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MAY. 27, 2022

Volatility – is all tech created equal?

By now it is clear that the technology sector is entering a slowdown. Big tech stocks have crashed in the public markets, scale-ups don’t want to IPO while the market is down and investors are questioning how and when they’ll start to see returns. The data validates this trend. According to the CB insights state of Venture report, the global funding to startups in Q1 was 19% lower than the previous quarter. Unicorn birth rate was also down by 15% QoQ.

As the public markets are punishing the high growth tech companies, the main effect is visible in the IPOs and SPACs, which are down 45% QoQ, as late stage startups are choosing to stay private longer. SPACs are especially vulnerable to this situation, as they represent the short-term opportunistic speculation and therefore are hit hard by the current market sentiment.

However, as we move across all stages of VC investment, we see a different picture. Late stage investing saw a drop of 20%, mid-stage saw an increase of 13% and early stage remained flat. While it is true that the valuation ripples will take some time to reach the earlier stages, it is also true that early stage investment is more immune to the public markets movements. The time horizon for an early stage exit is 7-10 years, so short-term market oscillations are not so relevant, as by that time we will be well into the next market cycle. This keeps early stage investors confident to keep deploying capital.

Similarly, we can look into how the median valuation trended over the last decade. Based on Pitchbook data, the median valuation in late stage software companies rose 3.5 times in that period, versus only 2.5 times for early stage rounds and less than 2 times for seed rounds. So the outcome is that earlier stage investing is less prone to the bubble characteristics we witness in the late stage and public markets.

There are also interesting findings in terms of geography. While funding in the US and Asia is down by 23% and 37% respectively, Europe and Canada are up 20% and 67% respectively. It is also worth mentioning that Africa, while it remains a small share of the global VC capital, saw a rise of 35% in funding.

Another interesting takeaway is that the quality of the company matters. The last few years gave a lot of leeway to questionable companies to raise record-breaking rounds. What we see now is that across stages, while the top quartiles of the valuations drop significantly, the medians are actually growing. This is a signal that high quality companies still exist, and disciplined founders with controlled cash flows are in a good position to seize this market opportunity to dominate in their respective markets.

Finally, the sectors show great disparities too. As expected, highly cyclical sectors such as SaaS, marketplaces, and fintech will end up taking a beating on valuations and funding in a downturn, as they're the same that get the most overheated when capital is abundant.  Those sectors are prone to speculation, as the high growth of user-count can radically change the sentiment when evaluating a company. Moreover, the promise of quick exits through IPOs has been linked with consumer software companies, further reinforcing unsustainable valuations. On the contrary, startups in deep tech sectors like robotics, materials and climate technology, are typically focused on producing economic value by solving fundamental technology problems, so it follows that they are more insulated from market dips. They are also associated with long waiting times before their exit, so a potential delay has a smaller impact. This is backed by Pitchbook data, where we see that the median round grew 5.2 times for the consumer tech sectors, versus 2.9 times for the deep tech sectors over the last decade.

In conclusion, we see that navigating the tech investment universe is not easy. It is clear that in today’s market it will be much harder for founders to succeed. It will be even more difficult for Venture Capitalists to pick the winners, especially as there is a lot of dry powder from the record fund raises for last years. However, it is in such times that opportunities are the greatest, for both strong founders to dominate and disciplined investors to see record multiples.

We thank you for the continued support.

The FAM team