US start-up failures up by 60% as founders face hangover from boom years

Private company shutdowns have jumped compared to last year despite an AI funding frenzy, threatening millions of jobs at VC-backed firms. Photo / 123RF

Start-up failures in the US have jumped by 60% over the past year as founders run out of cash raised during the technology boom of 2021-22, threatening millions of jobs in venture-backed companies and risking spillover to the wider economy.

According to data from Carta, which provides services to private companies, start-up shutdowns are rising sharply, even as billions of dollars of venture capital gushes into artificial intelligence outfits.

Carta said 254 of its venture-backed clients had gone bust in the first quarter of this year. The rate of bankruptcies today is more than seven times higher than when Carta began tracking failures in 2019.

Last week, financial technology company Tally became the latest casualty. The 9-year-old provider of credit management tools was valued at US$855 million ($1.4 billion) in a 2022 funding round and had raised more than US$170m from big VCs including Andreessen Horowitz and Kleiner Perkins.

Tally founder Jason Brown said in a LinkedIn post the San Francisco-based company was “unable to secure the necessary funding to continue our operations”.

It adds to a list of high-profile company shutdowns in the past year. Those include live-streaming website Caffeine, which raised more than US$250m from investors including Fox Corp, Andreessen and Sanabil Investments, an arm of Saudi Arabia’s sovereign wealth fund; healthcare start-up Olive, last valued at US$4b in 2021; and trucking company Convoy, valued at US$3.8b in 2022.

Desk rental company WeWork, which had raised about US$16b in debt and equity from SoftBank and its Vision Fund, folded in November after going public in 2021.

The collapses are part of a painful adjustment for start-ups triggered by interest rate rises in 2022. VC investment into early stage companies has plummeted, while venture debt has diminished following the collapse of Silicon Valley Bank last year, leaving many start-ups stranded.

In the boom years, VCs would encourage founders to take larger and larger investments, inflating valuations, according to Healy Jones, vice-president at Kruze Consulting, an accountant to hundreds of venture-backed start-ups. It was a “crazy fundraising environment” in which “VC and founder incentives did not always align”, he said.

Founders are now facing the hangover. The jump in bankruptcies is due to the fact “an abnormally high number of companies raised an abnormally large amount of money during 2021-2022″, said analysts at Morgan Stanley in a recent note to clients.

VC-backed firms employ four million people in the US, Morgan Stanley said, creating “spillover risks to the rest of the economy” should the rise in bankruptcies fail to slow.

Peter Walker, head of insights at Carta, said there had been a “huge drop” in the number of companies able to raise money again within two years of their last funding round.

That is particularly galling for start-ups that have slashed costs to survive over the past two years, sacrificing growth in the process. “The advice shifted ... VCs [were] telling you to grow at all costs, then to be profitable tomorrow,” said Walker. “If you’ve curtailed your growth with cuts, then it’s maybe not a VC business.”

According to Jones, the Kruze clients that are successfully raising a second round of funding this year are increasing revenues at an average of 600% annually.

Even for strong companies, public listings have dried up and M&A activity has slowed. That has prevented VCs from returning capital to the institutional investors who back them - an essential precursor to future fundraising.

Only 9% of venture funds raised in 2021 have returned any capital to their ultimate investors, according to Carta. By comparison, a quarter of 2017 funds had returned capital by the same stage.

Both Jones and Walker said that funding activity was beginning to pick up after two fallow years.

Investment is overwhelmingly going to start-ups working on artificial intelligence. Kruze’s clients have raised US$2b in 2024, said Jones, and three-quarters of that has gone to AI start-ups, despite them representing less than a quarter of its total customers.

For those in less glamorous sectors, the outlook is more challenging. “There are only so many ‘venture-backable’ companies at any one time,” said Walker. “The amount of capital may have grown faster than the number of start-ups to absorb it.”

Written by: George Hammond.

© Financial Times