Down, Down, Deeper and Down
That Was The Week #319
Essays of the Week
Down Markets and Liquidity
Secondary Markets to grow
Private Equity as Acquiror
Bid/Ask Spread in Venture
A16z closes HQ
Brad Feld on Matt Levine
FirstMark raises $1 billion in new funds
Amazon Buys One Medical
Tesla Sells Bitcoin
Stripe Lowers Valuation
Startup of the Week
Tweet of the Week
Long Hot Indian Summers
In a week that saw public markets largely up, my reading was dominated by those looking at private company stocks and pontificating on the downside. It is a commonly repeated mantra that private markets lag public market corrections.
Jason Lemkin writes about liquidity. This is a much under-appreciated concept in venture. Most funds report TVPI (total value to paid-in capital), which measures the value of their portfolio compared to how much they have invested. It is mostly made up of reported private valuations, so in layman's terms is “paper value.” DPI (distributions to paid-in capital) measures actual cash generated. This is almost always under 1 in the early days of a fund as exits that can return a fund are rare and usually happen several years into a fund. Liquidity for venture funds is driven by three things - companies sell out to a buyer, companies IPO or the fund sells its positions to a secondary buyer. For the most part, the first two dominate. But there is a growing occurrence of the third.
But to be honest, it makes little sense for a venture investor at the early stages to focus on liquidity. And if liquidity slows down, that will make very little difference to the outcomes unless it persists for 5 years or more. As Amazon’s purchase of One Medical indicates, exits may even become more likely in a public market correction. And Tomasz Tunguz has two pieces in the Essays of the Week - one of which points to PE firms as buyers of VC-backed companies and how important that is.
Lemkin focuses on founder liquidity, however. That is a very different thing to venture liquidity. Whereas the market for secondary shares is growing as an institutional phenomenon (funds buying out positions in other funds - from LPs or GPs), the secondary sale of employee shares seems to be slowing.
Personally, I have never sold a share in one of my startups before it did an IPO. I don’t think I ever would. You certainly couldn’t offer me enough for a share of SignalRank for me to want to sell it. But some founders and employees do sell shares - as witnessed by the existence of Forge Global and other buyers. Today that is going to prove harder as prices buyers will pay will fall precipitously.
Almost every post gathered below focuses on one or another element of a down market. However, as I have said before, that is a relative concept.
At SignalRank, we track live data related to the GPRank 100 (the best seed and A round investors). The past 12 months show some change.
This data comes from Crunchbase (which is our startup of the week this week after announcing a $50m raise at its D round). The graph above tracks 12 months of A rounds where a GPRank 100 investor invested at both seed and A in a company. These companies have yet to do a B round. It tracks the number of the number of investors across all of the rounds that month. Aside from December (and July which is not yet complete and suffering from data lag), the cadence of rounds is surprisingly stable, with June looking quite strong.
Chart two tracks the median amount raised at Series A for these companies; the $20m level seems quite consistent.
We also track B Rounds for these GPRank 100 companies, where the B includes a GPRanked B investor.
The median raise for a top-quality B Round has dropped a little through May but rebounded in June (July is incomplete and impacted by one large reported round) to about $60m.
So overall, the top quality (GP Rank subset) seed, A round, and B Round ecosystem is healthy. It is probably benefitting from lower valuations due to the reaction of the public market by venture capital. Tomasz Tunguz's second article this week focuses on the bid and ask delta between investors and founders. It is well worth a read. That delta drives investor interest in buying opportunities. In turn, that drives investors to want to raise funds in order to benefit. FirstMark announced $1 billion of funds this week.
Overall this is not a time to focus on the downside. It is a time to execute and succeed for founders. And a time to put money to work for early-stage investors. That said, understanding the reaction of the market is key. Enjoy the articles below.
The Video accompanying That Was The Week is recorded separately on Fridays and delivered to paying subscribers via email. To subscribe, go to our home at Substack
Essays of the Week
At this point, any founder in SaaS should know the public markets have fallen 50% or so from the peaks in 2021. It’s profoundly frustrating as revenue growth — hasn’t fallen. The best in SaaS are growing faster than ever, even past $1B or more in ARR. And yet, they are still worth half of what they were just a few months ago.
Now that the downturn in valuations is stretched out to months or longer, the next phase of issues will begin to set in. It’s not just that Snowflake, Datadog, Zoom, and so many other iconic leaders are worth half of what they were. That alone ultimately should cut venture valuations in half over time.
But a bigger reckoning may come around liquidity.
When times are great, everyone piles into illiquid assets like startups. No one worries about getting their cash out. They just want to get it in. In fact, they want to get it in so much, they just assume they’ll be able to get much more of it out.
Founder secondary liquidity gets a lot harder and rarer. And the amounts smaller. Venture markets were so hot in 2021, that many SaaS founders could sell a few million dollars worth of their shares even in a Series A. They used to have to wait longer, and it was hotter. And some of the hottest B2B founders in unicorns and decacorns took $20m, even $100m out in some cases (!) in secondary sales. This really only happens when there is much, much more demand for shares that supply. VCs don’t really want to buy founder common. They want to buy traditional preferred. But they’ll do it if there is no other way to get shares. As demand overall ebbs, it gets much harder to get material founder secondary. More on that here.
The IPO market is mostly frozen. A scale-up with incredible numbers can always IPO, at any time. Google and Facebook IPO’d during tough times in the market, and I’m sure Zoom, Slack, Datadog, Snowflake, etc. with their IPO numbers could have IPO’d any time they wanted. But for all but the best, it’s very hard to IPO today. And again, valuations are likely half or less of a year ago, even for the best in SaaS.
M&A (acquisitions) is way, way down. This is a bit counterintuitive. You’d think when assets are cheaper, more would be purchased. But it doesn’t work that way in practice. First, many potential acquirers own stock prices are way down. Which makes acquisitions sometimes more expensive in terms of dilution, if not cash per se. Second, it’s easier to pay up when your own stock price is on a tear. Salesforce bought Slack for 27x ARR. Today? I doubt it would pay even 10x. And third, many folks just don’t want to sell when prices are down. It’s easy to buy mediocre assets in a down market. They all become available. But top assets often become even less willing to sell at half or less the price of just a few months back.
The European venture secondaries market is expected to grow significantly as a lack of attractive exit options has increased the need for liquidity.
Increased volatility in the public markets for tech companies has severely reduced appetite for VC-backed exits in Europe. As of June 15, some 463 deals were completed this year worth an aggregate €16.9 billion (about $16.96 million), according to PitchBook data. That shows decreases of 61.4% in deal count and 87.6% in total deal value from the heights of 2021.
As investors and companies prepare for a cold winter on the exit front, Europe’s nascent secondaries market is heating up as startup investors and limited partners seek to cash out some assets.
“Current market conditions, which are characterized by higher interest rates and a rotation away from high-growth stocks, are leading to an [exit] liquidity crunch,” said Dany Bidar, principal at Octopus Ventures. “If those conditions persist, you’d expect to see increased pressure for liquidity within the VC asset class, making secondaries an ever-more-important liquidity solution.”
Global venture secondaries volume is estimated to reach $138 billion by 2023, according to data from Industry Ventures, but Europe has been slower than other regions to open up to these transactions.
This is due in part to a much smaller primary market, but the more complicated nature of venture secondaries deals also contributes. Many continental European jurisdictions restrict share transfers, and the inclusion of terms for the right of first refusal—allowing existing shareholders the opportunity to buy stakes before external buyers—can make these deals more costly and time-consuming.
Secondaries market to grow as European VC struggles to exit PitchBook News & Analysis
In 2018 at Saastr, Jason Lemkin & I talked about private equity becoming an increasingly aggressive buyer of venture-backed software companies.
Last year, private equity firms inhaled $29 billion dollars’ worth of startups - a twenty-year record and 50% more than the previous peak.
The high-water mark underscored the importance of private equity sponsors as an exit avenue for startups in black Sharpie marker. In 2021, PE buyouts constituted more than 20% of venture-backed M&A by dollars, doubling in the past decade.
VC2PE transactions - startups bought by PE funds - record median sales prices consistent with strategic M&A - when companies buy startups. The most recent surge notwithstanding.
Who makes for the most attractive VC2PE targets?
Private equity companies typically target SaaS/IaaS companies at $20M in ARR or more with good unit economics and growth in the 10-30% per year range. Gross & net dollar retention marks must impress, and net income should hover close to profitability.
In the second quarter of 2022, 32 companies joined The Crunchbase Unicorn Board, adding $49 billion in value and $7.7 billion in funding to the board.
I wish I had a chart of the bid/ask spread in venture capital today.
The bid/ask spread in VC is the difference between the post-money valuation between a VC (the bidder) & a company (seller).
In the past few years, the spread has been tight. The market is liquid. Many startups sell shares to buyers at mutually attractive prices. Like the old stock trading floors with brokers yelling at each other, but in our era, we negotiate over Zoom coffees instead.
Today, the bid/ask spread measures in the tens or hundreds of millions of dollars depending on the company’s stage.
A startups who had verbal offers in Q1 at $500m may expect to raise at $450m. The 10% originates from the Founder Sentiment Survey.
But the stock market comparables imply the company should trade at a 50% discount or $250m. The bid/ask spread stretches to 200m on 450m or 44%.
That’s not so much a spread as an abyss.
Since our inception in 2009, Andreessen Horowitz has been a Silicon Valley venture capital firm. This was highly intentional on our part. Historically, the largest number of great technology companies emerged from Silicon Valley for good reason – the network effect. Many things drove the network effect, but the most important was this: If you were a great technology entrepreneur born anywhere in the world where it was difficult to start a company such as Bangladesh or The Sudan or Marianna, Arkansas, and you decided to move, the place you were most likely to move to was Silicon Valley. As a result, Silicon Valley became the place that attracted most of the great national and international talent.
Then in 2020, COVID-19 hit and technology companies were forced to figure out how to work remotely. It turns out that running a technology company remotely works pretty darned well. It’s not perfect, but mitigating the cultural issues associated with remote work turns out to be easier than mitigating the employee satisfaction issues associated with forcing everyone into the office 5 days/week. As a result, nearly every technology company has moved to a remote or hybrid approach to work and this change is profoundly weakening the Silicon Valley network effect.
This is a very good thing for the country and the world. As my partner Marc wrote in his 2011 article, “Software Is Eating the World,” every important new company is likely to have a world-class software team at its core. Concentrating all of those companies into one or two geographies cuts off great opportunities from anyone who can contribute, but cannot easily move. Remote work is opening up many new locations for entrepreneurs and technology workers. We embrace that by changing our own operating model.
In our firm’s new operating model, we work primarily virtually, but will use our physical presence to develop our culture, help entrepreneurs, and build relationships. Specifically, the firm is now virtual, but can materialize physically on command.
Dr. Babak Hodjat, a serial entrepreneur in Silicon Valley and chief architect of the technology behind Siri, believes that insights aren’t enough. In a past ODSC East keynote address, Hodjat leads us through what he believes the issues are and how companies can build true AI-Powered Organizations.
When you ask companies what they want from AI, many of their responses are prediction-based — know if a transaction is fraudulent or predict the risk of insuring a property. When they have these analytics, the company can make confident decisions on their own. They would take appropriate action to counteract the fraud or decide whether or not to insure that property.
The company doesn’t use AI to make the decisions themselves, only to provide the analytics to inform the decision. The trouble is that getting to those analytics requires a lot of effort — charts are confusing, graphs can be manipulated, and few people have the visualization training to read these complex outputs.
What’s the Problem With Analytics?
Most companies are focused on preliminary analytics, but this doesn’t do business impact justice.
Most problems require multiple objectives — some kind of balance the company is striking between different solutions and needs.
Models become obsolete faster than we expect — changes in customer habits, regulations, even unpredictable events like natural disasters alter the course of AI models.
Dr. Babak Hodjat believes that AI should be helping us make our decisions rather than serving purely an analytics function. He believes we’ve gotten some of this backward, and becoming a truly AI-powered organization is the way to fix it.
Of all the business and technology writers out there, including bloggers, I think the best one, at this moment, is Matt Levine. He’s the only person currently writing on Planet Earth that I find myself reading every word of everything he writes. For the last few months, he has been mostly writing about three topics: […]
Some news: $1B in new funds! When FirstMark Capital was founded in 2008, the idea that one could build a premier, top-tier venture capital firm out of New York was still largely considered odd, perhaps even delusional. A barely nascent tech ecosystem, NYC at the time had few startups and even less venture firms, and seemed destined … Continue reading Announcing $1B+ in New Funds
Amazon is buying primary health care company One Medical for roughly $3.9 billion, the companies announced Thursday morning. The company says the deal will allow it to “reinvent” health care and “dramatically improve the healthcare experience over the next several years,” said Neil Lindsay, senior vice president of Amazon Health Services.
One Medical CEO Amir Dan Rubin said in a statement that the deal represents an opportunity to merge Amazon’s “customer obsession” with One Medical’s health care technology and expertise. Rubin will remain CEO upon completion of the deal, with Amazon acquiring the company for $18 per share in an all-cash transaction. The deal is subject to approval by federal antitrust regulators and requires approval by One Medical shareholders.
CEO Elon Musk said the cryptocurrency sale was to maximize its cash position only, but prices still slid after Wednesday’s report
Tesla’s second quarter of 2022 came to a shaky end as the electric carmaker reported a drop in profit after it struggled to meet demand due to a shutdown of its Shanghai factory and production challenges at new plants. The company also sold 75% of its bitcoin holdings, leading to a slide in the cryptocurrency price.
Tesla’s second-quarter profit fell 32% from record levels in the first quarter, with the company reporting a $2.26bn net profit on Wednesday.
The San Francisco-based company told employees last week that its internal share price was $29, down from the $40 per share figure the company had at its last internal valuation, WSJ reported.
Stripe was last valued at $95 billion in March 2021, making it the fifth most valuable private company in the world, according to the The Crunchbase Unicorn Board. The company is backed by investors including Andreessen Horowitz and General Catalyst.
Stripe lowering its share price also lowers the implied valuation of the shares to $74 billion, WSJ reported.
Stripe isn’t the first company to lower its own valuation this year. Instacart cut its own valuation from $39 billion to $24 billion in March. The move came as tech stocks were hammered in the public markets. Instacart was considered a prime candidate to go public in 2022, but IPO activity so far this year has pretty much been at a standstill.
Startup of the Week
Crunchbase secured a $50M series D investment in recognition of its account-based prospecting platform and growth potential.
Tweet of the Week
That Was The Week is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.