Valuation normalisation
Valuations have come down from the extreme highs, upending the prevailing trend over the last couple of years and bringing both founders and investors expectations down to a sense of normality. This is beneficial for investors, who by definition are price takers, allowing them to enter at competitive prices, in turn increasing the probability of achieving a larger multiple on exit over the long term. In public markets, median ARR multiples for software companies have dropped from 16x (March 2021) to 4.4x (Nov 2022) due to a higher implied discount rate on future revenues and a reversion to the historical mean.
Generational opportunities
Some of the world's greatest generational companies were created during market downturns including PayPal, Facebook, Uber, Airbnb. Starting a business is no easy task, creating a successful one is even harder. As the legendary investor Bill Gross refers to, 'Timing is everything'. Starting a business during a market downturn can be fortuitous due to a number of factors.
(i) less competition and access to greater talent
(ii) founders equipped with an efficient growth mindset
(iii) less competitors getting funded, helping to cancel out a lot of the noise.
Reduced competition
Competition to get into deals has moderated, providing more pricing power to those investors that have dry powder and the ability to become the preferred party to founders. It’s widely recognised that most Venture Capital investors tend to invest at Series A/B, having become by far the most saturated area in the market - for that reason we believe our seed stage investment strategy gives us a competitive advantage. We at Fuel Ventures have always specialised at the seed stage (pre series A), leading rounds with a £1m-£3m ticket and taking a seat on the board. We feel that by operating as an entrepreneur led fund we understand and can rationalise with founders at the early stage helping us win the majority of term sheets we go in for. Only 8% of European VC’s are entrepreneur led having become somewhat of a rarity, whereas in the US it’s more of a commonality.
Excess funding
Dry Powder in VC is at all time highs ($290b, Pitchbook 2022) due to the increasing desire from investors to get exposure to the asset class with the objective of creating a well rounded, risk adjusted, diversified portfolio. The majority of this dry powder sits at Series A+ stages. A leading indicator for us as investors constitutes to the amount of funding available at subsequent funding rounds, in a game of probabilities this increases the likelihood of a company raising a competitive follow on round, in turn achieving early investors a significant multiple uplift.
A better future
Technology and innovation are undoubtedly long term trends. One of the major forces behind global GDP growth will be continual innovation, leading to a more positive and vibrant macro environment. In the US alone the IT sector accounts for 28 percent of companies & establishments, 22.4 percent of jobs, and 30.7 percent of payroll expenditures (US Census Bureau, County Business Patterns Survey 2020). With a global economy that’s experiencing the largest debt/ GDP ratios in history it’s important we double down on the one thing that’s proven time and time again can increase productivity, create jobs, generate wealth and create a more globalised world.