The last time the Federal Reserve’s benchmark interest rate was much above zero Silicon Valley was a very different place. Facebook was still battling with MySpace, Twitter had raised less than $25 million and Uber and Snapchat hadn’t even been created.
Facebook is now one of the most valuable companies in the world (MySpace is an afterthought), Twitter is publicly traded and Uber and Snapchat headline a long list of Internet and mobile start-ups that have achieved multibillion-dollar valuations thanks in large part to access to cheap capital.
Seven years of record low borrowing costs have driven investors across the globe to seek yield. Mobile and Internet start-ups have been a popular place to park some of that cash, leading dozens of emerging companies to raise sums of cash that would have been inconceivable in prior cycles.
Starting now, money is getting more expensive.
The Fed is expected on Wednesday to announce a quarter-point increase to the federal-funds rate, the first hike since 2006. Fed Chair Janet Yellen said last month that a normalized interest rate policy is on the way, assuming continued economic expansion and job market improvement.
For start-ups, this comes at a time when valuations are at least starting to rationalize because of public market volatility and concerns that earlier high-priced rounds are resulting in losses.
It all likely adds up to greater financial discipline for those companies that can reel in their expenditures and challenging times ahead for those that can’t.
The good news is that venture capitalists have had plenty of time to prepare their portfolio companies for this reality. Back in March, the Fed axed the word “patient” from its rate hike plans, signaling that market participants need to get ready. At the time, economists predicted rates would already be on the rise by now.
Investors have had time to price interest rate risk into their funding rounds. But for companies that have lived solely in a world of cheap money, risk remains in the unknown.