In December 2021, I highlighted the dangers of tech startups raising capital at inflated revenue multiples, often soaring between 40x and an astonishing 70x. At the time, it was unmistakably clear that valuations were being propelled more by speculative hype and an abundance of cheap capital than by sound financial fundamentals or proven business models. The market was awash with liquidity, investor FOMO (fear of missing out) was rampant, and the prevailing sentiment was that "this time is different." Companies with nascent products and limited revenue were suddenly deemed worth billions, based on projections that seemed more like wishful thinking than rigorous analysis. The warning signs were glaring for anyone willing to look past the euphoria: unsustainable growth metrics, a disregard for profitability, and an implicit assumption that the market would continue to climb indefinitely. Now, years later, the predictable consequences of this speculative frenzy are materializing with undeniable force. Many of those companies, having raised at sky-high valuations, did so without ever establishing a clear path to profitability or demonstrating robust unit economics. As the economic tide has turned, interest rates have risen, and investor sentiment has become significantly more cautious, cash reserves that once seemed inexhaustible are drying up rapidly. They are facing a harsh reality: market multiples have contracted dramatically, often plummeting to single digits or low double digits, and those inflated valuations from 2021 are now a crushing liability, making subsequent fundraising rounds incredibly difficult, if not impossible.

The consequences of inflated valuations

The aftermath of the 2021 bubble has been a painful lesson for many in the tech ecosystem. The consequences of raising capital at unsustainable valuations are multifaceted and far-reaching, impacting not only the companies themselves but also their employees, early investors, and the broader market sentiment.

Firstly, down rounds have become a pervasive and demoralizing reality. A down round occurs when a company raises new capital at a lower valuation than its previous funding round. For founders, this means significant dilution, often at a lower per-share price than their initial investments, which can be a bitter pill to swallow. For early employees holding stock options, the value of their equity might be underwater, negating years of hard work and loyalty. Down rounds also signal to the market that the company’s previous valuation was unrealistic, eroding investor confidence and making future fundraising even more challenging.

Secondly, widespread layoffs and restructurings have swept through the tech industry. Companies that raised significant capital at inflated valuations often embarked on aggressive hiring sprees, anticipating exponential growth that never materialized. When the market shifted and funding became scarce, these overstaffed companies were forced to drastically cut costs to extend their runway. Tens of thousands of talented individuals have lost their jobs, leading to immense personal hardship and a significant drain on innovation. These restructurings also involve painful strategic pivots, shuttering non-core projects, and a general tightening of belts that can stifle creativity and growth.

Thirdly, the difficulty in raising future capital becomes a critical impediment. Investors, having been burned by previous speculative bets, are now demanding clear paths to profitability, robust unit economics, and demonstrated product-market fit. A company with a "toxic" valuation history – meaning a previous round was so high it’s hard to justify any current valuation – finds itself in a precarious position. New investors are hesitant to invest at a valuation that might still be considered too high, or they demand highly unfavorable terms to compensate for the perceived risk, leading to further dilution for existing shareholders.

Fourthly, there’s a tangible loss of investor confidence and increased caution. The exuberance of 2021 has been replaced by skepticism. Venture capital firms are taking longer to conduct due diligence, scrutinizing business models with far greater rigor, and prioritizing capital efficiency over rapid, unproven growth. This shift makes it harder for even fundamentally sound companies to secure funding, as the overall risk appetite in the market has significantly diminished.

Finally, these inflated valuations have also had an impact on mergers and acquisitions (M&A). Potential acquirers are less willing to pay premium prices for companies that haven’t demonstrated sustainable growth or profitability. Many startups that might have been attractive acquisition targets in a frothy market are now struggling to find buyers, or are being acquired at fire-sale prices, leading to further losses for their investors. The entire M&A landscape has become more challenging, as buyers are more discerning and valuation expectations have recalibrated.

The AI wave is showing the same patterns

What truly worries me is that we are witnessing a disconcerting replay of these same dynamic patterns today, particularly within the burgeoning AI sector. The excitement around artificial intelligence, especially generative AI, is palpable and, in many respects, justified. The technological advancements are profound, and the potential to reshape industries and human interaction is immense. However, this genuine innovation is once again being overshadowed by a speculative fervor that bears striking resemblance to the 2021 bubble.

Early-stage AI companies, sometimes with little more than a strong technical team, a promising research paper, or an impressive demo, are raising capital at valuations that are predicated on an assumption of future dominance. These valuations often bake in expectations of becoming the next Google or OpenAI, long before they have achieved product-market fit, demonstrated a viable revenue model, or even figured out how to scale their foundational technologies economically. The narrative is powerful: "AI is the future, and this company is poised to own a significant chunk of it." Investors, eager not to miss out on the next big thing, are pouring money into these ventures at multiples that defy traditional financial analysis.

While the technology is undeniably exciting and the potential is real, history offers a stern warning: not all companies riding a technological wave will emerge as winners. For every Google during the dot-com bubble, there were hundreds of Pets.coms. For every NVIDIA in the current AI surge, there will likely be dozens of highly funded startups that fail to find a sustainable business model. The fundamental challenge remains: how do these groundbreaking technologies translate into profitable, scalable businesses? Many AI companies face substantial challenges in terms of high computational costs, data privacy, ethical considerations, and the constant evolution of underlying models. Building a truly defensible moat and a clear monetization strategy takes time, discipline, and a deep understanding of customer needs, not just technological prowess.

When the inevitable hype settles, as it always does, those companies that have focused on building sound business models, cultivating disciplined financials, and delivering tangible value to customers will be the ones that remain standing. They will have iterated on their products, found their niche, and demonstrated a clear path to profitability. Others, however, will be left grappling with the harsh realities of down rounds, painful layoffs, or, worse still, the complete dissolution of their ventures. The current AI boom, while promising, carries the same speculative risks that led to widespread disappointment just a few years ago.

What founders should focus on now

In this volatile and increasingly discerning market, founders must pivot their focus from chasing vanity valuations to building resilient, sustainable businesses. The playbook of "growth at all costs" is no longer viable; instead, a more pragmatic and disciplined approach is essential.

Firstly, prioritize profitability and sustainable business models. The era of burning cash indefinitely in pursuit of hyper-growth is over. Founders need to understand their unit economics intimately – the cost to acquire a customer versus the lifetime value they bring, their gross margins, and their operational efficiency. Develop a clear, credible path to profitability and demonstrate capital efficiency. This means optimizing spending, ruthlessly prioritizing initiatives, and ensuring every dollar spent contributes to tangible value creation.

Secondly, achieve undeniable product-market fit (PMF) before scaling aggressively. Many companies in the last bubble expanded rapidly before truly understanding if they were solving a problem that enough people cared about and were willing to pay for. Now, the emphasis must be on deeply understanding customer needs, iterating on the product, and validating demand through metrics that go beyond simple user acquisition. Focus on retention, engagement, and genuine customer satisfaction. Only once PMF is firmly established should founders consider significant scaling investments.

Thirdly, master capital efficiency and burn rate management. Extend your runway by meticulously managing expenses. This means scrutinizing every line item in the budget, delaying non-essential hires, and negotiating favorable terms with vendors. Cash is king, and preserving it provides the flexibility to navigate uncertain times and avoid distressed fundraising situations. Regularly forecast your cash flow and have contingency plans in place.

Fourthly, cultivate strong financial discipline and transparent reporting. Founders must have a deep understanding of their financials, key performance indicators (KPIs), and projections. Be honest with investors about the company’s performance, challenges, and realistic outlook. Transparency builds trust, which is invaluable in a tough market. Implement robust financial planning and analysis (FP&A) processes.

Fifthly, build a resilient team and culture focused on long-term value creation. In times of uncertainty, a strong, adaptable team is paramount. Focus on hiring individuals who are not only talented but also aligned with a culture of prudence, innovation, and customer-centricity. Foster a culture that values sustainable growth over short-term hype, where disciplined execution is celebrated, and learning from mistakes is encouraged.

Finally, be open to realistic valuations. While it’s natural for founders to want the highest possible valuation, in the current market, accepting a realistic valuation that reflects current performance and market conditions is often a wiser strategic move than holding out for an unsustainable valuation that never materializes. A fair valuation enables a successful fundraise, brings in valuable partners, and allows the company to continue its journey with a healthier foundation.

Itay Sagie is a strategic adviser to tech companies and investors, specializing in strategy, growth and M&A, a guest contributor to Crunchbase News, and a seasoned lecturer. Learn more about his advisory services, lectures and courses at SagieCapital.com. Connect with him on LinkedIn for further insights and discussions.

Related reading:

• The Anatomy of a Bubble: Lessons from Past Tech Booms and Busts
• Beyond the Hype: How to Identify Sustainable AI Business Models
• Navigating Down Rounds: Strategies for Founders and Investors
• The Resurgence of Profitability: Why Unit Economics Matter More Than Ever

Illustration: Dom Guzman

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