Eugene Zhang is a founding partner at TSVC, a U.S. venture capital firm focusing on seed-stage investing.
Years from now, historians may say that March 10, 2023, marked a pivotal day in the history of the global economy, when Silicon Valley Bank was forced to shut down amid one of the largest bank runs in U.S. history, a prelude to a global banking crisis. I think the world has entered a long and deep bust cycle, the magnitude of which will exceed the 2000 dot-com crash and 2008 financial crisis.
The sharp rise of interest rates over the past year has yet to be felt across many industries, but the first casualty happens to be Silicon Valley Bank (SVB), once the leading provider of financial services to startups. With the market downturn and the loss of venture capital funding, startups started to default on their loans. As a result, SVB’s balance sheet took a massive hit, sparking the bank’s downfall.
Then fear spread, two other U.S. banks failed, and a separate but equally concerning meltdown happened at Credit Suisse.
The only choice in front of us now is high inflation or recession, depending on how central banks deal with the fallout. Both options are unpleasant for startups, but unpleasantness is necessary.
We’re coming off a 13-year bull market fuelled by low interest rates and easy money. Many managers have known only good times. Private equity and the venture-capital sector have attracted too much capital, propping up unreasonable valuations for growth stage and “pre-IPO” financings – fuelling bloat, froth and bad business models.
The fallout from this is a much-needed wake-up call for the entire ecosystem, and a painful downturn is necessary for a healthy new reality to be built for startup founders and investors.
For too long, the startup ecosystem has been the darling of investors and entrepreneurs alike, with billions of dollars invested in the hope of discovering the next unicorn.
The past decade has seen an explosion in the number of startups and venture-capital funding. The focus was on growth at all costs, and many startups were burning cash without any clear path to profitability. Quibi, Jawbone, WeWork – the list of companies that raised $10-million, $100-million or $500-million before failing goes on and on.
Investors were chasing unicorns, and founders were living in a bubble. However, this unsustainable model is starting to unravel.
The message is clear: In order to succeed, startups must be market-focused, customer-centric and mindful of how they allocate their resources. Startups need to prioritize substance over style and focus on delivering a quality product or service that meets the needs of their customers. Ultimately, a company’s success is determined by its ability to deliver value to its customers and build a sustainable business model, not just by its name or perceived cachet.
Investors must also be more discerning in their investment choices and focus on startups with a clear path to profitability and sustainability.
Moreover, the pandemic has accelerated the adoption of new technologies and business models, and startups need to be at the forefront of this change. This means they need to be more agile and willing to pivot their business models as the market changes.
The venture capital-startup ecosystem needs to go through a severe correction to rebuild a more healthy system. The focus must shift from growth at all costs to profitability, sustainability, diversity and inclusivity, as well as embracing new technologies and business models. The pandemic has shown that the current system is unsustainable; it is time for a reset. The future of the startup ecosystem depends on how well it adapts to the changing realities of the market.
The bubble has burst, and reality has set in. Since no active investors today have experienced working in a high-interest-rate world, everyone needs to learn.