Goodbye to easy money and automatic up-rounds
The days of easy money and automatic up-rounds seem to be over – at least for the foreseeable future. Already reeling from a valuation reset that started in 2022, the industry faced another unexpected blow to its ecosystem with the demise of Silicon Valley Bank, and to a lesser extent, the weakening of First Republic. The private equity landscape has definitely changed since we last discussed this topic with Longley Capital back in September 2022.
Why is the demise of Silicon Valley Bank so meaningful?
- SVB was the backbone of start-up and VC ecosystem, growing with the industry over the last 40 years.
- SVB had provided services to nearly 50% of all VC-backed startups, services that such firms had trouble finding elsewhere on reasonable terms, partly due to the higher risk associated with these activities.
- SVB’s massive network provided multiple revenue opportunities across every relationship.
In the near term, the biggest impact will be the loss of alternative capital provided through credit facilities and venture debt – many counting on this to extend their runway as equity capital dried up.
Capital now has a meaningful opportunity cost.
On the urging of their VC backers from “on high”, portfolio companies are being told to batten down the hatches, but many lack a roadmap. Further, we are not convinced that the skill sets of many founders – encouraged to be brazen in their spending to capture share — are well-suited for such an environment in which efficiency and cost-control will take center stage. Remember, many “spun out” from large, well-capitalized technology companies. Can these management teams walk and chew gum at the same time? In our view, most can’t – without help.
Don’t get us wrong, many sub-optimal opportunities will still get funded.
Remember, over the last two years since the pandemic, $724 billion has been raised by PE funds according to Pitchbook. And the clock is ticking to put money to work, especially if the current freeze persists for 12–18 months, leaving precious little time to execute a reasonable investment period. That said, portfolio companies will likely have to leave their historical metrics behind to secure additional capital. This may require making tough choices like founders retaining less equity through the stages of growth to maturity than they typically would expect.
What about the VCs?
For starters, it is harder to raise new capital — a persistent denominator effect and lack of distributions from GPs have left LPs capital-constrained. Further, most VCs have grown up in a world with a low cost of capital tailwind and have rarely had to distinguish between opportunities, clamoring to compete for the same perceived winners at almost any price. In their minds, any one investment succeeding isn’t important – after all, statistically many investments don’t succeed — it’s all about playing the percentages. Remember, these are the folks who were willing to torch the very ecosystem that they had relied upon in a heartbeat – stepping over each other as they ran for the doors at Silicon Valley Bank, ensuring its rapid demise. We prefer those that leave no one behind.
These difficult times require more than top-down advice.
But assisting portfolio companies through these difficult times requires more than advice from “on high”, delivered in a memo. It requires real and specific insights derived from operating experience and old-fashioned hard work. Many have outsourced these responsibilities to consultants, formally entrepreneurs, now retired. We don’t think this model is sustainable during real industry inflections. In short, after years of bloated returns, the industry is fat and happy, not hungry.
Seems like it’s time to revisit the discussion we had a few months back in our conversation with Longley Capital.
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Validus Growth Investors, LLC seeks to invest in companies at every stage of their growth. From startups to publicly traded companies, our research identifies inflection points that have the potential to produce meaningful growth and income for the clients we serve.
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