The Present Value with Alex Harper
A hallmark of any growth shock or macro weakness is the inevitability of broad-based, multiple compression and reduced valuations as investors scramble to reassess the worth of assets and cash flow in a new environment. But in the early-stage, a unique idiosyncrasy arises where these high-growth, high-multiple companies can be considered to have the lowest “beta” (the measure of how much volatility an individual asset has in comparison to the movements of the index). This is because they are farthest away from the public markets and are usually addressing an issue or problem either previously untouched or in a more efficient manner than existing solutions; because of that, and up to a point, growth trajectories can be insulated from broader macro fragility. Thus, multiple contractions tend to hit this space last as daily price discovery is absent from the private markets and recency bias is ubiquitous amongst venture investors who grew up in a zero interest-rate environment. That being said, we’re witnessing the effects of macro uncertainty and tightening financial conditions seep into the early-stage sector. In Israel, pre and post-money valuations are now moving lower alongside the amounts raised. Activity, as well, is on a downward trajectory. This turn has caused every one of our portfolio companies to scrutinize runway and adjust burn rates accordingly in order to not be forced to tap the markets during this time of turmoil and subject shareholders to a downround of brutal dilution.
Where last year the ecosystem was defined by FOMO (fear of missing out) on new deals, now venture funds have shifted the focus to stress-testing portfolios, meeting with portfolio companies, and attempting to model future cash flows under deepening weakness and an ever-changing weighted average cost of capital. Due to this shift, venture investors with dry powder have been granted an air of forbearance to make proper investment decisions versus worrying about how quickly a competitor can deliver a term sheet. Though many of the early-stage companies have been lucky and raised before the cost of capital became a headline issue, many have not and are waking up to the changed atmosphere that exists where investors are more fastidious in their due-diligence process and more selective in capital deployment.
Our view is very much inline with a longer-term approach where we see tech becoming prodigiously more ubiquitous than most investors can currently fathom. Due to this, startups’ ability to leverage secular growth trends, and the tremendous amount of private capital thrown at a limited amount of opportunities, valuations are in the latter half of the pullback as we move away from pricing interest-rate increases and towards a global slowdown/recession. Investors will eventually cease the indiscriminate selling of anything long duration as they once again realize why recurring-revenue streams were once granted premium multiples. We can take solace in the fact that the public markets have discounted “unprofitable tech” to such a point that valuations are becoming not just attractive, but shockingly cheap with many trading as if bankruptcy is imminent. In our view, this bodes well for the private market—one, valuations have come back down to earth as investors grapple with a new macro regime of elevated inflation and rates; and two, that the excess froth in the venture space is being wiped away as it mean-reverts, subsequently becoming more attractive to traditional investors previously uncomfortable with sky-high prices. Thus, as mentioned above, valuations might be closer to the end of their retracement than the beginning (barring a global and prolonged depression, of course). As they move low enough, those savvy investors with cash will step in, and when prices do recover, the 2023 vintage of companies that survived will provide early investors with returns beyond the standard deviation of the right-side tail.