The VC market is taking a pause, but the future still looks bright

Valuations in the venture capital (VC) market are either in decline or flattening out, primarily due to inflated expectations, says Michael David, Managing Director for the Equity Fund Resources team at Bridge Bank.

“Startup companies always have nonlinear rates of progress,” David says. “Companies haven’t performed as well as they had been forecasted and the stable of investors has pulled back. Many are looking at this correction cycle as an opportunity to invest in good companies, but they are not going to pay the valuations they did a year ago.”

VC investments reached a 15-year high last year as the sector capitalized on the relative weakness of other markets. But what goes up must come down again at some point and VC investing has slowed down in 2016.

“Companies that are still burning cash, are not yet profitable and are not growing as much as they were are in danger of not receiving funding,” David says. “There is a much more cautious view.”

At the same time, there is still a great deal of capital available to be invested when the right opportunity presents itself.

Smart Business spoke with David about the state of the VC market and what it means for startups.

What factors are driving the drop in valuation?
A number of firms in the market were driving up valuations, including nontypical investors in the segment such as Fidelity and T. Rowe Price. They came into the market and paid very high valuations for high-profile companies.

Since that time, however, these public mutual funds have written down their investments in some of the later-stage companies.

They have created a revaluation of the market, particularly in the so-called ‘unicorn’ companies they had invested in — startups that are valued at more than $1 billion. The reason is that public valuations are not staying in line with what was being paid on the private side.

There was also an expectation that these companies would go public in a relatively short period of time, perhaps within 12 to 18 months. But the public markets have not been receptive to new issues unless you can show a high rate of growth right off the bat.

A number of these companies that have gone public have missed their forecasts, which affected the whole market, as well as the private market.

What effect does the state of the VC market have on the overall economy?
You have the local Silicon Valley economy and the greater economy. They are related, but distinct. Some of the public companies and even a portion of the private companies are still burning cash, but growing. Investment has declined or pulled back and boards are directing companies to get back to profitability. The result is some companies are looking at layoffs.

This correction or right-sizing of companies is not as big as when the dot-com bubble burst, but there definitely is a movement to get cash flow to break even or to be cash flow positive.

Silicon Valley has a robust economy so while there are some layoffs in the tech sector, it’s not affecting unemployment much. It’s just not quite as robust as it once was.

What’s the takeaway at this point on the state of the VC market?
The environment has changed, particularly in terms of valuations. The VC world is looking harder at companies and their subsequent valuations. I don’t think that anyone thinks there will be a robust IPO market anytime soon. Companies will stay private longer and are going to need the capital to get there.

Rather than just focusing on growth on the top line, there is more of a focus on the bottom line. In 2015 alone, VC funds raised close to $30 billion in new investible capital and if a company hits the right target, there will always be capital available. ●

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