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Investors and start-ups face hard choices during rocky economic forecast

RACHEL MARTIN, HOST:

The market is down, especially for tech stocks. And that changes the calculations for the private equity investors known as venture capitalists. As Wailin Wong and Adrian Ma from the Indicator podcast explain, both investors and startups are facing hard choices.

ADRIAN MA, BYLINE: Before we get to the doom and gloom, let's revisit some of the high-flying times for tech. Nicole DeTommaso is a senior associate at Harlem Capital. It's a firm that specializes in early-stage funding for startups run by women and people of color.

NICOLE DETOMMASO: Valuations were through the roof. You know, people were getting 30 million valuations off of an idea. And we still wanted to be in with those great founders. You couldn't sit out because, otherwise, you just wouldn't be deploying.

WAILIN WONG, BYLINE: Deploying is, basically, spending money. It's what venture capitalists live to do because the sooner those funds go to work helping a company create the next bit of world-changing technology, the sooner they might see a return on that investment.

MA: And as it turns out, VCs have their own investors to answer to. Those investors are called limited partners - or LPs.

WONG: Limited partners are often wealthy individuals or institutions who spread their money around to lots of places, including VC funds. And one reason they're called limited partners is because they don't get involved in picking which startups to invest in.

MA: So to sum it up, startups get their money from venture capital firms, which get their money from limited partners. And so now it is time to follow that same flow of money that we talked about, and follow it in a down market. Nicole says the trouble started with that thing we're all living with now, high inflation.

DETOMMASO: Honestly, it probably started kicking off when inflation rose to 40-year highs. Interest rates hiked. Once those hiked, the equity markets dropped.

WONG: Stock markets tend to fall when interest rates go up. And publicly traded tech companies set the expectations for how much private tech companies should be worth. So as public valuations fall, so do private ones, which means a startup that was maybe once poised to be the next Uber or Shopify now just looks like too risky of a bet.

MA: So now you have startup valuations falling, meaning venture capital firms aren't getting the kind of returns on investment that they want.

WONG: And remember, venture capital firms are investing money they got from their limited partners - the people trusting them to make smart bets on startups. Now venture capital firms are returning less money to their LPs.

MA: Right. And when it comes time for venture capital firms to fundraise, their limited partners write smaller checks. And then the VC firms, they have less money to invest. And so they, in turn, write smaller checks to the startups.

WONG: Nicole says the advice she's been hearing is that in this market, startups should have 18 to 24 months of cash on hand because they can't count on being able to fundraise like they used to. For companies that don't have this cushion, it's time to start cutting costs.

DETOMMASO: Unfortunately, sometimes that means you do have to lay off people. But, I think, something that you have to consider as a founder is if you don't lay off certain people, the whole business might go under, right? And then you're laying off everyone.

WONG: Nicole says her venture capital firm is still actively investing in startups. And as the pace of deal-making slows down, she expects valuations to be based less on hype and more on a founder's ability to navigate the leaner times ahead.

MA: Adrian Ma.

WONG: Wailin Wong, NPR News.

(SOUNDBITE OF FRITZ KALKBRENNER'S "RIDE") Transcript provided by NPR, Copyright NPR.