State of Private Markets: Q1 2023

https://carta.com/blog/state-of-private-markets-q1-2023/

by tim_sw • 3 years ago

151 72 3 years ago

The transformation of the venture capital industry over the past year has been stark. Total venture capital raised by startups plunged 80% from Q1 2022 to Q1 2023. Venture deal count fell 45% over the same span. Overall, Q1 was the slowest quarter for both capital raised and deal count since 2017.

Does this come to a shock to anybody given the sequence of events:

1. Pandemic economic relief to offset otherwise lost wages due to restrictions is roughly equivalent to "injected money/liquidity from the sky"

2. Subsequent inflation

3. Subsequent federal reserve monetary policy in response said inflation in an attempt to stop it from spiraling

How is venture capital expected to perform well in these conditions? Is the point of this article "venture capital was expected to do worse off given the change in underlying economic conditions, but not this drastically of a difference"?

Federal Funds Rate is about to be 5.25%

30 year fixed mortgages are ~7%

Financing a new car for 60 months is 7%

I'm less interested in "how bad is the state of venture capitalism" right now and more interested in "when is it roughly expected to get better/be less bad again"?

slap_shot2• 3 years ago

How is venture capital expected to perform well in these conditions?

I'm not sure that this author or Carta as a whole is trying to suggest private markets should be performing better right now. We're all painfully aware of why this is happening. These reports are usually just presenting the raw data.

I'm less interested in "how bad is the state of venture capitalism" right now and more interested in "when is it roughly expected to get better/be less bad again"?

An analyst's report for any asset class (real estate, public equities, etc) has to start with the cut and dry numbers. But they do sprinkle in a bit of guidance using the data:

"There are signs of a venture spring. Valuations from seed to Series C ticked up from recent lows. Median round sizes mostly stabilized. But these green shoots were overwhelmed by the decline in total rounds across all stages."

tpankaj• 3 years ago

I don't think it's fair to complain that you're not interested in reading about the state of venture capitalism on an article titled "The State of Private Markets". The article delivered exactly what it promised in the title.

MuffinFlavored3• 3 years ago

I don't think it's fair to complain that you're not interested in reading about the state of venture capitalism

Apologies, I should've tried to sound less whiny. I guess what I was trying to say is "things are bad, what did you expect?"

nawgz9• 3 years ago

1. Pandemic economic relief to offset otherwise lost wages due to restrictions is roughly equivalent to "injected money/liquidity from the sky"
2. Subsequent inflation

I dislike this representation a LOT because I have the feeling more money was distributed to business owners under the incredibly corrupt PPP loans, and then... it turns out corporate profiteering is the real driver of inflation.

People keep peddling this "giving people money in a pandemic caused all our problems" line, but it's just not true, it's not grounded in reality, and if it was a contributing factor, let's look at the other things that costed more...

Citizen's tax dollars being paid back to them when you can't leave your home is not a driver of inflation

Citizen's tax dollars being gifted to business owners who also proceeded to jack up their profit margins due to shocking price elasticity due to a complete lack of antitrust enforcement for 40 years is THE driver of inflation

It's amazing how on an article about VC you've both managed to argue that no one should write articles about VC and then blamed citizens for corporate-driven inflation.

seizethecheese• 3 years ago

The mainstream economics consensus is that inflation was kicked off due to excess savings and limited supply of goods (first) then services (second).

The idea that business profits are driving inflation is a partisan talking point, not at all consensus.

icedchai2• 3 years ago

My uncle's business got a $600K+ PPP loan. They had at least 10 million in cash and did not need the money. Why did they get it? Because they could. To be fair, they did pass it all out as employee bonuses.

gruez2• 3 years ago

Citizen's tax dollars being paid back to them when you can't leave your home is not a driver of inflation

The pandemic relief wasn't funded by "Citizen's tax dollars". It was funded by borrowing. Lending/printing this much money in such short amount of time is going to cause inflation because demand (caused by dollars cojured out of nowhere) is chasing limited supply.

sbierwagen• 3 years ago

I'm less interested in "how bad is the state of venture capitalism" right now and more interested in "when is it roughly expected to get better/be less bad again"?

This rounds up to "how long do recessions usually last" and the answer is an unsatisfying "it depends" https://cdn.statcdn.com/Infographic/images/normal/25364.jpeg

somewhereoutth• 3 years ago

I'd suggest that ~5% is monetarily neutral and roughly the correct rate for pricing time/risk, it only seems high compared to the zero rates we've had recently. It may have to go (much?) higher for a (long?) period to fix the current inflation situation.

slap_shot2• 3 years ago

Fascinating.

Jumping up to public markets, I thought this was an interesting insight yesterday from Jamin Ball at Altimeter:

There's now only 3 cloud software companies trading >10x NTM rev. Snowflake at 15.2x, Veeva at 10.8x and Cloudflare at 10.5x [0]

[0] https://twitter.com/jaminball/status/1653482586054987776

claytonjy2• 3 years ago

How does this compare to private companies? I don't see anything in the article about revenue multiples, but I was on the market recently and anecdotally everyone is trying to justify much higher multiples for early stage (pre-C) private SaaS right now.

JumpCrisscross2• 3 years ago

everyone is trying to justify much higher multiples for early stage (pre-C) private SaaS right now

Growth adjusting à la PEG [1] might help normalise the data. Pre-C businesses should grow faster than public ones. That said, these are all heuristics—details like churn, margins and customer acquisition cost matter.

[1] https://en.m.wikipedia.org/wiki/PEG_ratio

MuffinFlavored3• 3 years ago

how high?

monero-xmr• 3 years ago

Most post-seed rounds happening now are existing investors doubling down on their winners. Losers will get acquired or shut down. Revenue is king, promises and future growth and TAM hand-waving is in the graveyard. If you need VC money to survive within the next 12 months and aren’t already trying to raise it you are probably dead.

sroussey• 3 years ago

Acquisitions are not really happening.

nuclearnice1• 3 years ago

The article disagrees. But my sense is you are right in relative terms. Much more failing than acquiring.

Article:

Startup M&A bounced back: The number of venture-backed companies that were acquired or merged with another company increased by 20% in Q1 compared to Q4 2022, with 57% of those M&A deals valued at $10 million or less.

hcazz• 3 years ago

Sure they are, JPMC just recently acquired a small startup.

foobiekr4• 3 years ago

Without commenting on my current employer, all of my previous large employers are busy buying more companies this year than the last three years combined.

choppaface4• 3 years ago

The percentage of employees who exercised their vested options before expiration has now declined for five straight quarters, with the rate falling from 46% to 28% over that span.

This is key to Carta’s business model, as they want to be the next SecondMarket / private market that flips employee stock in liquidity rounds for a hefty premium. Carta needs high employee engagement with stock compensation. It’s remarkable that they spend so little of this report on the topic.. if engagement stays low they’d need VC deal making to 10x to grow themselves.

Why might engagement be low? Well besides the current economic environment, the implosion of SVB et al took with it a lot of venture debt, which may result in unusual dilution down the road. Also, employees are mostly just trying to get their jobs done versus VCs who were aware of the unusual bank fragility.

Overall, employee stock-based comp has taken a huge downturn in real value (if not paper value). The top start-ups need to innovate new compensation packages when the bull market returns.

ryanSrich3• 3 years ago

It also can’t be overstated just how expensive things have gotten. I’d wager a large percentage of the exercise decline is due to employees having less cash.

choppaface4• 3 years ago

Yeah I’m trying to allude to that, but the bank failures make the probability of “my options round down to zero or less than that (via taxes)” significantly higher. In the 2008 financial crisis the problem was in an adjacent industry, but here in the SVB case the banks are failing at basic compliance as well as trying to juggle crypto fraud. The information disparity between VCs (whose job it is to convince banks that the venture asset class is worthwhile) and employees is bigger than ever.

Right now, like maybe Stripe is worth taking the risk to exercise, and Clubhouse borderline because they have $100m in funding. But most other early stage companies, there’s much bigger risk that the company’s projections look ok to the employee so they exercise. But then the existing funding busts and then the employee ends up paying taxes on something that’s worthless. And the bankers / VCs likely had the info to know it was worthless at the time of exercise.

umeshunni• 3 years ago

the implosion of SVB et al took with it a lot of venture debt, which may result in unusual dilution down the road

Can you explain what this means? Does it mean (1) SVB used to a major holder of venture debt (2) Now that they don't exist, no one is likely to buy venture debt (3) therefore, companies have to issue more equity, leading to dilution

choppaface4• 3 years ago

I’m not aware of banks as friendly today towards venture debt (really small business loans) as SVB et al were. There was probably a bubble in lending there in part due to crypto fraud. (VCs of course want this marketed as the Fed disrupting their house of cards through raising rates).

Will start-ups just issue more equity? It could be more likely they simply fail to raise anything.

solatic• 3 years ago

Why might engagement be low?

Easy. The whole point of owning stock is to (a) have the right to vote in elections for the Board, (b) have a share of dividends, (c) potentially sell for a profit in the case of an acquisition or IPO.

If the company is private, with no exit in sight: (a) isn't true in your case, as your right to vote is taken away from you, (b) is a pipedream, because the company is either not profitable or because profits are being re-invested into growth.

In a bad economy, where you're trying to build up savings because you have no real idea if you or your partner or someone in your family is going to be laid off in the near future, where exercising options requires both a large cash expenditure on the part of the employee and a huge leap of faith that, in the span of years, there will be some kind of a return...

Stock-based compensation means very different things in VC-controlled and non-VC-controlled companies. Stock-based compensation is "real" in non-VC-controlled companies (be they bootstrapped businesses or large public enterprises) because there's actually a legitimate chance at a dividend issue and/or a real (if small) voice in Board elections. But the value of stock compensation in VC-controlled firms entirely depends on whether the firm is going to be a VC-style success. If it's not a portfolio winner, then the employees don't win either. And employees have a front-row perspective on whether the company is a portfolio winner.

choppaface4• 3 years ago

And employees have a front-row perspective on whether the company is a portfolio winner.

This is often false, especially for ICs. The C-levels in early stage companies hide a lot of key info (intentionally or not). The most material info like the cap table and the relationship with investors (especially record of “no” answers received) is never shared.

corry2• 3 years ago

The decline in employee option exercise... is that the canary in the mine? If the team itself is saying less and less that their company's equity is worth taking a risk on -- and they are in a good position to be optimistic, rightly or wrong -- then that's a pretty bearish signal.

Of course there are other pressures on peoples' personal finances that makes money dearer... but still.

Or perhaps with layoffs there is just a lot of people who could be exercising vested options, but won't because (1) they no longer work there and won't be able to contribute or have an insider advantage, and/or (2) they now don't have a job so won't risk the capital in buying out their options.

adoxyz• 3 years ago

It doesn't necessarily signal that the company's equity is in a bad position. I'd venture to think a lot of people would rather keep cash on hand in these times than locked up in a private company.

persedes• 3 years ago

plus for a lot of companies an IPO might be not in the near future due to the stock market being what it is (even though who knows anymore...). So why buy options if you don't know when you'll get to sell it.

cj• 3 years ago

Are 409a valuations coming down for companies who raised at crazy valuations? Are startups repricing their employee stock option strike prices (highly unlikely?)

I think the most obvious explanation is a lot of people were hired during a time of inflated valuations and those employees received stock option grants with incredibly high strike prices.

Now valuations have tanked over 50%. If this happened in the public markets, you would simply let the options expire rather than acquire the stock at a 100% premium (for example). For similar reasons, it’s probably not advisable to exercise options granted in the last couple of years in most cases, but that’s because valuations are likely down below the strike price for a lot of people.

stanleydrew• 3 years ago

In my experience 409a valuations for common stock are effectively set based on a discount to preferred and some handwavy math related to "comparable" public market valuations. So I would expect them to come down, but they will lag 1-ish years behind private preferred round prices.

I do think it's somewhat likely that a company would offer to rewrite options at a new lower strike price if employees ask. Of course you'd start all the capital gains clocks again, by probably worth it if the price difference is substantial.

corry2• 3 years ago

Good point, if your options are underwater you probably aren't exercising... although would be sad to watch them expire.

cassonmars• 3 years ago

Seeing the Midwest figures is unsurprising and still disappointing. As someone pitching a startup, the number of big name investors that have asked where I’m calling from and have this look of “why?” or even outright asking it really shows some extreme bias. Given the world is moving more towards remote work, it’s strange that VCs still have this belief that only coastal areas can innovate.

esafak• 3 years ago

Tell 'em you're a remote company, if you are. State it in your pitch so they don't ask.

thomasjb• 3 years ago

Confusion ensues when you are 'remote first' and also manufacturing the latest in vertical lathes in your multi-dozen square foot shed

smabie• 3 years ago

So what's the why?

kaesar142• 3 years ago

I don't think it's such an unreasonable question when VCs are trying to maximize their investment, and being in a hot tech market has shown to be an accelerator in finding talent and growing a startup

brazzy• 3 years ago

How much of that "has shown to be" is just confirmation bias, though? Seems to me as likely to be a dampener on "finding talent" when you have to compete with FAANG (or MANGA, or whatever).

netman21• 3 years ago

During the dotcom boom I called Vinod Kkosla to pitch my Michigan based startup. Left a voice message. Got a call back to my 313 number from his assistant. Call went like this:

Her: "Hi Mr. Khosla asked me to call to ask where you are located." Me: "Michigan" click

State of Private Markets: Q1 2023

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