What the Fed Raising Interest Rates Means for Startup Fundraising?

In this video, you'll learn about the fed raising interest rates and what it means for startup fundraising.

00:00 Introduction
00:11 Fed raising interest rates
01:02 What happened in November, 2021
02:13 Imagine you're a money manager
03:38 Venture capitalists
06:14 Series B round
06:35 Conclusion

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Additional Resources

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It's instructive just to kind of think about, the startup ecosystem often works backwards, off of the public stock markets. And so, you know, venture capital often tracks what's happening in the NASDAQ and some of the other indexes, but usually like a 3 to 6 month lag. And so it's helpful to think like, "What's happening in stock market? How is that going to affect venture financing, especially if my company needs to raise money?" Now, the NASDAQ is down about 35% at the time we're recording, mid-June 2022, from the November peak, but the Bessemer cloud index which tracks SaaS companies, which is a better barometer of a lot of startups, is actually down like 60, 65%, so a huge amount.

Now what happened in November, 2021? Well, the market started seeing some pretty intense signs of inflation, and stock market investors are really smart and they worry about inflation all the time. And so what happened is, the investors started selling stocks because they thought, "You know what? This inflation is going to make the Federal Reserve have to start raising interest rates, and pretty aggressively." And so it's this really negative feedback cycle. Investors start selling. The stock market starts coming down. The Fed has to react to inflation and so they start raising interest rates, and so it kind of like, compounds.

Now it's worth mentioning, when rates are going down and there's no inflation, the same compounding benefits the stock market. Like, that's kind of what we experience when the COVID rally happened. Like, interest rates went way down. There wasn't really inflation at all. And so the stock market really, really popped up into those 2021 highs, right? So now, the market's retrenching because inflation has reared its ugly head. Now what does high interest rates mean for stocks? Well, it actually makes the competition for an investment dollar, much more intense.

Now imagine you're a money manager, and all of a sudden bonds are yielding 5% and it's... Bonds are safe. These are big publicly traded bonds and you don't have to do anything. You just have to own the bond and you get paid, right? Or you put your money in a CD and own a couple, and generate a couple interest percentages, right? So all of a sudden, the money that goes into risky stocks, and especially risky private stock, like venture capital backed startups, has more competition for the investment dollar.

Another way to think about this, is most tech companies and biotechs are not going to generate profits and cash flow and dividends for a very long time, like 5 to 10 years out. And so when interest rates go up, those cash flows that one will get someday, if things go well, are discounted back to the present value of today by a much higher interest rate. And so when you increase the denominator, the interest rate or the rate of return that you're going to discount those cash flows back on, all of a sudden, those cash flows are worth way less, right? A dollar today is worth more than a dollar 10 years ago, especially when interest rates are really high. And so what we've seen is, the market has reevaluated what valuations, tech stocks and private venture capital backed startups should be trading at.

Now, venture capitalists, they don't, they can't react quite as fast as the stock market. You know? The hedge fund people who are just lookin' at the numbers all day long, because venture capitalists are like, they have term sheets out, and they're in the middle of documentation and closing a deal. So it takes them a little while. This is that 3 to 6 month lag that I was talking about. And so, eventually, the VCs say, "Whoa, wait a second.