Last month, I traveled to the VC and financial capitals of the world – Silicon Valley and New York City – for meetings with VCs and potential investment opportunities, plus a few days of meetings at CES, the largest consumer technology conference in the world. Being another tough week for the financial markets, it was an interesting time to take such a trip. Here are some of my thoughts that I wrote up initially as an internal memo after returning, and decided to share with our broader community.
While we generally spend our time focusing on the micro side of investing – companies, their teams, the competition, the technological and business advantages — it is important that we remember that investment opportunities do not exist in a vacuum.
We need to raise our eyes to view the broader picture. Below, I discuss:
- The overall global investing environment
- What it means that valuations are coming down
- Takeaways: Private market investing during a public market downturn
- But… good companies will continue to be built, raise capital and create wealth
- OurCrowd in the mix: What’s next?
The overall global investing environment
The overall global investing environment should play a role in how we – whether the investment team at OurCrowd, VCs, or angels – consider potential investments. This helps inform how we think about the environment in which potential portfolio investments will be operating. In particular, it will help us think about future funding for our companies, particularly with regards to valuation. In addition, it is important for us to be open and transparent with the entrepreneurs who we are backing about the current realities of the capital markets and the shift we are seeing in valuations.
Specifically, it is our job to find and select companies which we believe have the best chance of resulting in outsized investment returns. This requires us to constantly work to improve our deal sourcing, and then dive deep into company analysis and diligence, considering each company’s technology and competitive advantages.
This should be our focus.
However, ultimately, investing is not only about finding the next top company; it is about finding investments that will make money for investors. As I have learned over the years, a great company is not necessarily a great stock (or startup investment). Valuation must play a role in any investment decision. And valuations in the public markets are a key ingredient when thinking about the appropriate valuations for startups.
What it means that valuations are coming down
During my visit, I met with at least 15 VCs, strategic investors or professionals connected with the startup market. Almost every one of them feels that valuations for VC investing have already come down, and are starting to fall faster. In a recent survey of 156 VCs published by Mark Suster of Upfront Ventures, 61% said that prices in Q4 last year had started to drop and 91% said they expected them to continue to drop in the first six months of this year (with 30% expecting serious drops).
Remember, VC valuations are not like the public markets: you can’t see prices on a screen every day, and the change in trend for equity valuation may sometimes be tougher to perceive at the outset. Therefore caution and discipline are even more critical. Moreover, prices are set quietly, in private transactions every day, and we only hear about them on a time-delay. We are part of the price-setting mechanism, and our discipline in thinking about and setting valuation today will play a key role in our future returns.
Closely related to the point above, the public markets are currently not healthy, and valuations in many sectors have dropped in a meaningful way. Since December 1st, the S&P 500 and the Nasdaq 100 (representing the largest and most liquid stocks) are down 12% and 15%, respectively. The Russell 2000 (representing small/mid-cap stocks) is down roughly 20%. And many stocks – particularly high growth technology companies – are actually down much more than this, many as much as 40%+.
Maybe more importantly, though more subtly, many parts of the financial markets have been in what can be viewed as a down-trend, or some kind of correction since last summer. The correction has been broad and affected all market sectors, including financials, energy, and recently – technology.
Will this continue? Hard to say. In any case, the change in public market valuations and sentiment is meaningful and absolutely has an impact on private market/VC valuations and capital availability. Moreover, the timing and valuation of exits may shift temporarily. Our investing discipline and decisions must factor in these changes in the investing environment.
Takeaways: Private market investing during a public market downturn
Bottom line, here’s what happens in private market investing when public market valuations contract:
- VCs slow down their investing pace.
- Valuations come down at all stages of deals, but particularly in B and C rounds and beyond.
- Entrepreneurs still have higher valuations in mind, because they remember where valuations “used to be.”
- VCs continue to wait… entrepreneurs eventually need money… and valuations come down… rinse and repeat.
- Fund raising cycles take longer; deals take longer to get funded.
- Capital becomes scarcer, and companies will need to focus not just on growth, but on profitability and business model sustainability; investors will put this in focus.
- Great opportunities are created for those who have patience and discipline.
What else could this mean? Follow-on rounds in our portfolio – and throughout the startup ecosystem – may be more difficult to complete and VCs will need to be pickier as to which companies to refinance. VCs that are planning to raise new funds in the near future may have a harder time doing so as LPs will be hesitant to commit new capital.
But… good companies will continue to form and raise capital
There is good news. Market downturns do not hinder innovation; on the contrary, they often push people to be more creative in finding efficient solutions to problems. Promising companies will continue to be formed and grow and VC investing during these times can offer some great opportunities.
Some of the most successful technology firms are built during tougher periods in the financial markets. During the last downturn we saw the enormous wealth creation in companies, such as Facebook, Tesla, Twitter, and more. In the 2001-2002 period, it was Google, Salesforce, and LinkedIn.
These are just a few examples of companies that raised significant financing rounds surrounding the 2008-2009 financial crisis:
- SolarCity: Oct. 2008, $30M Series D
- Siri: Oct. 2008, $8.5M Series A led by Menlo
- Tesla Motors: Nov. 2008, $40M Debt financing
- Twitter: Feb. 2009, $35M Series C led by Benchmark
- Palantir Technologies: Apr. 2009, $8.3M Debt financing
- Facebook: May 2009, $200M Series D
- Uber: Aug. 2009, $200K Seed round
- Waze: March 2008, $12M Series A
- WIX: Oct. 2008, $3.5M Series B
- Varonis: Jan. 2009, $15M
- Annobit: Jan. 2009, $23M Series B
The current environment for technology innovation is as strong as ever. My recent trip to CES was confirmation that the creativity and technological evolution/revolution continues at top-speed: I was one of 170,000 attendees, which is far bigger than the last time I was there, about five years ago, and the wide array of new technologies, and new modalities of using technology was almost overwhelming. It is incredibly exciting to be investing in this environment. Nonetheless, it still requires discipline and forward thinking (and some luck…) to make the right calls.
And the technology itself? The recent CES conference was all about the connected car and home. IoT is very real, and is going to be huge within many consumer and industrial sectors. There were hundreds of companies solving for the connected home, and creating the next generation of automobiles. And yes, many companies look and feel the same, and the competition – as with any large market opportunity – will be fierce. We will continue to be very focused on competitive analysis as a core part of our investment selection. Just another reason why when we see something we like, we conduct a thorough vetting and due diligence process.
OurCrowd in the mix: What’s next?
To be clear, all is not gloom and doom. There are incredible companies out there – we continue to meet some of the most creative and talented entrepreneurs each day. There is unprecedented innovation in many sectors, driven by technologies that a few years ago we likely could not have predicted. We absolutely remain excited about the great technology and business innovation we are privileged to see, analyze and invest in. Our team will continue to search for and get into the top investing opportunities we find. But of course, we need to remain cognizant of changes in the investing environment, and disciplined in valuing companies.
The investment team at OurCrowd will continue to carefully choose great Israeli and global startups while keeping a constant eye on the state of the markets and industry. We invite you to be in touch with any questions you may have.
Elan Zivotofsky has over 18 years of extensive, on-the-ground experience, focused on researching, raising capital for, and investing in Israeli companies. Before joining OurCrowd as one of the founding partners, Elan was the Managing Partner of the Prelude Israel Fund, which was a hedge fund focused on Israeli companies, and a Senior Vice President and the Head of Technology investment banking at Lehman Brothers in Israel from 2004-2008.