From: allin
The current startup ecosystem is experiencing significant turmoil, characterized by exaggerated valuations, a lack of due diligence, and the emergence of “zombicorns.” This period reveals fundamental issues within venture capital and startup funding, mirroring past market bubbles despite the current frenzy around AI [01:10:40].
High-Profile Failures and Turmoil
IRL
Social messaging startup IRL is shutting down following a board investigation that revealed 95% of its claimed 20 million users were fake [01:09:41]. In June 2021, IRL raised a 1 billion, making it a proclaimed Silicon Valley unicorn, primarily funded by SoftBank’s Vision Fund [01:09:51]. An investor on the board noted that SoftBank provided an investment term sheet to IRL faster than they had for any other startup [01:10:04].
Byju’s
Byju’s, an Indian educational technology company once valued at 1 billion in capital to stay afloat [01:10:25]. One investor significantly marked down the company’s valuation by 75% to $5.1 billion [01:10:34].
Underlying Issues in Venture Capital
These failures highlight systemic problems within the venture capital industry, which are not new [01:10:53]. Similar patterns have been observed in past hype cycles, including crypto, co-working, synthetic biology, and SaaS [01:10:53].
Inexperienced Investors
A core issue is the influx of deeply inexperienced individuals in crucial roles [01:11:21]. Many venture capitalists, often former mid-level VPs from startups, are unprepared for the responsibilities of capital allocation. They may lack the fundamental skills to ask basic questions or the courage to confront founders [01:11:32]. This phenomenon emerged as venture capital firms raised increasingly larger funds, leading to a focus on checking boxes rather than rigorous evaluation [01:11:48].
Lack of Due Diligence
The absence of proper checks and balances is a significant concern [01:11:21]. In some instances, companies seeking financing would provide only a Google Doc spreadsheet instead of a comprehensive data room with operational and financial metrics [01:12:10]. Boards, comprised of inexperienced individuals, fail to hold these companies accountable [01:12:43]. Diligence should involve verifying data and speaking to customers from lists generated independently, not just those provided by the company [01:18:41]. During hot markets, founders often exploited the situation to avoid participating in due diligence processes [01:15:52].
Fund Size Dynamics
The size of venture funds plays a critical role in these issues. With funds in the hundreds of billions, as SoftBank’s Vision Fund, writing 200 million or more, into companies that are effectively at the seed or Series A stage [01:18:10]. This leads to outsized mistakes [01:18:17].
The optimal fund size for venture capital is generally considered to be between 600 million [01:20:24]. As input costs for startups (e.g., engineers, hardware) decrease due to advancements like AI, greater outcomes should theoretically be generated with fewer dollars, suggesting that fund sizes should ideally decrease, not increase [01:20:36]. However, the incentive structure—an annual management fee based on fund size—drives firms to raise larger funds [01:20:52]. This focus on fees over profits means outcomes and diligence become secondary [01:21:41].
Market Reset and “Zombicorns”
The current market is undergoing a significant reset [01:22:08]. Fundraising for late-stage funds has “cratered” [01:22:17]. For example, Insight Partners reportedly aimed to raise a 10 billion, and has only managed to raise 12 billion, cut to 2 billion [01:22:31]. This represents an 80-90% reduction in fund sizes [01:22:39].
Many “zombicorns” – companies with unicorn valuations but unsustainable business models – are predicted to fail [01:23:07]. Estimates suggest 30-40% could be zombicorns [01:23:11], with some projections as high as 700 out of 1400 total unicorns [01:23:16]. It’s predicted that 60% of these will go to zero [01:23:29]. This period of cleanup will take years, as historical instances of fraud have shown [01:17:00]. The market is sending a clear message: the era of inflated valuations for companies lacking real-world economic viability and high gross margins is ending [01:16:34].