Financial backers and firms are both caught in a ‘Wile E. Coyote’ dilemma “VCs now must decide which startups to save and which to let go.”

Startup companies increasingly are tumbling over a financial cliff, while others are hanging in mid-air like Wile E. Coyote before the inevitable fall.

Startup shutdowns hit 770 in 2023, up from 467 in 2022, and for those startups lucky enough to get funding in 2023, 20% had their valuations reduced. Most observers knew these companies were past the cliff edge, although many hoped that they could stay suspended in mid-air until their problems went away. 

These troubled startups didn’t need more time, they needed better ideas. Venture capitalists had pressured them to grow and grow some more, but growth can’t be sustained if the underlying fake-it-til-you-make-it business model is flawed.

Now VCs are worried. They have some dry powder because their fundraising set records a few years ago and many were smart enough to sometimes say no to the most fanciful startups. Unfortunately, they didn’t say no often enough and, with fundraising shriveling, they can’t keep every floundering startup in mid-air even if they wanted.

VCs raised just $161 billion in 2023, down from $307 billion in 2022 and $380 billion in 2021. At the same time, their startup investments fell to $171 billion in 2023 from $242 billion in 2022 and $348 billion in 2021. In other words, VC investments fell by half between 2021 and 2023 and still they raised less money than they invested—which is clearly not sustainable. 

Even worse, the IPO market has collapsed and interest rates are still high, which makes fundraising more challenging and reduces the value of any profits that startups might eventually realize. The bottom line is that VCs now must decide which startups to save and which to let go.

“VCs, like the startups they invested in, have overpromised and underdelivered. ”

Investors are also concerned about the money they’ve given VCs with little to show for it and they are tired of paying 2% annual management fees to VCs that, like the startups they invested in, have overpromised and underdelivered. 

Most everything that VCs have invested in is now junk. About 90% of publicly traded unicorns — startups valued at $1 billion before going public — are losing money. Morgan Stanley researchers recently concluded that this figure is even higher for privately held startups.

While there have been a few successes such as Moderna MRNA, +0.15%, Zoom ZM, -1.34%, Airbnb ABNB, -0.59%, and Uber Technologies UBER, +0.48%, there are far more shiny baubles that have broken: ride-sharing was supposed to eliminate parking lots; electric vertical take-off and landing (eVTOL) aircraft were supposed to reshape our cities,  blockchain was supposed to become the basis for our information systems.

‘How many bears have the Russians sent into space?’ The latest bauble is large language models (LLMs) such as OpenAI’s ChatGPT, Alphabet’s Gemini GOOG, -2.56%, and Microsoft’s Copilot MSFT, -0.01%. Enormous amounts of energy and brainpower have been devoted to these undertakings but, so far, their main successes have been in generating disinformation and phishing scams.