“Analyzing the Post-Crash VC Market: Insights by Mark Suster”

The Future of Venture Capital and the Startup Ecosystem

Recent Market Trends

At our mid-year offsite, we discussed what the future of venture capital and the startup ecosystem looked like. From 2019 to May 2022, the market was down considerably with public valuations down 53–79% across the four sectors. Our conclusion was that this isn’t a temporary blip that will swiftly trend back up in a V-shaped recovery of valuations but rather represented a new normal of how the market will price companies somewhat permanently.

Historical Valuation Trends

We drew this conclusion after a meeting we had with Morgan Stanley where they showed us historical 15 and 20 year valuation trends and we all discussed what we thought this meant. Should SaaS companies trade at a 24x Enterprise Value (EV) to Next Twelve Month (NTM) Revenue multiple as they did in November 2021? Probably not. We think 10x (May 2022) seems more in line with the historical trend.

Public vs. Private Markets

It doesn’t take a genius to realize that what happens in the public markets is likely to filter back to the private markets. The ultimate exit of these companies is either an IPO or an acquisition, often by a public company whose valuation is fixed daily by the market. This happens slowly because while public markets trade daily and prices then adjust instantly, private markets don’t get reset until follow-on financing rounds happen which can take 6–24 months.

Valuation Reset

But we’re confident that valuations will get reset. First in late-stage tech companies and then they will filter back to Growth, A, and ultimately Seed Rounds. When you look at how much median valuations were driven up in the past 5 years alone, it’s bananas. Valuations for early-stage companies tripled from around $20m pre-money valuations to $60m with plenty of deals being prices above $100m.

Impact on Startups

If you’re exiting into 24x EV/NTM valuation multiples, you might overpay for an early-stage round, perhaps on the “greater fool theory,” but if you believe that exit multiples have reached a new normal, you can’t overpay. It’s just math. No blog post about how Tiger is crushing everybody because it’s deploying all its capital in 1-year while “suckers” are investing over 3-years can change this reality. VCs have to make money in good markets and bad.

Money on the Sidelines

There is a LOT of money still sitting on the sidelines waiting to be deployed. And it WILL be deployed, that’s what investors do. Pitchbook estimates that there is about $290 billion of VC “overhang” (money waiting to be deployed into tech startups) in the US alone, up more than 4x in just the past decade.

Return of Normalcy

We already see a return of normalcy on the amount of time investors have to conduct due diligence and make sure there is not only a compelling business case but also good chemistry between the founders and investors.

Upfront Ventures’ Strategy

At Upfront, we believe that investors in any market need “edge.” We focus heavily on geographies and have partners that lead each practice area. We don’t want to compete for the largest AUM with the biggest firms in a race to build the “Goldman Sachs of VC.” We stay close to our investment themes of healthcare, fintech, computer vision, marketing technologies, video game infrastructure, sustainability, and applied biology.

New Partnership with Nick Kim

We’re excited to share that Nick Kim has joined Upfront as a Partner. While Nick will have a national remit, he is initially going to focus on increasing our hometown coverage. Nick is an alum of UC Berkeley and Wharton, worked at Warby Parker, and most recently at the venerable LA-based Seed Fund, Crosscut.

Managing Our Portfolios

For Upfront Ventures, across more than 10 years of investing in any given fund, 5–8 investments will return more than 80%. We manage our portfolios as a funnel. If we do 36–40 deals in a Seed Fund, somewhere between 25–40% would likely see big up-rounds within the first 12–24 months. Of these companies that become well financed we only need 15–25% of THOSE to pan out to return 2–3x the fund.

Conclusion

As the market recalibrates, venture capitalists need to adapt their investment strategies to reflect the changing landscape. At Upfront Ventures, we remain focused on our investment themes and geographies while managing our portfolios as a funnel to maximize returns.