The China-led global markets meltdown has triggered a wave of panic in Silicon Valley. The question on everyone’s minds: Will that fear persist in the tech funding market?
Founders and investors I spoke with think the answer is yes. They said that even before the stock market began tanking, investor sentiment had started swinging toward conservatism. Regardless of what happens with the stock market, a tech market correction is under way, these people say.
“Silicon Valley has two modes: Fear and greed,” said Keith Rabois, an investor at Khosla Ventures and former executive of PayPal and Square. “We’ve been in greed mode for a long time and now we’re moving back toward fear.” He pointed out that 2008 was the last time tech faced a downturn and even then, it was short-lived.
But this time, it’s different. Nobody could point to a single trigger, but they mentioned the lack of exits for investors in the form of acquisitions or IPOs, bloated valuations for companies, the slow downward trend of the stock market and the shutdown of Homejoy and fundraising struggles of Quirky, both of which were backed by prominent, respected venture investors. These factors have collectively contributed to the gloom that has swept across tech financing.
Companies that have been fundraising recently told me that Uber investor Bill Gurley’s warning about investors prioritizing profit isn’t just a prediction — it’s already happening. “In the last few months there’s clearly been a stronger interest in unit economics and how you would transition your spending in a downturn,” said one founder whose startup raised north of $100 million before its recent fundraising endeavor.
The difficulties that hit Homejoy and Quirky “got people thinking ‘If I make the investment, who is going to invest after me?’” said seed investor Semil Shah, who runs his own fund called Haystack.
Venture capital investing is a game of psychology. Especially in the early stages of a company, investments are frequently made on gut instinct or belief in the ability of a founder, not necessarily on revenue or hard business results. One investor blamed a “spider sense” for why the mood has darkened as of late.
“Investors socialize with each other,” said Shah. “Fear and excitement can spread through the ranks quickly.”
The sentiment is unlikely to improve, said investors and founders I spoke with, even after the public markets stabilize.
Josh Elman, a partner at the investment firm Greylock, who serves on the boards of Meerkat and Medium, says that although his pace of investing hasn’t slowed, he is encouraging founders to think through their models even more so than in earlier eras. “Nothing is more important for companies, especially in this time of uncertainty, to understanding the keys to sustainability of the business instead of assuming there is always a new big up round around the corner,” he said.
Three investors, including Elman, made the point that the companies with strong growth metrics will continue to be chased by venture dollars. However, everyone else might face tougher term negotiations, especially over their valuation.
“There has become a huge discrepancy between public valuation and private valuations,” said Alfred Lin from investment firm Sequoia, who sits on Airbnb’s board.
Others agree. One venture capitalist told me the intensity of the public market correction gives investors an “excuse” to apply more scrutiny to valuations without losing out on a deal. Some believe that private market valuations will start shrinking as a result.
There’s also a good chance we’ll bid farewell to “tourist” investors like the mutual and hedge funds and founders who were attracted by the frothy nature of the market. When the going gets tough, only the committed will stick around, investors said.
“A market downturn might be the best time to start a company,” said Lin. “After all the tourists leave, you have the real founders, the real employees, the real investors that want to play this game for the long run.”
This article originally appeared on Recode.net.