FT writes – Venture capital starts to tune out of on-demand services

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Venture capital starts to tune out of on-demand services

As questions mount over Silicon Valley’s sky-high valuations, start-ups face a time of reckoning

One of the hottest areas of venture capital investing has had a cool start to the year: on-demand start-ups, ranging from food delivery to valet apps, face a moment of reckoning.

As questions mount over Silicon Valley’s sky-high valuations, many of the companies that have been hit hardest are those that provide consumer services through an app. Some have had to cut valuation targets, while others have radically reoriented their business, pulled back from unprofitable markets or cut staff.

Such shifts follows a period in which a glut of venture funding flooded the on-demand space, subsidising business models that have not always proved to be sustainable. More than $6.5bn was invested in on-demand start-ups last year, according to venture capital database CB Insights, which is 10 times the level of 2013. (These figures exclude big fundraising rounds from Uber, Lyft, Airbnb and Didi Kuaidi). However, investment levels started dropping in the fourth quarter, and sentiment has changed markedly.

Many point to Uber as the company that kicked off the on-demand craze. As the ride-hailing app saw its popularity rise, investors started looking for companies that had similar business models.

“Every VC has gotten the drug that is Uber, it is like the heroin of VC,” says Marcela Sapone, co-founder and chief executive of Hello Alfred, a personal concierge service that aggregates on-demand services. “People are starting to realise that most on-demand companies are not going to be like Uber, but they are still valuable businesses.”

Ms Sapone and others point to a dramatic shift in the venture community’s appetite for investing in the sector. “Now it’s close to impossible to get venture funding” for some on-demand companies, she says.

Chart: US investment in on-demand apps, deal value

“What we’ve just gone through is a typical boom-bust cycle,” says Scott Stanford, co-founder and managing partner at Sherpa Ventures, a San Francisco-based venture capital firm. He pointed to the big asset management groups that were making high-profile start-up investments but are now much less active. “It’s back to traditional growth investors,” he says.

“As soon as we see this tide going out, we work with our CEOs” on how they can get closer to being cash flow positive, he adds. “Even if you have 20 months of runway, you might need three years of runway.”

Every VC has gotten the drug that is Uber, it is like the heroin of VC

Marcela Sapone, co-founder and chief executive of Hello Alfred

Faced with this environment, some companies are starting to shift their business models. Many on-demand companies initially focused on rapid growth, on the grounds that achieving scale would help them lower costs and become profitable. However, as companies matured, their long-term costs often turned out to be higher than expected.

Many businesses that grew rapidly by subsidising costs with plentiful venture capital are having to readjust. Shyp, an on-demand postal company that has raised $60m, announced it was shutting down its Miami operations. Good Eggs, an organic grocery delivery company that has raised $50m, closed down all its markets outside the San Francisco Bay Area. Zirx, a valet service that has raised about $40m, terminated its consumer business to focus only on enterprise clients.

Investors say that the glut of funding that flooded the sector is one reason why so many of these businesses are struggling. It is a phenomenon known as “venture fratricide”: when companies in the same area receive venture funding and then end up burning cash on deep discounts, without developing a sustainable business model.

Still, other on-demand companies that have not readjusted are going ahead with fundraising efforts. One litmus test for the sector will be the upcoming fundraising efforts of Postmates, one of the earliest food delivery apps in the US. Bastian Lehmann, chief executive, says the company is planning to raise money this quarter. “It is probably going to be really difficult,” he admits. “But it was really difficult right from the start. Fundraising has never been easy.”

Postmates has raised about $140m from investors already, and was valued at more than $400m in its most recent funding round.

DoorDash, a close competitor, has struggled to raise money in recent months, and had to cut its desired valuation level due to weak investor demand.

The company has raised $60m in previous investment rounds and is aiming to raise $100m in its current round, which has not closed yet. The company’s valuation is expected to remain similar to the $600m tag it had last year.

Chart: US investment in on-demand apps, number of deals

“As these companies need to go back to private investors for more growth capital, we will start to see either more flat rounds, or possibly some consolidation,” says Matt Wong, a researcher at CB Insights. “It is definitely a critical time for these companies, and it is precarious that the market has turned at this time.”

As for investors, there have been few signs so far that the funds that have been most active in the on-demand sector have been affected — and many are raising fresh funds from limited partners. Index Ventures, the most active in on-demand deals outside the US, recently raised a further $1.3bn.

Despite this success, however, partner Danny Rimer acknowledges that markets are “jittery”. “Everyone in the tech sector had assumed this could not last for ever, that these valuations were getting completely out of whack and were not justified,” he says. “There had to be some rationalisation.”

Many of the most active on-demand investors in the US are groups that focus on seed-stage investments, such as SV Angel or Slow Ventures.

Mr Rimer says Index Ventures makes a lot of small, seed-stage investments in on-demand companies, and some of these have been doing well. “Deliveroo is probably the fastest-growing company we’ve had in our portfolio to date,” he says, referring to the London food delivery group.



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