As interest rates rise, startups and VCs are playing a new game

The era of free money is over as the United States Federal Reserve raised a key interest rate benchmark this week.

The sun is always shining on effectively zero-cost money. As a result of low rates, the attractiveness of investing in bonds and other safer, if lower-yielding, assets was reduced, meaning investors around the world were looking for a place to park funds and have a shot at material incomes.

Tech startups received a larger shot in the arm during the period. Low rates lead to capital flowing into more exotic investments, like venture capital funds. The funds grew in size and number. There was a burst of funds for startups after that influx of cash to investors.

Competitions for deal access led to the creation of more capital pools with more funds, putting the founder in the driver's seat when it came to valuations and terms. The value of public tech companies was boosted by the COVID-19 Pandemic and many other concerns took a hit due to travel restrictions and other economic changes.

There was a wave of funding events that stretched valuation multiples to the moon due to the influx of funds into tech companies public and private.

The rubber band is snapping back. As interest rates rise, available funding to venture capitalists decreases and the scene is left to lick its wounds. Other investments think bonds are more lucrative than they were.

The tech trade has faded, leaving public comps for startups far from their peak valuations. This creates a uniquely shit moment in which startups are fighting a capital shortage at the same time that investors are becoming more conservative and exits are constrained due to depressed public-market prices.

It is a mess for startup that have only known summer. The winter is not here.

The venture reaction

When commentary on the changing climate was scarce earlier in the year, venture capitalists are now talking about it publicly. The commentary is now strident and regular, whether it is due to more near-term pain in the market or VCs simply finding their voice.