As covid-19 continues to snarl the public markets, the venture market should prepare for a downturn. But investors shouldn’t expect it to look the same as the Global Financial Crisis (GFC).
Despite the comparisons being drawn about the current stock market slumps and past recessions, the venture asset class looks differently today than it did during the GFC.
Private markets, like VC, have expanded and matured greatly since then and their response won’t completely mirror 2008, according to a recent report from PitchBook.
“Just [look at] the size of a lot of these asset managers now in PE and VC and the size of the companies they are supporting,” James Gelfer, a senior strategist and lead VC analyst at PitchBook, told Venture Capital Journal. “Companies are staying private for longer and these companies look more and more like a public company in the past would.”
Gelfer said that the other main changes between the market then and now concern valuations and the ease of access to liquidity options.
“The development of the secondaries market is really going to mitigate some of the downturn risk we saw during the GFC,” Gelfer said.
He added that there was a lot of distress and uncertainty surrounding illiquidity during the GFC because many institutional investors were over allocated to private markets at that time and the secondaries market just wasn’t as robust as it is now.
Now, many of these same investors are currently under allocated and have more options if they need liquidity.
Valuations are also poised to take a hit, but they were beginning to head in that direction anyway, Gelfer said. The median valuation for late-stage startups was already starting to decline at the end of 2019.
“A lot of these late-stage and nontraditional investors who have exposure to both public and private companies won’t be able to go in at those valuations, when the public valuations are so much lower,” Gelfer said.
The valuations, in tandem with the public market turmoil, will also have an adverse impact on exit activity. With companies staying private longer already, this downturn will only add to that.
Gelfer said he wouldn’t be surprised seeing some companies raise unexpected extra rounds of funding to further delay an exit in the current environment.
This “pendulum shift” may also cause what has been a founder-friendly market to become the opposite. As market conditions worsen and valuations drop, founders looking to raise capital may have to take what they can get even if the terms aren’t as favorable.
The fundraising landscape will also change, and Gelfer predicts that certain managers will fare better than others.
Firms looking to raise later vintages, who already have strong existing relationships with LPs, may not as much of a hit. If institutional investors feel they have to deploy capital these funds may seem like the safest options.
He added that these later vintages may also be seen as safe option for LPs to invest in a new manager. These funds come with track records and performance data that could be enough for some LPs to feel comfortable making commitments over video.
Emerging managers may be the hardest hit by this disruption, and Gelfer predicted this drop off could arise six to nine months from now.
Fund performance during this time will depend on vintage. Gelfer said fund vintages that started investing right before the GFC underperformed and he expects that to continue.
“The assumption now is that the 2017-2019 vintages will have the most challenging performance,” Gelfer said. “At the high valuations they have firms have to hold on to investments a little longer.”
He said that funds closed during the downturn will probably outperform the last couple of vintage years and funds prior to 2017 probably won’t see drastic under performance.
“Every VC says they are writing checks right now and everyone is keen to say they are allocating capital,” Gelfer said. “The biggest mistake of the crisis were people not investing enough. Everyone is trying to deploy capital into this market. Dips like this is where you see the best performance.”