by Zain Jaffer
Is US Venture Capital (VC) broken? There was an interesting discussion from Silicon Valley’s top rated All-In podcast in mid September 2023 about this. Personally I have seen many of the things they have pointed out in my own venture capital efforts. But I’d like to give credit to the excellent way that they tackled a lot of the issues we all face right now.
Several of the current crop of investment bank led VC IPO’s like ARM, Instacart, etc are not doing well. ARM’s price for example, had fallen below the IPO price a few days after its launch. But granted that Jerome Powell’s September FOMC speech before the press did shake the markets, that is also a major part of the problems that current IPO’s face now.
Some of the reasons discussed in the All-In podcast for why US VC is broken are as follows:
One, interest rates are at a record high forcing some Limited Partners (LPs) to reconsider their VC involvement. The present value (PV) of speculative future cash flows (FV) always becomes lower when interest rates go higher. The new computed Alpha from VC investments is no longer as big compared to returns from S&P 500 and fixed income, so many hesitate to take on the added risk.
Also, US retail is in trouble as personal savings have dwindled from the peak of the 2020 pandemic savings. People starting to max out on credit cards. US credit card debt has now exceeded $1T, and credit card interest rates are above 20%. Student loan payments are expected to resume October 2023, thus cutting available discretionary family spending further. Delinquencies and defaults are expected to increase.
Most companies are also forecasting revenue targets downward. When asked in the last Sept 2023 press conference if a “soft landing” (no recession) was the target, Fed Chairman Jerome Powell implied that it is just a nice to have. A hard landing means a recession. The Fed needs that economic slowdown to arrest inflation.
They also pointed out that the float (amount of shares available in the market) is less than the normal 20% of previous IPOs. In the case of ARM, it was only 9.4% and it was spread out among many early investors. The subdivided small tranche amount was too negligible for some hedge funds and institutional investors.
There was no lockup period. Previously early investors could only sell after six months. Now they can sell immediately when the price goes up.
They also pointed out that retail investors are all hyped up but late to the party. Thus they end up becoming the exit strategy of the early investors.
The group feels that there is an overemphasis on an immediate price rise after IPO, instead of letting market dynamics determine true price and value.
Personally I can feel that the public is still expecting parabolic returns from blockbuster IPOs such as those of the tech giants in the past. Unfortunately in this regime of high interest rates that may not end soon, that might not be a reasonable expectation to have at this time.
The US VC system has produced several of America’s great tech companies over the past few decades. If it cannot be fixed from its current inefficiencies, it may lead to America’s decline as the world’s leader in tech innovation and industry.
SOURCES
https://www.youtube.com/watch?v=X-Sb8sIi22g