The pandemic led to an explosion in tech startups receiving ridiculous amounts of funding despite never being profitable, creating a bubble of highly valued yet unsustainable companies. This was a result of years of investor FOMO as big tech companies like Amazon and Google normalized burning cash while achieving wild growth and success. However, easy money can’t last forever and the bubble appears to have finally burst in 2022. With rising interest rates and a crumbling economy, VC funding has fallen off a cliff, leaving most of these unprofitable startups scrambling.
The Rise of Growth Investing Over Profits
In the past, tech startups typically aimed to build superior products that could command premium pricing, allowing them to become profitable fairly quickly after launch. Companies like Intel, Apple, Microsoft, and even Google reached profitability within a few years of being founded by selling great products.
But in the 1990s, Jeff Bezos and Amazon popularized a new perspective of focusing ruthlessly on growth and gaining market share above all else. Bezos wanted to compete mainly on low prices instead of premium quality. The resulting race to the bottom with competitors like pets.com led many e-commerce startups to go bust when capital dried up after the dot-com crash, as their economics did not work.
Big Tech Fueling the Growth Obsession
In the 2000s and 2010s, the continued success of Amazon and the rise of companies like Google and Facebook normalized unprofitable growth. Google especially built consumer internet products like Gmail, Maps, and YouTube that lost money or had no direct monetization. They funded it with search and advertising.
Facebook took it further, acquiring Instagram and WhatsApp for billions while they had little revenue. At the time, these seemed like outrageous purchases but they proved to be brilliant growth plays. Their strategies centered on reach and engagement over profitability.
Seeing their fantastic success, investors became more accepting of short-term losses balanced out by long-term growth.
Pandemic Accelerates the Mania
But things went into overdrive during the pandemic. With people stuck at home, big tech and startups saw hypergrowth in users and revenue. This led to a fear of missing out, with VCs dumping unprecedented amounts of money into any startup they could find, bidding up valuations like crazy.
The number of new “unicorns” (startups worth over $1 billion) exploded to over 200 per quarter in 2021. Funding multiplied 10x between 2011 and 2021. Investors were determined not to miss the next big wave.
Most of these startups were operating with huge losses offset by hockey stick user projections, just like the original dot-com bubble. Customer acquisition costs vastly outpaced revenue. The business models were not sustainable without endless cheap capital.
The Inevitable Crash
But in 2022, the stock market crashed and economic instability grew. Interest rates rose while VC funding plunged 53% year-over-year in Q1 2023. Without new capital, most of the bubble startups began hemorrhaging cash.
Dozens already declared bankruptcy in 2023. Major companies like Uber and Lyft scrambled to implement layoffs and cost cutting to stave off collapse. But achieving profitability proved much harder than they anticipated.
The startups that survive the next year or two will likely see their valuations decimated as they are acquired or go public. Of the current crop of unicorns, less than half will make it through this purge intact. The easy money party is over.
Looking Ahead
For most startups, their stock will follow the stereotypical bubble pattern: rocketing up during the mania then crashing down for good as funding disappears. But a small number will prove to be the next generation’s Amazon or Google, defying the odds to reach new heights. Though the music stopped on easy VC money, those built on strong fundamentals can still thrive.