Falling Valuations: Poison for Venture Capital
Here's more proof that Silicon Valley's financing ecosystem is under assault: the value of the start-ups they are investing in just keeps dropping. — In a quarterly study of venture financings published Friday, Fenwick & West …
Context & Ripple Effects
This lands four months after TechCrunch's April report that venture funding was down 50% and not just because of the recession — Fenwick & West's quarterly financing study now supplies the pricing half of that picture: it isn't only that less money is going in, it's that each dollar buys more equity because start-up values keep dropping.
The firm's survey matters because Fenwick & West sits inside the deal flow itself, tracking term sheets rather than sentiment, so the decline is documented at the round level. It also feeds a running argument dating back to at least 2006 that scarcity of risk capital and technology understanding — the scarcities the traditional venture model priced against — have been eroding since 1995, making this downturn a stress test of the model rather than a routine cycle.
First-order effects
- Founders raising their next round in late 2009 face down-round economics — more dilution per dollar — while existing investors' marks fall with every new financing the study records.
- VCs holding those marked-down portfolios must decide between writing follow-on checks to defend ownership or letting weaker companies run out of runway.
Second-order effects
- With valuations low, new money can buy in cheaply, shifting negotiating leverage from founders to investors and pushing firms toward insider-led bridge rounds rather than fresh outside leads.
- A widening spread opens up between companies that can still raise and those that cannot, accelerating consolidation as acquirers find distressed targets cheaper than building.
Third-order effects
- If the pattern holds, the shakeout points toward a smaller set of venture firms concentrated on fewer, larger bets — consistent with the argument that the classic broad-based seed model has been structurally strained since the mid-1990s.
- Sustained markdowns also reset exit expectations for everyone downstream: IPO windows and acquisition prices get renegotiated around a lower clearing level for private company value.
The trend: Venture is moving through a cyclical repricing that doubles as a structural test of whether the traditional venture capital model, built on scarce risk capital, still fits an ecosystem where neither is scarce anymore.