Morning Markets: Let’s return to our discussion of how confident Silicon Valley is in itself and the larger U.S. economy.
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After we published our look at two venture surveys that showed falling confidence among venture capitalists, another industry comment came in on the matter we had to share.
I think the main factor driving the dip [in confidence] is the general perception that valuations are rich and that they probably will decline over the next 1 [to] 4 years. Public market valuations are still at historically high levels, so there is concern that they might decline. When that happens, generally, less M&A [activity] occurs and when it does, the prices are lower. This could create a challenging exit environment.
There is also a lot of capital in [private equity] and venture capital at the moment, which has propelled valuations upward. When you have to buy at higher multiples today and sell at (potentially) lower ones, that will put pressure on returns.
The belief that public valuations will fall fits into the context of Fortune’s survey, which indicated that 41 percent of respondents had zero or only some confidence in the U.S. economy; if the US economy slips, stocks would fall, and the pressure that reaction would inflict on startup valuations is a fair reason for VCs to worry.
But while falling confidence isn’t much of a bullish indicator, there’s more than just bad news to be found. Indeed, Silverton’s Flager went on to explain to Crunchbase News the silver lining a market correction could have on early-stage investors:
As an early stage investor, a market correction, should it occur, is both a curse and a benefit. The mid to late-stage investments could face headwinds, but a correction could [also] normalize prices and make new investments more attractive. Since our [average] hold period is 6 [to] 7 years, we tend to not overreact too much to the environment in terms of how much capital we are putting out.
So the idea that companies should raise to avoid evaporation if the capital markets snap shut is still likely popular advice from investors. It’s a narrative we’ve heard during, and after, market wobbles, most notably following 2016’s SaaS Crash.
Finally, Flager had a somewhat regular call for safety, echoing the recent 2019 Bessemer cloud report, which included a call for startups to hold 18-to-24 months worth of cash:
“We are telling our companies to prepare for worsening market conditions by keeping their burn rates rational and raising a little of additional capital, if possible, to strengthen their balance sheets—but haven’t taken any drastic actions.”
When will the correction come? Who knows! Bears have been expecting it for years; bulls don’t think it is coming. At some point, the business cycle will recall that it is a cycle and we’ll have a reset. Until then, check out the most recent private market rounds of $250 million or more.