Through much of last year there was talk of a bubble in venture capital, particularly in late stage investments. Valuations were stretched, both on a fundamentals basis and compared with the public markets, and there were even whispers of a ‘new paradigm’ for valuing companies now that businesses can expand around the world so fast. It was inevitable that the heat was going to come out of the market at some point and my hope was that it would come out sooner rather than later, and that the down-rating would be more correction than crash and the collateral damage would be limited.
That process started quietly after the summer last year. Whilst valuations in the UK at the very early stages at which Forward Partners invests haven’t moved much (yet) friends here who invest at later stages are telling me stories of companies slashing their expectations by 40-50%. On the other side of the Atlantic the sentiment was even more negative, not helped by Fidelity (and others) writing down the value of their holdings in previously high-flying unicorns.
A bit of context is important. Information flows slowly in the venture world, at least compared with public markets, and changes like this take time to play out. That’s partly because investors look at returns over 5-10 years and are less concerned about their position at the end of the quarter, partly because transaction data is private and it takes time for people to find out what’s going on, and partly because deals are often put together over many months and people don’t like to radically change course. The last point is related to the first two.
The interesting question now of course is how far it goes and recent weakness in the public markets won’t help. NASDAQ is off about 10% since it’s Christmas peak and fears about rising interest rates, falling oil prices, weakness in China, and falling corporate earnings generally are contributing heavily to negative sentiment. Worse from a venture perspective is that GoPro and Fitbit have both seen huge falls in their share prices recently, adding concerns about exit potential in specific categories to fears about the market generally.
The good news is that innovation continues to happen faster and faster each year, so the fundamentals for startups are strong, and that this correction is happening now rather than after another couple of years of irrational exuberance. That said, we could bounce back to heady times quite quickly, particularly if central banks react to the current situation by deciding to keep interest rates low. The more likely, and to my mind healthier, scenario is that we see a few months of continued weakness in the venture markets and then things level off. I think it’s unlikely we will crash as hard as did in 2000 or 2008. Given the paucity of information and pace at which changes happen we will be left guessing which of these scenarios we are in for a good few weeks yet.