What venture capital layoffs mean for the startup economy

Silicon Valley was thrown off balance this year thanks to the ongoing rise in interest rates and a particularly unpredictable stock market. It’s led to a rare event in the startup economy: layoffs at venture capital firms.

In the past few weeks, two of the biggest names in VC — Sequoia Capital and Y Combinator — parted ways with a number of their staff and investors.

These kinds of layoffs were once unthinkable, according to Sarah McBride, a reporter at Bloomberg News.

In a conversation with Marketplace’s Lily Jamali, McBride said the outlook for startups and their investors has been bleak for a while and the latest layoffs are part of a bigger trend.

The following is an edited transcript of their conversation.

Sarah McBride: It’s just a reckoning right now. People had been so brash and optimistic. A lot of people who came into the ecosystem 10 years ago had known only success. They saw so many companies having these incredible and successful trajectories where in three to five years, a lot of them were selling for hundreds of millions of dollars or listing on stock markets. We had more unicorns than ever before — that’s a [privately owned startup] company worth $1 billion or more. Every year, the number of unicorns grew astronomically. Now, what people are watching is how many companies that had once been valued at $1 billion are now cutting their valuations to way less than that. People just aren’t walking around with the same swagger they used to have, and a lot of people are losing confidence and realizing that things don’t always go up and to the right.

Lily Jamali: What is the reason behind that? We talk about this hockey stick graph of growth, but what’s behind the turnaround?

McBride: There are a few things. Everyone was expecting the economy to go into a freefall during the beginning of the pandemic, and that didn’t really happen. There was a lot of stimulus and things were actually surprisingly good. Now we’re in a situation where interest rates are rising, the stock market is up and down and there is very little M&A, which is mergers and acquisitions. That’s the way most startups get acquired by a bigger company. Even though the stock market has somewhat recovered, it’s still very hard to do an initial public offering.  So now these venture capitalists are thinking, we invested all this money in these startups. When are we going to see a return on this money? These returns usually do take some time, usually about seven to 10 years. But this is a little bit difficult, even if you’re taking a long-term time horizon.

Jamali: Let’s dig into the details a little bit. You reported that the startup accelerator Y Combinator cut 17 people and Sequoia Capital, a prominent venture capital firm, laid off seven staffers in its talent operation unit. On their face, those numbers don’t sound like a lot, but is it a lot?

McBride: It’s more noteworthy that they did layoffs at all. Venture capital is just kind of a clubby world. And if it’s time to reduce staff, it’s usually done very quietly. Sequoia does urge people to move along. It’s a top firm and if you’re an investor, and you really haven’t had any hits, they will urge you to move along. But it’s more that you won’t be a partner on the next fund and there’ll be some sort of graceful exit found for you. Maybe you’ll start a startup, and Sequoia will invest with it.

With this, it’s the sheer number of people at one time, even though Sequoia says it didn’t all happen at once and it was over a few months, that is still a lot of people, especially on the investing side. And we don’t know exactly what some of them are going to be doing, which is another tell.

Now other firms have quietly been making similar cuts, but when Sequoia does it and word leaks out, it’s kind of the seal of approval for other venture capital firms. People really look to them for what to do. They have an outsize role here.

Jamali: You’ve noted that early in the pandemic, venture capitalists were telling their startups to start tightening their belts and prepare to do layoffs. Has that idea come full circle?

McBride: That’s right. Before they’d been telling startups to focus on growth and not worry about profits. Then it was “Wait a minute. Time to worry about profits, please cut the fat.” But, the VCs themselves weren’t worrying about cutting the fat within their firms. This year that changed, and a lot of VCs, because they’re not getting the same management fees and they have a little bit less cash to play with, finally those VCs are also cutting the fat themselves.

Jamali: Is there a bright spot in artificial intelligence? Is that an exception to this trend?

McBride: That is the big exception. The companies that are doing well and can raise a lot of money at high valuations are artificial intelligence companies. And it’s been an incredible bright spot. They’re hiring, their valuations are going up and VCs can’t invest fast enough. So that is one area where people feel very optimistic.

More on this

Sarah McBride mentioned that artificial intelligence startups are a bright spot in an industry that is otherwise looking a little grim. As PitchBook put it in May, in the world of startup valuations, there’s generative AI, and then there’s everything else.

According to that PitchBook article, “Compared to 2022, median pre-money valuations for early-stage rounds of generative AI companies have jumped by 16% so far this year,” while “prices for all other startups raising a Series A or Series B have dropped by nearly 24%.”

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