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How the prices paid for unlisted startups will adjust to falling share prices

Surprisingly slowly YOU HAVE probably noticed that there has been something of a reckoning for the shares of fledgling technology companies in the public markets. An index of stocks that have floated via an initial public offering (IPO) within the past two years, compiled by Renaissance Capital, is down by around a third in the past year. In the private markets where venture capitalists (VCs) supply funding for startups, the term you hear for more sober valuations is “reset”. This is gentler than “reckoning”, with its overtones of punishment. In venture circles, mistakes carry no shame. If your startup is a bust, you learn lessons, move on and back a new firm. There are some signs that the public-market reckoning is causing a rethink in private markets. Technology IPOs are being pulled. Entrepreneurs are advised more pointedly to conserve cash. And there is tentative evidence that VCs are pulling in their horns. The Information, a tech-industry news site, reported recently that Tiger Global Management, a prominent financier of maturing tech firms, had cut back its earlier offers of financing to a handful of startups. Is this the start of a trend? Don’t be too sure. A lot of venture capital has been raised from investors. Around $750bn was committed, waiting to be deployed, at the end of 2021. The most gilded startups might be hard pushed to notice any shift. Their big funding cheques are likely to keep coming. In the rest of the startup market, any mark-down to more sober valuations will happen with a delay. For now, at least, the wall of venture money militates against a big reset. The world of VC has changed a lot in the past decade or two. It used to be a cottage industry based around San Francisco. But as interest rates slumped, other kinds of investors were pushed into taking VC risk to generate sufficient returns. The lower interest rates are, the less investors care about whether they receive a dollar today or a dollar tomorrow. It is a perfect climate for funding startups, whose pay-off may be years away. The cottage industry soon faced competition from private-equity and hedge funds, especially in the funding of mature “late-stage” startups. These “macro” investors look at a portfolio of pre- IPO firms much like a portfolio of listed stocks, says Ajay Royan of Mithril, a VC firm based in Austin, Texas. Their instinct now is to write smaller cheques for startups to reflect the heightened risks to IPO pricing. But competition from rivals makes this harder than it sounds. A VC firm that tries to align a funding round with the prices paid in public markets may find that another VC firm comes over the top with a better offer. Venture capitalists are caught between two opposing forces. On the one hand, they see that interest rates are going up and technology stocks are falling. On the other hand, there is an array of tempting startups that are also being chased by lots of rival shops. The expectations of entrepreneurs matter in this regard. Many will look to the terms their startup peers achieved recently as a guide to their market value, says Simon Levene of Mosaic Ventures, a London-based VC firm. It is not healthy for startup founders to think that capital will always be forthcoming. But try telling them that. An excess of optimism is part and parcel of being an entrepreneur. People who are more mindful of risks get regular jobs. Memories do not reliably stretch back to the dog days of 2002 when VC funding was hard to come by. Founders grew up in a world of near-free money. It will take time for them to adjust to a different landscape. A deeper fall in tech stocks might nudge that adjustment along. But a true reset would require something else to happen. Were VCs themselves unable to raise capital for new funds, they would surely be forced to be less generous in the prices they paid. If you can’t raise money and you know your peers can’t raise it either, you become more sparing with capital. Discipline becomes a watchword. Valuation matters more. This could happen. But it would probably take a much bigger fall in the overall stockmarket to spur it. The share of portfolios allocated to VC would then have to fall in line with diminished public stockholdings. Subscriptions to new funds would dry up. But there is not much sign of this. Big new funds are still being raised, even after the repricing of listed tech stocks. VC does not yet seem to have lost any of its sheen with pension funds, endowments and family offices. As long as the money flows in, it will be deployed. The reset may have to wait a while.

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