Losses Are Pushing Venture-backed Startups Over a Cliff and Driving Ipos Down the Drain

The precarious state of startup companies has become increasingly evident, with some hurtling towards a financial abyss while others linger in suspense, reminiscent of Wile E. Coyote suspended in mid-air before the inevitable plunge.

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In 2023, startup shutdowns surged to 770, up from 467 in the previous year. For those fortunate enough to secure funding in 2023, 20% experienced reductions in their valuations. Many observers recognized these companies as teetering on the edge, with the hope that they could remain suspended in mid-air until their issues resolved. However, the root problem for these struggling startups was not a lack of time but a deficiency in innovative ideas. Venture capitalists, pushing for relentless growth, inadvertently fueled the downfall by endorsing flawed "fake-it-til-you-make-it" business models.

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Now, venture capitalists find themselves in a worrisome position. Despite record fundraising in previous years, the dry powder is shrinking, and they can no longer sustain every struggling startup in mid-air. In 2023, VC fundraising plummeted to $161 billion, down from $307 billion in 2022 and $380 billion in 2021. Simultaneously, startup investments declined to $171 billion in 2023 from $242 billion in 2022 and $348 billion in 2021. The result: a 50% decrease in VC investments between 2021 and 2023, with raised funds falling short of the invested amount—an unsustainable scenario.

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Compounding the challenge, the IPO market has collapsed, and high-interest rates make fundraising more arduous, diminishing the potential value of eventual startup profits. VCs now face the daunting task of discerning which startups to rescue and which to release.

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Investors, having little to show for their contributions to VCs, are growing weary of paying 2% annual management fees to funds that have often overpromised and underdelivered. Approximately 90% of publicly traded unicorns, those startups valued at $1 billion before going public, are currently operating at a loss. Recent research from Morgan Stanley suggests an even higher figure for privately held startups.

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While success stories like Moderna, Zoom, Airbnb, and Uber exist, there is a plethora of failed ventures. Initial promises of ride-sharing revolutionizing parking lots, electric vertical take-off and landing (eVTOL) aircraft reshaping cities, and blockchain becoming the basis for information systems have largely fallen short.

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The latest trend under scrutiny is large language models (LLMs) like OpenAI’s ChatGPT, Alphabet’s Gemini, and Microsoft’s Copilot. Despite significant investments in these models, their primary successes thus far have been in generating disinformation and phishing scams.

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The fundamental challenge lies in the fact that LLMs lack understanding of the text they process, rendering them unable to assess the truth or accuracy of their responses. The consequence is a training process based on falsehoods, potentially driving out useful information in favor of LLM-generated untruths.

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Despite these challenges, numerous LLM startups persist in seeking funding with promises reminiscent of the "fake-it-til-you-make-it" approach. Investors, akin to Wile E. Coyote, seemingly fail to learn from past misadventures.

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The shutdown of 770 startups in 2023, a record number, represents only a fraction of the approximately 50,000 startups purportedly receiving VC funding in the past decade. The Financial Times notes a burgeoning secondary market for private shares, providing some relief, albeit with substantial discounts. However, the deeply discounted shares raise concerns, signaling a potential further decline. As employees seek exits, expressing worry about their startup's value, it prompts broader concerns about the fate of these ventures.

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