Silicon Valley's reality: The party is over

Investors and entrepreneurs celebrated success at the ninth annual Crunchies Awards in San Francisco. But irrational exuberance was in short supply at the end of a day, when Zenefits, nominated in the fastest rising start-up category, announced an executive reorganization.

The Valley is in the midst of a correction, and that is a good thing, said insiders. It has become harder to raise money, terms like "cash-flow positive" and "sustainable growth" are coming into fashion, and venture capitalists are doing something they haven't done in years — they're saying "no."

"The party is over and we all have hangovers," said Menlo Ventures partner Venky Ganesan, incoming chairman of the National Venture Capital Association. "We have to take a couple of aspirin and ride through the pain."

The latest data from PitchBook show that VC investing in U.S. companies dipped to $9.3 billion in the first quarter of 2016, down from $17.6 billion in the fourth quarter. "There's significant uncertainty in the market right now and (we) would advise companies looking to raise capital to close quick and — while financing is available — maybe close on more capital than is necessary to be prudent in this environment," said PitchBook analyst Garrett Black.

At Tech Crunch's Crunchies awards Monday night, the best new start-up prize went to Honor, which is focused on tackling home care. That market is expected to reach $355 billion by 2020, according to a recent study by Grand View Research.

Silicon Valley
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"Money is a little bit tighter from investors and what that tends to do is it means that only the strongest start-ups are able to raise funding," said Honor CEO and co-founder Seth Sternberg.

Sternberg is a serial entrepreneur who sold his last venture to Google. "The best start-ups like Google — or hopefully Honor — tend to come out of periods like this when investors are looking for high quality companies that have real business models behind them. That's when you get amazing breakout companies."

It is very much a tale of two cities for entrepreneurs seeking to raise capital. For early stage companies looking to raise a seed or Series A round of funding, very little has changed. Investors are bullish on the long-term prospects for tech start-ups to disrupt the giants and change the world. "Life is normal at the early stage," said Ganesan. "But late stage people are very cautious."

With the IPO window slammed shut and the current turbulence in the public markets, raising tens of millions of dollars is a lot harder than even six months ago. "There's a little bit of skittishness about some of the things that have happened in the market just recently," said Josh Zaretsky, director of Altman Vilandrie & Co., a strategy consulting firm to big tech and telecom companies. "But overall we're still pretty confident and bullish about where things are headed."

For some start-ups unable to rein in costs or raise more capital, investors predict turbulent times. "Some of them are not going to make it and when they don't make it they will cause a lot more pain than normal," said Ganesan.

This sentiment has been echoed by many investors and entrepreneurs.

"The rubber is meeting the road and errors are much more consequential when the capital is tighter, because you can't raise your way out (of a) problem anymore," said Ash Rust, co-founder and CEO of SendHub. SendHub is a Menlo Ventures portfolio company that came out of Silicon Valley incubator Y Combinator and raised $10 million in Series B funding in 2015.

Rust noted that in addition to liquidity becoming harder to come by, investors are getting more concerned about liquidation preferences, which are showing up in more and more deals. Liquidation preferences protect those investors so that if a start-up sells or liquidates, they are guaranteed a certain amount of money back — often one times their investment — before anyone else. Many companies are opting instead to take on debt. Expect more of that, said Rust.

One company that does not seem to have had any issues attracting funding is Uber, which took home the award for best overall start-up for the second year in a row.

Software engineer James Mishra was at the Crunchies and, though he would not comment on specifics at the company, reflected on general advice he has received.

"A lot of my mentors have lived through the past two bubbles and they're not afraid of a third," said Mishra. Their advice to entrepreneurs in general? "Keep your burn rate low, put a lot of money in the bank, both as an individual or as a company, and don't panic," he said.

One benefit — for well-funded start-ups like Uber, as well as public tech giants with cash to burn — is that the hiring market has become less competitive. "It's a little bit easier to find interested engineers than a year ago, but it's still extremely competitive and it always will be," said Mishra.

Of course, when it comes to start-ups, picking winners has always been risky business.

Scanning through the list of past Crunchies winners and nominees reveals a slew of venture-backed fallen stars. They include controversial Theranos, which won best health start-up last year, HomeJoy which was nominated for best collaborative consumption service in 2014 and subsequently closed for business.

Noticeably missing this year from the CEO of the Year list of nominees was Marissa Mayer, who has made an appearance in that category every year since taking on the role at Yahoo. Facebook CEO Mark Zuckerberg took home that accolade for the third time.

CORRECTION: An earlier version of this story said Fab was defunct. It is not, having been sold to PCH in 2015.