AlayaCare had some promising acquisition candidates lined up at the start of 2022, including one worth about $10-million that Adrian Schauer, chief executive officer of the Montreal tech startup, had already budgeted for.
Then, one of Canada’s fastest-growing startups had a rude awakening.
By the time summer hit, the leadership team of the home-care software provider realized its lagging growth rate – 80 per cent of target – wasn’t just a blip, after the third quarterly miss in a row. The pipeline for new business had slowed, and AlayaCare, whose platform manages the work of home-care staff, found its customer companies were struggling to hire and retain workers.
So AlayaCare’s board came to a consensus. They had to stop burning so much cash. They halted the deal-making, then had to make a second call: Should they cut staff, too?
“You don’t want to be the first one doing it,” Mr. Schauer says.
All kinds of Canadian companies, including fintech financier CFT Clear Finance Technology Corp. (Clearco), investment firm Wealthsimple Technologies Inc., social-media management platform Hootsuite Inc. and e-commerce provider Shopify Inc. SHOP-T had already laid off swaths of staff by mid-August.
AlayaCare, which had raised $225-million from investors including Al Gore’s Generation Investment Management just a year earlier, followed suit, reducing headcount to where it was four or five months earlier. It laid off 80 staff in mid-August – a 13.6-per-cent cut.
“I feel for every one of those people who no longer work at AlayaCare,” Mr. Schauer says. But, he adds, “This was good stewardship of our business.”
Faced with such sudden shifts, tech companies have cut deeply. More than 81,000 people have been laid off from the sector worldwide so far this year, including thousands in Canada, and further cutbacks are likely.
The grim outlook was very much on the minds of attendees at this week’s Elevate technology conference in Toronto. “I don’t think we have hit close to the bottom yet,” said Michele Romanow, a star of TV’s Dragons’ Den and CEO of Clearco, which pulled out of the European market this summer in addition to laying off staff. “I think tech has seen the first kind of bump in this road and it could get a whole lot worse.”
For years, tech companies pounced on opportunities to harness the widespread disruption brought on by smartphones, cloud computing, artificial intelligence and other innovations. They enjoyed near-perfect market conditions to nurture their growth, as interest rates stayed low and risk-taking proliferated.
Venture capitalists, private-equity players and pension funds eagerly handed over billions of dollars in financing to countless young companies on the promise of big long-term returns. The COVID-19 pandemic provided a windfall, as the world turned to e-commerce and all manner of digital life.
But the pandemic boost proved to be the final hurrah of a years-long party, and the hangover is forcing painful changes. Instead of chasing capital and rapid growth at all costs, many businesses are now getting lean and focused, hoping to achieve something sorely lacking in boom times: profits.
“When capital was so cheap, you wouldn’t have to think that way, because money was just thrown at you,” says Barbara Dirks, partner at Framework Venture Partners and a long-time banking executive, including at startup debt provider Silicon Valley Bank.
If AlayaCare’s Mr. Schauer had a do-over, “I would have maybe slowed hiring earlier,” he says. But, he adds, “We have the team that we need to win, and we’re a lean, mean machine, with everything we need to execute our vision” and a runway that extends years out, he says. “So I don’t regret delivering the business to that state.”
Now, AlayaCare is at the forefront of the sector’s shift to bottom-line results. “I think we will be more focused on building an efficient growth company, with more focus on achieving profitability,” Mr. Schauer says.
Investors began turning against public tech companies in November, 2021. Months of supply chain crunches, inflation and rate-hike fears finally permeated markets and sent the stock prices of companies such as Amazon.com Inc. and Shopify down from stratospheric levels. Widely-hyped cryptocurrency and blockchain-based technologies such as non-fungible tokens (NFTs) began collapsing, too.
The shift was just starting. Russia invaded Ukraine in February, exacerbating the supply chain crisis and inflation. Central banks began hiking interest rates. This has hit tech stocks hard, since they’re particularly sensitive to rates – the higher rates go, the lower the current value investors ascribe to the companies’ expected future cash flows.
The downturn has been brutal, snuffing out an unprecedented boom for initial public offerings in Canada.
The Toronto Stock Exchange, which had seen an average of about one tech IPO over $50-million a year since the financial crisis of 2008-09, hosted 20 from summer 2020 until fall 2021. All but two of those companies have tumbled below their issue price at some point; many are still there. Similarly, in the United States, there’s been a drought in tech IPOs worse than the downturns after the 2001 dot-com bust and the financial crisis.
Jason Smith, CEO of Vancouver business-intelligence software company Klue Labs Inc., began to slow hiring in April and slashed advertising to focus on what he calls the “hand-to-hand combat work” of chasing new clients directly. He describes the tenuous market earlier this year as “like walking around the musical chairs, where you just knew the music was going to stop.”
The music was fading quickly by May, when the largest shareholder of Wealthsimple, one of Canada’s highest-valued private startups, announced it had slashed its valuation of the company by 20 per cent (it would further devalue its stake by another 47 per cent three months later). Wealthsimple then cut 13 per cent of its 1,260 staff in mid-June.
Shopify said it would cut a 10th of its staff of 10,000 in late July. CEO Tobi Lutke admitted his earlier expectation e-commerce activity would “leap ahead by five or even 10 years” turned out to be wrong. Days later, Ms. Romanow’s Clearco laid off a quarter of its 500 employees.
In August, the Vancouver social-media management company Hootsuite – a one-time tech darling that had been on the rebound under new CEO Tom Keiser – said it would lay off 30 per cent of staff, or 400 people. Mr. Keiser said in a statement the company needed to put more emphasis on “efficiency, growth and financial sustainability.”
When the Toronto investor relations software maker Q4 Inc. revealed in late August that it would lay off 48 people, CEO Darrell Heaps said the company had been hit by a double whammy: Not only was it directly affected by the tech downturn, its flow of new customers began slowing when other companies slowed their public listings.
“The market ahead of the beginning of ‘22 was very tuned for growth – a high degree of IPOs, high degree of capital raising, high degree of investments being made across the capital markets,” Mr. Heaps said in an interview last month. “That’s something that we were very much a part of and benefiting from. The market was rewarding growth companies. When you look at the context of where we are now, with the market demand changing – growth companies versus profitability – that’s what really warrants us making a change.”
The sector-wide shift changed the relationship between founders and investors, too. For years, the power dynamic favoured startups, as they sold chunks of their business to whoever would give them the highest value – often in deals led by large institutions such as Tiger Global Management LLC and SoftBank Vision Fund that were keen to back mega-unicorns (unicorns are tech startups that have achieved a US$1-billion valuation). It was a FOMO-driven phenomenon that helped inflate tech valuations, which few people acknowledged as a bubble.
Now, however, offers advanced by investors to young companies, known as term sheets, are starting to include greater protections for new financiers.
Jacques Bernier, managing partner of Montreal’s Teralys Capital, one of Canada’s leading venture capital financiers, says he’s seeing more term sheets outlining liquidation preferences. If a company is sold or goes public, certain investors are first to be repaid, and receive a locked-in return on their investment before the balance is paid to other investors. Such terms were a feature of past downcycles, but have been so rare for so long, Mr. Bernier quips, that “young analysts have never heard the word.”
Christiane Wherry, vice-president of research and product at the Canadian Venture Capital and Private Equity association, says her members have become “very careful” in recent months – especially small venture funds and family offices. “For growth-stage companies, I think we’re going to see a slowdown that might persist,” Ms. Wherry says.
As the growth-at-all-costs era comes to an end, some tech leaders are embracing traditional business metrics such as positive cash flow and earnings for the very first time.
Many executives have no choice but to cut back, since investors are now reluctant to continue funding businesses that lose money. “If you take the scalpel and focus on parts of the business that are more profitable, and optimized for that, can you delay raising [more capital]?” says Framework Venture Partners’ Ms. Dirks.
Others that can’t make the shift are in trouble. “The companies burning cash with no foresight for profitability are hurting deeply,” says Maverix Private Equity founder John Ruffolo, one of the country’s best-known startup financiers, who had been warning of a collapse on his blog since last October.
Meanwhile, tech companies that listed publicly before the downturn face heightened scrutiny. Lightspeed Commerce Inc. LSPD-T, one of Canada’s highest-profile public tech companies, has lost money in each of its past four years, totalling about US$530-million in operating losses over that time.
Now, Lightspeed wants to change that. The Montreal company, which offers point-of-sale and payment-processing services to restaurants, retailers, golf courses and hospitality businesses, recently gave staff T-shirts that read “Payments Payments Payments.” CEO Jean Paul Chauvet hopes the mantra will help employees focus on a part of the business that is expected to fuel the company’s growth and its drive to reach profits.
If Lightspeed’s staff can persuade enough existing clients to embrace its payment-processing service, Mr. Chauvet thinks the company can become profitable – as measured by adjusted earnings before interest, taxes, depreciation and amortization – in its next fiscal year. (Adjusted EBITDA excludes a variety of costs factored into bottom-line net income or net loss.)
“Payments is the most important thing for us to get on the path to profitability,” Mr. Chauvet said in an interview earlier this summer. “Everybody knows, at every single meeting, that our job now is to drive velocity in payments.”
The Lightspeed CEO insists the push for profits was not prompted by the downturn. Instead, he says, it’s a natural progression for the 17-year-old company after building up its customer base, buying up complementary companies and integrating all its capabilities.
Founding CEO Dax Dasilva stepped down in February, replaced by long-time president Mr. Chauvet. In Mr. Dasilva’s final quarters as CEO, he didn’t describe a path to profitability with much urgency on analyst calls. But Mr. Chauvet made his priorities immediately clear.
“We know that the market is interested in our profitability,” Mr. Chauvet told analysts. “I want to stress that I will continue to invest in the business and growth remains our top priority. However, given our increasing sales and strong improving unit economics, the path to profitability is becoming more apparent.”
But investors remain in wait-and-see mode. Lightspeed shares haven’t moved significantly, and are trading at less than one-fifth of their peak price about a year ago, before the company was hit by a short-seller report that cast doubt on Lightspeed’s customer counts, revenue growth and competitive position – and then the downturn a few months later.
Meanwhile, Lightspeed has had to adapt to a lower stock price. Mr. Chauvet says the company has reissued restricted stock units to its staff at a lower price point, and is reassuring them it’s a stable, growing place to work. “Even though the rest of the world is letting people go and slowing down, we are growing.”
There’s no sign of the downturn ending any time soon. Public markets rallied for some of August, but have sputtered again amid continuing worries about inflation and higher interest rates. Mr. Smith, the CEO of Klue, says he’s seen job applications jump but salaries remain high, suggesting there’s still some competition for talent.
Some startups are also completing venture financings and opening new offices. Optimists in the sector hope things will smooth out in a quarter or two; others think the pain has just begun.
As investors press companies to be more cautious about spending, many simply won’t do that. Some businesses can’t cut enough and may still be years from reaching profitability, if they ever can. With the onset of a funding winter, many that were propelled by easy money will find it difficult to survive.
Those whose growth has tailed off and are still deeply in the red are particularly vulnerable. They’re unlikely to draw anything close to the interest they once commanded from capital providers.
“Companies are essentially going to need to be put on the block and sold” as investors abandon them, says Chad Bayne, co-chair of Osler, Hoskin & Harcourt’s emerging and high growth companies practice, and Canada’s top lawyer in the sector. Some companies are talking to bankers or have begun exploring their strategic options, which is expected to lead to a flurry of mergers and acquisitions – particularly if offers for more growth financing come at disappointing valuations.
“The board has a fiduciary obligation to do what is in the best interests of the company. If nobody is going to fund it, you’d best find a buyer for it or shut the company down,” Mr. Bayne says.
Many companies, he says, will be sold at cut-rate prices that leave some low-tier investors with little or nothing. “Over the next 12 to 18 months, we’ll see a lot of portfolio companies be essentially jettisoned” by venture capital firms, he says.
But, Mr. Bayne added, that’s exactly the way things are supposed to work.
Venture capital is an inherently high-risk business. Typically, early-stage financiers make a lot of bets, the majority of which fail or barely return their money. But one or two generate enough outsized returns to make the shotgun approach worthwhile.
For the past few years, however, with so much money sloshing around, too few businesses have failed. “It’s like, now we’ll actually see what venture really looks like,” Mr. Bayne says.
The downturn could be a chance for tech power brokers to acknowledge blind spots. Companies led by women – and especially Black, Indigenous and racialized women – have been widely underfunded as they face systemic biases and discrimination in a sector that is still vastly male-led.
Halifax’s Sandpiper Ventures raised the first $10-million of its initial fund for female-led companies just before the downturn, and closed it at more than $20-million in August, in the thick of the chaos. Rhiannon Davies, founding and managing partner at Sandpiper, says during the past decade’s boom, “we didn’t see the explosive valuations in women-driven companies.”
In a moment when startups are now scrambling to stretch out cash, female-led companies are better placed to do that, according to research by the Kauffman Fellows venture program. “That gives them a leg up in terms of their resilience, their efficient use of capital and their resourcefulness,” Ms. Davies says.
The downturn could also be a chance for employers to reset their relationship with employees.
Toronto medical images and records company PocketHealth Inc. was self-funded for four years before it first raised seed financing. CEO Rishi Nayyar says that he embedded caution into everything he does – every dollar needs to be respected, and people need to be respected. They aren’t costs to be shorn away in tough times. He implores companies to see job offers as more than just new line items; they’re social contracts.
“Outside of tech, and prior to the last 10 years, this is what jobs were considered,” Mr. Nayyar says. “But then something happened through the boom, where people started hiring based on market demand that they knew might disappear. They were okay with hiring a lot of people – making a bet that if it didn’t disappear, that would catapult them into a stratosphere of company size and equity value that they wouldn’t have otherwise.”
But implicit in that risk, Mr. Nayyar points out, is a lot of downside. Many executives thought, “but didn’t say out loud, that if demand disappeared or changed course – sometimes even slightly changed course – those people we brought on, it might not make sense to have them around any more. … You’re just a number on the page; whatever happens, happens.”
More tech leaders are bound to take the careful approach Mr. Nayyar has employed, as the sector trudges through the downturn and hopes for better days ahead. With the easy money gone, the tech world has shifted from a speculative binge to an industry-wide battle for survival.
As Mr. Nayyar knows: “When you’re bootstrapped, you’re fighting for your life every day.”