Fed’s Interest Rate Decision Splits Startup Investors in Funding Frenzy

A trader on the floor of the New York Stock Exchange reacts to news that the Federal Reserve decided to not raise interest rates.
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The Federal Reserve on Thursday left short-term interest rates at near-zero levels, a decision that should keep the funding party going for startups, but one that splits investors.

Like all asset markets — from stocks to bonds to real estate — the valuations of fast-growing tech startups have benefited from years of rock-bottom rates and central bank money-pumping programs.

Low interest rates encourage investors to take more risk because parking capital in bank accounts or Treasuries doesn’t pay off. As a result they tend to chase higher yielding assets like junk bonds and the equity of fast-growing companies. Venture capitalist Fred Wilson explained the relationship between venture capital and interest rates in a 2014 blog post, concluding that the good times for VCs and

would continue “as long as the global economy is weak and rates are low.”

The number of companies valued at $1 billion or more has doubled to 121 in the past 12 months, adding an average of more than one per week, according to data from Dow Jones VentureSource. Driving the valuations of many of these companies are public-equity investors such as mutual funds, hedge funds and big banks. Of the 79 billion-dollar private companies in the U.S.,  55 have a least one such firm as an investor, according to VentureSource. These firms could be among the first to retreat from startups when interest rates rise.

“The low cost of capital in today’s world is fueling an investment and M&A boom,” said angel investor Fabrice Grinda in a May blog post. “When rates start to normalize in a few years, people will come to regret the prices they paid for assets when money seemed virtually free. It’s not a coincidence that the Internet bubble burst after the Fed increased the effective Feds Fund Rate by 1.91% between 1999 and 2000.”

Rich Wong, general partner at Accel Partners, an investor in at least 15 private companies valued at $1 billion or more, counters that the startup ecosystem can and should look past near-term Fed actions. “We are still in the early innings of some major technology disruptions that have a long way to go,” said Wong in an email, adding that any pullback in his firm is beginning to see in late-stage private market fundraisings is the result of business fundamentals rather than interest rate forecasts.

Wesley Chan, general partner at Felicis Ventures, said he is pleased the Fed stood pat. “I believe that investors across all stages will continue to invest in these companies as it provides strong growth alternatives to low yield bonds and treasuries,” he said. Felicis is an investor in at least four private companies valued at $1 billion or more.

Taking the opposite view is John Borthwick, founder of New York startup investor Betaworks. He says that the six to seven-year run of flat rates have created the expectation on Wall Street that money and credit is almost free. “The Fed needs to edge up rates, bring us back into reality — slowly and gain some leverage to one day move them down again,” Mr. Borthwick wrote in an email. “Our sector (tech) has reaped huge dividends from QE and policy of the past six years — I think it’s healthy to let the fresh air of reality back into the room.”