KLARNA IS THE CANARY IN THE COAL MINE

Swedish fintech unicorn Klarna is one of a few companies in the emerging ‘buy now, pay later’ market. According to Crunchbase, Klarna has raised a total funding amount of $4.5 billion from a slew of investors but has recently experienced a precipitous drop in its valuation…

Following a $639 million funding round in June 2021 led by the Softbank Vision Fund, Klarna achieved an eye-watering valuation of $45.5 billion. Impressive.

Fast forward a year later to July 2022 and Klarna closed a new $800 million investment round from the likes of Sequoia Capital and Silver Lake. What was not so impressive was that Klarna saw an 85% fall in its valuation to $6.7 billion amid inflation challenges, higher interest rates and big-name competition. Ouch.

With the era of low-cost capital coming to an end, Sebastian Siemiatkowski who is the CEO of Klarna said “With the recent shift in investor sentiment, we also now shift our focus and look forward to returning to a modus operandi of growth and profitability”. While it is refreshing to see a business return to the fundamentals, Klarna really is the proverbial canary in the coal mine for the investment industry.

In this article, the team at Déjà Partners explores why Klarna is the precursor to an enormous valuation reset in the venture capital industry and the implications for early-stage funding…

What is different between Klarna and large number of venture capital backed companies is that Klarna needed funding now and hence, the severe valuation reset that reflects a future with higher cost of capital. There will be many more companies in the coming months and years looking for follow-on funding that will have their day of reckoning and it won’t be pretty. And sadly, there will be many early-stage companies perhaps seeking a first round of institutional funding that will suffer unduly because of the near decade-long funding binge.

So how big is the hangover going to be? This graph from the Financial Times and Venture Monitor reveals just how big it is going to be:

Focusing solely on the US venture market, the latest investment frenzy has far surpassed the dot-com era of the late 1990s, when annual investment reached $100 billion in the US. Last year, American tech companies raised a staggering $330 billion, more than double the amount of the previous year.

There is also a fundamental difference between now and the 1990s. The Internet was relatively new in the 1990s and the resulting widespread adoption of the internet, funded by the capital markets, was to have a profound impact on businesses and consumers alike; think Amazon, Google and Facebook.

However, while technology continues to evolve and innovation is everywhere, the extreme valuations seen in recent years is more about cheap money chasing returns versus the venture industry supporting innovation. A case in point is Klarna whose product is not a fundamental innovation but essentially a repackaging of the ‘hire purchase’ model from yesteryear.

With such a huge wave of low-cost capital over the last decade, and an influx of new players into the venture ecosystem, many venture capital firms will admit that their market became dysfunctional with compressed due diligence, extremely risky investments, and an appetite for deals at almost any price.

FOMO is an acronym that stands for “fear of missing out.” It’s the feeling of anxiety or insecurity that comes from thinking you might miss out on something important, exciting, or valuable. FOMO can be a powerful motivator, driving us to take actions we might not otherwise take. And this is exactly the motivator that has brought the venture capital industry into an extreme valuation reset territory.

For many venture investors, it is not all doom and gloom. Yes, there will be behaviour change after the intoxicating years of free money but the current circumstances will bring forward a necessary reset after which deals will be priced at reasonable valuations, startups with financial discipline and innovative products will get funding, and the recent financial entrants and speculators will be wiped out.

So where do we go from here?

The team at Déjà Partners believe that for most tech startups, the world just got a whole lot more challenging.

Many venture funds, especially funds raised recently, will have large amounts of cash in which to sustain credible companies in their portfolio, meaning companies with proven business models that are not adversely impacted by a slowing economy. For those portfolio companies who have no immediate funding requirement, there will be a pivot from growth at any cost to sustainable and profitable operations. However, there will still be uncertainty come the next funding round.

For early-stage companies however, the fundraising process will likely be a long and difficult one and we believe that it’s only going to get harder in the current market. For early stage companies considering a Seed or Series A Funding, Déjà Partners is advising leadership teams to start assessing their business situation now and take the necessary actions to extend their cash runway as fundraising will take longer.

With constrained capital supply, there will be fewer companies that are able to secure funding. This is particularly true for companies that are not well-established or that are working in new or niche markets.

However, Déjà Partners does see some opportunity for companies that are able to offer a unique solution or that have a strong team in place. So, while the current market conditions may be challenging, there is still reason to believe that early-stage companies can successfully fundraise.

At Déjà Partners, our team has a proven track record of success in both good times and bad, and we are confident that we can help you weather this storm and come out the other side stronger than ever.

Thank you for reading and we hope you found it useful.

Contact us today to learn more about how we can help you achieve fundraising success in this increasingly challenging environment.

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