There have been 23 IPOs so far this year, by comparison over the same period last year there had been over 60. So this year is down a lot, and we know a few things about IPOs. There are a lot of reasons for this decline, all of which can be largely summed up as Uncertainty. Interest rates play a big role in this, and no one is clear if rates will go up further or stay at current levels, or how long they will stay there. Will there be a recession? What will China’s economy do? These are all big questions that will have a big impact on financials markets, and obviously a factor in the IPO process. Most analysts seem to agree that we have entered into a new ‘paradigm’, with no chance of going back to the last decade’s zero per cent environment. All of this matters tremendously to technology investments, despite our sector enjoying the ability to ignore macro conditions for so long. One of our first posts on this sites touched on how interest rates would eventually rise and spell trouble for the industry. Of course, that post was published in 2013, so these things can take time.
To be clear, we do not need to see ultra low rates return for the IPO market to return, it is just that the Street would like a bit more clarity on the risks they face right now before they consider all the risks of some new stock listing. Once upon a time, the tech industry equated a closed IPO window with a closed venture funding environment. This is no longer an absolute rule, but VCs face a lot of the same questions about their own position in the macro-economy which most definitely has slowed down their pace of investment.
All of which is a long way of saying the pace of investment in technology has hit a bit of a pause. It will likely ease up later in the year, but the conditions we have enjoyed for so long will not come back. The long, lazy summer is over, and something new is coming.
There are some signs of optimism. There is still an immense pool of capital floating around out there. Silicon Valley Bank just issued their regular report on the state of venture funding, noting that the amount of VC “dry powder” is at an all time high. And arguably macro conditions do not look terrible, with what seems a consensus emerging that at least the US is not entering a recession. Our best guess is that the IPO market opens up again later this year as public company results show some sign of bottoming out, if not actual recovery.
That being said, all is not well in tech investing land. Investor and market commentator Trevor Loy recently posted a thread on Twitter casting some doubt on that notion of record dry powder. Long story short, much of that money was raised recently, in a very different market, and may not actually materialize. While public market valuations have taken a big hit, many big funds have not reflected those valuations in the assessments of their own portfolios. Many late-stage, private companies (especially in software) are hanging onto valuations well above where their public peers are trading. This creates a mismatch between VCs and the LPs who provide their funds. LPs are widely diversified and look at this math every day and may see little reason to throw more money at software venture funds.
This does not spell the end of the tech industry, it probably does not even spell the end of the Bay Area Infinite Housing Bubble. It does mean that going forward venture investors have to rethink their strategies and find new ways to differentiate. The tried and true formula of bidding up hot SaaS companies based on analysis of some numbers in a spreadsheet is no longer true.
For later stage companies this is likely to mean some uncomfortable adjustments, they are the ones who will feel the brunt of the slowdown, stuck between the rock of changing venture patterns and the hard place of no one likes to do a down round. Smaller, newer companies will likely only have to contend with a longer fund raising process and less lofty valuation expectations. (Unless they have AI in their name, in which case it might as well be 2021.)
We are also likely to see an increase in sector specialization. The world probably does not need another CRM company or data management layer right now. But other sectors look attractive. AI is obviously very much in vogue right now, but no one is entirely clear where the investment dollars should go in this ecosystem (other than Everywhere!). Andreessen Horowitz’s Martin Casado recently published a very smart piece on this subject, and even he is not entirely certain about where to direct those investments.
We obviously have our biases, but we think Deep Tech looks all the more promising. This field of semis, electronics and hardware has been starved of capital for a long time. All that AI needs semis on which to run and sensors from which to gather data.
All in all, the current downturn is not a bad thing. It will not feel that way to many, but we can all agree that conditions had gotten frothy, verging on absurd, last year. A hard rain to clean it all out was overdue. Whatever emerges whenever down the road, will feel different. We think it is unlikely that we just snap back to a bubble in a few years. Start-ups will have to work harder to raise money. they will have to plan on short runways to profitability, and focus a lot more on product and differentiation. None of which are bad things, but all of which are very different than where we have been.
Photo by Louis Maniquet on Unsplash