2022 Year in Review for Southern California Tech
A Sobering Year
2022 was not a good year for the tech industry. While the broader stock market tumbled the most since the Great Recession, tech bore the brunt of the selloff. The S&P 500 fell 19%, while the tech-heavy NASDAQ fell 33% and the BVP Emerging Cloud Index representing enterprise SaaS fell 52%. Leading cryptocurrencies Bitcoin and Ethereum were down over 70% from their peaks. The number of newly launched IPOs fell 80%. Global venture capital funding slowed dramatically, approaching a rate that is almost down 70% year-over-year.
In crypto, blowups of 3 Arrows Capital and FTX triggered selloffs, fears of contagion, and criminal proceedings. In traditional venture capital markets, the crossover hedge funds that drove so much of 2021’s frenzied dealmaking were forced to scale back or shut down their venture investing altogether. Big tech platforms such as Meta, Alphabet, Microsoft, and Amazon were all under attack by regulators. There was seemingly nowhere to hide.
For Southern California’s tech ecosystem, the story was no different. Both investment and exits were down. Local companies struggled — some caught up in crypto frauds or anti-trust battles, but many simply trying to reach profitability as soon as possible while facing uncertain capital markets. But there are reasons to remain optimistic. As happens every year, a new crop of companies was able to demonstrate groundbreaking technologies or show remarkable growth. Over time, these companies will find their way to sustainability and help inspire the next generation of startups for the region.
Pivot Back to Consumer Startups
Since the term “unicorn” was coined by Cowboy Ventures’ Aileen Lee in 2013, the number of companies earning the description by reaching a $1B valuation in private markets continued to increase steadily. According to unicorn tracking by CB Insights, 2021 saw a record 525 newly minted unicorns worldwide. Dealmaking slowed considerably in 2022, and the number of companies reaching the $1B valuation mark fell by half, to only 259. This drop was mirrored in Southern California, with only 10 new unicorns in 2022, down from 20 the previous year:
All 10 companies reached their unicorn status in the first half of the year. This dramatic falloff in new unicorn formation locally was reflective of the global situation, which saw only 18% of the year’s unicorns minted in the second half of the year. Barring a dramatic recovery in the venture capital dealmaking and valuations, we should expect the coming year to return to Southern California’s historical norm of single-digit unicorn fundraises each year.
Not only did the total number of new unicorns fall, but the composition of those unicorns shifted notably towards consumer-facing companies. I am a staunch believer that any startup ecosystem needs to be built on a base of traditional enterprise software. Enterprise startups see more consistent exits than consumer startups, which is key for recycling capital and talent throughout the ecosystem. Enterprise startup success stories are particularly significant for Southern California, which is still fighting a perception that it is weak in that sector and overly reliant on media and consumer plays.
Of the seven newly minted consumer-facing unicorns in Southern California, three were fintech companies (Acorns, Happy Money, and iTrustCapital). This sector faced a tough year in the public markets, with valuation multiples for fintech companies resetting from exuberant enterprise software levels down to more appropriate traditional financial services levels.
As might be expected, ThatGameCompany is a local video game developer that has been active since 2006. Video gaming has always been a strong industry in Southern California, and one of the region’s most notable tech stories of 2022 has been Microsoft’s blockbuster acquisition of Activizion Blizzard for $69B. The deal has caught the eye of anti-trust regulators, who are attempting to block the transaction in a new battle against the growing market power of large tech companies.
Spotter is essentially a modern MCN that invests in YouTube creators to license their content. There were multiple MCN exits in Southern California in the early part of the 2010s tech cycle, helping jumpstart a local tech ecosystem which had remained somewhat dormant since the dotcom bubble burst in 2000. The most notable MCN exit at the time was Disney’s $675m acquisition of Maker Studios in 2014. However that was an outlier in terms of valuation. Other MCNs such as Machinima, StyleHaul, and Jukin Media all saw exits closer to the $100m mark. Spotter’s $1.7B valuation implies that investors see a much brighter outcome this time around for serial MCN founder Aaron DeBevoise’s latest foray into the space.
The region also saw its share of new unicorns in the crypto and Web3 sectors, with Autograph, Genies, and iTrustCapital all focused on the space. However, 2022 was not a good year for the crypto markets. Prices peaked in November 2011, and both Ethereum and Bitcoin saw price declines of over 65% in 2022. These declines, combined with implosions of key crypto players including FTX and 3 Arrows Capital have led many to speculate that we are entering a new “crypto winter” of slower end user adoption, which could lead to significant growth headwinds for these companies.
On the enterprise side, the region continued to show its relative strength in deep tech. Only Invoca fits the mold of traditional enterprise software. Divergent builds additive manufacturing solutions for the automotive sector that have the potential to remake the entire production process and opens the market for new OEM entrants. Epirus plays to Southern California’s traditional strength in the Aerospace & Defense market, which is seeing renewed interest overall because of the war in Ukraine and tensions over Taiwan.
A Tough Year for Exits
Last year I wrote that 2021 was a banner year for exits for Southern California startups. There was $135B of announced exit value via IPOs, SPACs, and M&A transactions, almost matching the total of $161B for the previous 10 years combined.
In comparison, 2022 was a disastrous year. Throughout the year, only $8B of exit value was announced. Of that amount, $4B was the headline SPAC valuation for fintech company Dave. Unfortunately, Dave has not fared well in the public markets. After reaching a peak market cap of $5.3B in early February, the stock began to slide alongside other SPACs. Dave closed out the year with a market cap just above $100m, a dismal outcome for investors who had cumulatively poured several hundred million dollars in financing into the company.
Dave wasn’t the only Southern California tech company to struggle in the public markets. Almost every company in the region that IPO’d or SPAC’d in the past two years performed poorly, even compared to the broader market pullback in tech that was triggered by rising interest rates and a sense that valuations had become unsustainable. An index of 12 Southern California public companies from 2021 and 2022 would have fallen 78% over the course of the year, significantly underperforming the technology-heavy NASDAQ index, which recorded a 33% fall:
There seem to be two main factors underpinning the region’s underperformance. The first is the heavy reliance on the mobility sector for exits over the past two years. Of last year’s $135B of announced exit value, 62% came from IPOs and SPACs for new auto OEMs Rivian, Faraday Future, and Xos Trucks, autonomy provider TuSimple, and scooter sharing leader Bird. Rivian alone was almost half of the exit value. It has fallen dramatically since its IPO, from a market cap of $92B at the beginning of the year to $17B at the end.
The second main reason for the region’s struggles was the reliance on SPACs. In 2021, over $17B of exit value in Southern California came from SPAC transactions, making them the second largest source of exit value. SPACs were the exit path of choice for local companies including Rocket Lab, Science 37, Bird, Faraday Future, and Xos Trucks. SPACs performed poorly in 2022 as investors realized that this “back door” to being a public company was often being used by companies that simply weren’t ready to be public in terms of risk profile or operational rigor.
Return to Normalcy
While 2022 looks like a tough year for the tech industry in isolation, there are reasons to remain optimistic. In many ways, the slowdown in the capital markets is simply a return to normalcy. The pace of startup growth and investor dealmaking in 2021 and the first half of this year was simply unsustainable, and in many ways illusory.
Startups should have solid evidence of product-market fit before pouring cash into growth. Venture investors should do proper due diligence before writing checks. Companies should have repeatable business models and predictable financials before going public.
For local companies building for long run success, this is all fine. A less frenzied market allows them to focus on building products, delighting customers, and recruiting talent in an efficient, sustainable manner. They will be better off for it.
And when the capital markets do thaw out, Southern California startups will be ready. The region now has over 30 companies with valuations exceeding $1B, for whom an IPO and public company status is the goal. The list includes some of the greatest success stories of the region, names like SpaceX, Anduril, Seismic, and ServiceTitan. So while 2021 may have been a year of exuberance and 2022 a speedbump, the best is still to come for the region’s tech ecosystem.
