What does the post-crash VC market look like? | by Mark Suster

During our mid-year outing, our partnership with Upfront Ventures was discussing what the future of the venture capital and startup ecosystem looked like. From 2019 to May 2022, the market fell substantially with government ratings down 53-79% in the four sectors we were looking at (it has declined further since then).

==> On top of that, we also have a NEW LA-based partner that I’m thrilled to announce: Nick Kim. Please Follow him and welcome to Upfront!! <==

Our conclusion was that this is not a temporary blip that will quickly roll back to the upside in a V-shaped valuation recovery, but rather represents a new normal for how the market will value these companies in some sort of permanent way. We drew this conclusion after a meeting we had with Morgan Stanley where they showed us historical trends in 15-year and 20-year valuations and we all discussed what we thought that meant.

Should SaaS companies trade at 24x Enterprise Value (EV) over next twelve months revenue (NTM) multiple as they did in November 2021? Probably not and we think 10x (May 2022) seems more in line with the historical trend (actually 10x is still high).

It really doesn’t take a genius to realize that what happens in public markets is very likely to trickle back into private markets because the eventual exit of these companies is either an IPO or an acquisition (often by a corporate whose valuation is set daily by the market).

This happens slowly because while public markets trade daily and prices adjust instantly, private markets don’t reset until subsequent funding rounds occur which can take 6-24 months. Even then private market investors can mask valuation changes by investing at the same price but with a more structured structure, so it is difficult to understand the “major valuation”.

But we are confident that ratings will be reset. First into late stage tech companies and then it will filter back to Growth and then A and finally Seed Rounds.

And reset they have to. When you look at how many median ratings have been raised in the last 5 years alone, that’s bananas. Median valuations for early-stage companies have tripled from about $20 million at pre-money valuations to $60 million with many deals priced in excess of $100 million. If you are exiting in 24x EV/NTM valuation multiples you may be overpaying for an initial round, perhaps based on the “big fool theory” but if you feel that exit multiples have reached a new normal, that is clear to me. : YOU. SIMPLY. YOU CAN NOT. OVERPAY.

It’s just math.

No amount of blog posts about how Tiger is crushing everyone because it’s deploying all of its capital in 1 year while the “suckers” are investing in 3 years can change that reality. It’s easy to make IRRs work really well in a 12-year bull market, but VCs have to make money in good and bad markets.

Over the last 5 years some of the best investors in the country could just anoint the winners by giving them large amounts of capital at steep prices and then the media hype machine would create awareness, talent would race to join the next perceived $10 winner billions and if the music never stops then everyone is happy.

Only the music stopped.

There is a LOT of money still lying around waiting to be distributed. And it WILL be implemented, that’s what investors do.

Pitchbook estimates that there is about $290 billion of VC “overburden” (money waiting to be distributed in tech startups) in the US alone and that it has increased more than 4x in the last decade alone. But I believe it will be handed out patiently, waiting for a cohort of founders who don’t artificially cling to 2021 valuation metrics.

I’ve talked to a couple of my friends who are late stage growth investors and they basically said to me, ‘we just aren’t having meetings with companies that ramped up their last round of growth in 2021 because we know there’s still a mismatch of expectations. We will just wait until the companies they created last in 2019 or 2020 come to market.”

I already see a return to normal on the amount of time investors have to conduct due diligence and make sure there is not only a compelling business case, but also good chemistry between founders and investors.

I can’t speak for every VC, of ​​course. But the way we look at it is venture right now you have 2 choices: super size or super focus.

At Upfront we clearly believe in “super focus”. We don’t want to compete for the biggest AUM (assets under management) with the biggest companies in a race to build the “Goldman Sachs of VCs,” but it’s clear that this strategy has been successful for some. Over 10+ years we have maintained the median first check size of our Seed investments between $2-3.5 million, our Seed Funds mostly between $200-300 million, and delivered median holdings of approximately 20% since first check we write in a startup.

I’ve been telling people this for years and some people just can’t figure out how we’ve been able to maintain this strategy in this bull market cycle and I say to people: discipline and focus. Obviously ours execution against the strategy had to change but the strategy remained constant.

In 2009 it could take a long time to review an agreement. We may talk to customers, meet with the entire management team, review financial plans, review customer buying cohorts, assess the competition, etc.

By 2021, we had to write an average first check for $3.5 million to get 20% ownership on average, and had much less time to do an appraisal. We often knew about teams before they actually set up the company or left their employer. It forced extreme discipline to “stay in our swim lanes” of knowledge and not just write checks in the latest trend. So we largely excluded funding from NFTs or other areas where we didn’t feel we were experts in or where the valuation metrics didn’t align with our funding goals.

We believe investors in any market need the “edge”… knowing something (thesis) or someone (access) better than almost any other investor. So we’ve stayed close to our investment themes of: healthcare, fintech, computer vision, marketing technologies, gaming infrastructure, sustainability, and applied biology, and we have partners driving every area of ​​practice.

We also focus a lot on geographies. I think most people know that we are headquartered in Los Angeles (Santa Monica to be exact), but we invest domestically and internationally. We have a team of 7 in San Francisco (a counter bet to our belief that the Bay Area is a great place). Approximately 40% of our deals are done in Los Angeles, but nearly all of them leverage the Los Angeles networks we’ve built over 25 years. We do business in New York, Paris, Seattle, Austin, San Francisco, London, but give you the ++ of having access to Los Angeles as well.

To that end I’m really excited to share it Nick Kim joined Upfront as a partner based in our Los Angeles offices. While Nick will have a national mandate (he’s lived in New York for about 10 years), he’ll initially focus on increasing coverage of our hometown. Nick is an alumnus of UC Berkeley and Wharton, worked at Warby Parker and then most recently at the venerable Seed Fund in Los Angeles, Crosscut.

Anyone who has studied the VC industry knows that it operates on a “power law” in which a few key operations return the bulk of a fund. For Upfront Ventures, over > 25 years of investment in a given fund, 5-8 investments will return more than 80% of all payouts and is generally over 30-40 investments. So it’s about 20%.

But I thought a better way to think about how we manage our portfolios is to think of it as a funnel. If we take 36-40 trades in a Seed Fund, between 25-40% would likely see big upside within the first 12-24 months. This translates into about 12-15 investments.

Of these companies that become well funded, we only need 15-25% of THOSE to get a return of 2-3x the fund. But all of this is driven by the assumption that we didn’t write a $20 million check out of the gate, that we didn’t pay a $100 million pre-money valuation, and that we took a significant ownership stake by making a very early bet on the founders. and then collaborating with them often for a decade or more.

But here’s the magic few people ever talk about…

We created over $1.5B in upfront value from just 6 transactions that DID NOT immediately be up and right.

The beauty of these businesses that didn’t get immediate momentum is that they didn’t raise as much capital (so neither we nor the founders had to take the extra dilution), they took the time to develop real IP that is hard to replicate, they often have attracted only 1 or 2 strong competitors and we could offer more value from this cohort of even our cutting edge companies. And since we still own 5 of these 6 companies, we think the benefit could be much greater if we are patient.

And we are patient.

Source link

Leave a Reply

Your email address will not be published. Required fields are marked *