bust of the early 2000s, in which a bubble grown in the preceding years spectacularly burst, wiping out early internet start-ups and billions of dollars of investors’ cash.

“Startups are shutting down left and right, and you need to grow or cut your way to profitability now [because] you’re not raising funds anytime soon,” said Adam Jackson, a serial technology entrepreneur and investor based in California.

In this new environment, VCs are being selective about which companies they continue to support. “As much as we want to save someone’s life, if they’re falling and dying we simply don’t have enough capital,” said Masha Bucher, founder of early stage venture fund One Day Ventures. 

That has left founders with dwindling cash reserves with a choice between selling up or collapsing. “It’s like a cold shower for start-up founders,” said Bucher. “Public markets have hit the bottom, private markets still have some way to go.”