Private Market Technology Investments Are Here to Stay

Art: Pete Ryan

“Technology is embedded in everything we touch: food, medicine, commerce. and I think that means staying here. On private technology assets in 2023.

Despite being prevalent in so many sectors, 2022 hasn’t been kind to tech investors. The sex tech index, a publicly traded stock index, is down more than 50% by 2022.

The discounted cash flow model and its emphasis as a fundamental valuation tool are, from a theoretical point of view, often responsible for the price collapse of risky assets. The DCF model uses expected future cash flows to value a company against its risk-free rate of return.

Higher interest rates reduce the future value of the cash flows a company generates when compared to the discount rate. This is the effect of considering the time value of money, which is more valuable now than in the future. Therefore, in this model, applying a higher discount rate automatically reduces the present value of the firm.

The tech sector has been punished for often offering investors unprofitable companies that promise future cash flows.

Private market market participants have already seen declining valuations, and private technology assets are also immune to the valuation crunch seen in the public market technology sector. “I think we are going to see [valuations depreciating] more comprehensive [in 2023]’ says Biers.

The number of so-called “unicorns,” or private companies with valuations above $1 billion, fell 48.3% last year, compared to 596 at the end of 2021, reaching 100,000 at the end of November 2022, according to PitchBook data. became 308 companies. “If you think about the simple investment theory of buying low and selling high, the conditions are ripe for that to happen,” said Beers, noting that declining valuations can create buying opportunities.

In addition, private assets enjoy the flexibility of not being valued by the market on a regular basis, mitigating some of the paper losses experienced in the public markets.

“What retail investors have particularly benefited from is the growth rate within their personal portfolios. [For many investors, they are] Miguel Ruinha, Managing Director of Fund Investments at Hamilton Lane, said: “When multiples decrease, their growth rate can offset the decreases in those multiples. Because you are growing in that reputation.

Better than accounting procedures and growth rates is how the tech sector will be set up for 2023. It’s almost a natural law of the market that some of the worst performing sectors in the previous year will rebound to the best performing sectors in 2023. following year. Of the 11 sectors in the S&P 500, energy was the second worst performer in 2020, down 33.7%, and real estate down 2.2%, according to Statista. In 2021, energy and real estate were his two best-performing S&P 500 sectors.

Moreover, according to Yardeni Research, the S&P 500 sector, information technology, has had negative yields only twice since 2010, falling 29.6% in 2022 and 0.3% in 2018.

“The long-term growth dynamics of technology-enabled businesses [haven’t] Changed because the stock market went up or down. We are looking at a longer holding period,” said Jeffrey Stevenson, his partner managing VSS. “Now is an interesting time to invest in this kind of business.”

But just because a buyer has a chance doesn’t mean a seller will be happy to close a deal with a low valuation. Stevenson notes that 2023 will be a very tough year for his private equity exits. He suggests that buyers and investment committees are becoming much more cautious and conservative in evaluating companies, noting that the sale process for deals has been postponed or canceled.

Falling valuations in 2022 could create headwinds for exits in the foreseeable future, but Stevenson said the lack of exit activity and appetite for high multiples is good for private credit strategies. thinking about.

“The classic exit for technology companies is an IPO,” says Beers. “We are out of a period where IPOs were pretty strong. Now that window is essentially closed and I suspect it will be closed for a while.

Beers attributes the lack of activity in the IPO market to valuation concerns, but Luiña said:at the end [1990s], the venture was typically funded through Series A, Series B, and Series C rounds. With little private growth equity capital available, companies had to tap into the public markets to continue their growth trajectory. Much of the value creation and growth of these companies took place in the public markets. “

Beers confirms that companies are not limited to going public just to access funding options or exits, as they were decades ago. “There is a growing tendency to [general partner]We have led secondary type deals in the form of continuing funds,” he says. “Activity in the venture world is beginning to pick up, providing liquidity. [limited partners] And some longer funds. “

Higher interest rates have more consequences than just lower valuations and tighter liquidity conditions. Moreover, not all consequences of rising interest rates are negative. Some results create positive net externalities for venture space and private technology assets.

“I think there will be less innovation, at least in terms of bad ideas being funded,” Stevenson said of the long-term effects of rising interest rates on innovation in tech. “Cream will always come out on top, and deals that should never have been funded in the first place probably won’t be funded. Innovation will continue because it makes sense and there is demand. [for innovative technology solutions] will always be there “

Luiña agrees that tightening economic conditions could “provide a very positive trend in the performance of venture firms,” ​​citing less competition for new deals among investors. He focuses on proving business models early in the company’s existence. We reach more milestones ahead of our Series A funding round. And “in theory, investors will reduce their allocations to companies that eventually fail, limiting the rate of write-offs.”

In addition, higher interest rates make private credit opportunities more attractive as higher yields have come to accompany commodities.

“With private credit, you have a lower leverage multiple and a higher interest rate, so you trade less. Trades are ultimately less risky, but offer a better return profile,” Stevenson says. “Private credit with a twist on equities has two advantages. One is that it generates above-average current income. can generate higher returns [from structured capital]”

Ruinha prefers venture equity as an investment approach to the asset class.

“I think there is an attractive market for ventures. “If you look at some of the recent tech companies that went public and hit $25 billion, $50 billion or more in market capitalization, even if you cut that in half, the early-stage entry into these companies for less than $1 billion investors, and even at sub-$100 million valuations and in a tough environment, it’s still going to do very well.”

Beers cites healthcare technology as the most exciting investment sector within the private technology asset class. He believes this class is essential for solving future problems.

“(Technology) is what ultimately changes the world,” says Beers. “So given climate change and other factors that we are dealing with, technology must somehow step in and play a key role in closing those gaps.”

Related story:

The World of Private Equity: Anxiety, Elation and Sanfloyd

Private equity, a popular asset class for allocators, faces headwinds

Private Credit: Too Risky? Not for Asset Allocators

Tags: Goldman Sachs Non-Profitable Tech Index, Hamilton Lane, Jeffrey Stevenson, Joshua Beers, Miguel Luiña, NEPC, private assets, Private Debt, Private Equity, Special Coverage: Technology, Technology, VSS, Yardeni Research

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