By now, it's evident to most investors that the tech downturn is not just a brief blip of the type we witnessed at the beginning of the pandemic.
The tech-heavy Nasdaq has tumbled 22% since the start of the year. And judging by the recent earnings reports of a number of the bellwether tech companies, the rising rate of interest environment and unsure economic conditions, a rebound is clearly not round the corner.
In a matter of months, late-stage VC deal-making has turned from frenzied to near-quiet. One such investor told me that he hasn't made one new investment since the beginning of the year, and he sees others during this market segment dramatically curtailing their deal-making.
At some point, this slowdown will likely spread to deals for early-stage startups.
While many tech investors are preparing for a rough time ahead, some private market strategies will find attractive opportunities during this environment. Here is how some investors are using their playbooks to win in current market conditions.
Structured debt is gaining a much bigger role in deal financing
Since the IPO market is in an exceedingly deep freeze and it's much harder for founders to lift equity rounds at increased valuations, late-stage companies in need of money will communicate convertible debt or a similarly structured product.
Many recently announced late-stage deals with private equity involvement have included a big structure component, an investor with an oversized PE firm told me. When these deals get announced, they give the impression of being sort of a traditional growth equity round, but, in keeping with the investor, in most cases these rounds consist largely of a structured product and a little portion of equity.
There has always been an interest in these debt products because they're relatively non-dilutive, but deal-making in convertible debt has grown many fold over the last few months, and therefore the demand continues to increase.
Buyout firms see juicy targets in tech
As tech-focused private equity buyout firms like Thoma Bravo, Silver Lake and Vista Equity Partners raise funds over $10 billion, they will want to use a number of their dry powder to get public companies with valuations that have dropped significantly since the beginning of the year, said Wylie Fernyhough, a senior analyst with PitchBook.
Rumoured take-private activity is incredibly high now, including for software companies within the $1 billion to $10 billion enterprise value range, the investor at an oversized PE firm told me. He added that some companies that went public via a SPAC are considered take-private candidates.
VC-backed 'special situation' deals benefit of valuation markdowns
Special situations may be a strategy that few venture capitalists used over the last 10 years, but it had been popular with some VCs within the 2007-2012 era, per Josh Wolfe, co-founder and managing partner at Lux Capital.
Lux is again actively searching for special-situations investment opportunities, which Wolfe describes as investing in late-stage businesses at early-stage prices.
These deals are essentially equity recapitalizations, Wolfe said, with most of the economic benefits visiting the management team and also the participating investors, but not the initial backers.
What makes such opportunities "special" is that they will be found anywhere.
"It might be an R&D group inside a serious tech company. It might be a division within a personal company. It may well be a corporation where the investors are tapped [out]," Wolfe said. "We're searching for those proverbial Rembrandts within the attic where something is de facto valuable but stuck."
While special-situations financing isn't a VC-specific strategy, Wolfe says that Lux's approach to that is the "epitome of working capital."
"You're still taking technology or market risks," he said. "You are still funding losses. you're just doing it when plenty of these risks were taken by somebody else, but they don't seem to be visiting to get the reward."
Seed investors are in it for the long-term
It is generally understood that seed-focused investing is the most insulated from market gyrations because seed-stage companies are a few years away from an exit.
A part of Lux's barbell strategy is investing in new companies and fully funding them through a market downturn. But other large firms are likely to begin clamoring more for this a part of the VC market over the following months.
"In the first stage, it's still blue," Wolfe said.
These are by no means the sole venture investing strategies that perform well when the tech market is during a downturn.
Comments
Post a Comment