Venture Markets Update - 2023 H2

With the majority of companies implementing cost-cutting measures, we've observed distinct patterns. Start-ups, grappling with uncertain revenues, have often reduced their workforce by up to 50%. Consequently, founders are assuming a greater role in sales and development. Scale-ups, on the other hand, are focusing intently on successful verticals, leading to a decline in new product development.

Balanced growth: the current metric of health

Growth, while still a primary concern, has shifted from unchecked expansion to balanced, sustainable models. Scale-ups, in particular, are showcasing their pathways to profitability. Cash runway to break even stands out as a crucial metric, with our most promising scale-ups projecting a 12–18 month window and possessing the requisite funds or actively raising them.

IPOs - still the lighthouse for venture capitalists

Despite the decade-long trend of businesses remaining private and inter-VC sales growing commonplace, the importance of IPOs as a cash-recycling mechanism remains paramount. Case in point: the significant interest around impending IPOs such as Birkenstock and the recent successful launch of ARM on the Nasdaq. Of particular interest is Instacart - the IPO valuation of $8.3bn is a sharp drop from its $39bn valuation in 2021. This shift underscores the importance of an IPO as a viable VC exit strategy, even with potential value reductions.

Market valuations: a sobering perspective

The highest-performing businesses have retained their value, but they are the outliers. Broadly speaking, valuations have seen a downward adjustment of 25%–75% from 2021's peaks, with a median decline of around 40%. This recalibration has led to a rift between VC expectations and those of entrepreneurs, often necessitating a significant realignment in fundraising expectations.

Venture debt: an evolving landscape

Equity valuation reductions have heightened the appeal of venture debt for entrepreneurs keen to avoid high dilutions. Though venture debt costs have risen from mid-teens to low-20s, mirroring the rise in Bank of England interest rates, demand remains high. Supply remains extremely thin, and demand outstrips supply by a ratio of at least 10:1, providing venture lenders with significant pricing leverage.

The case for venture debt

Venture debt's rise in the U.S., now constituting 20% of venture funding, is a testament to its potential. Entrepreneurs increasingly recognize the exorbitant costs associated with dilution. Simultaneously, lenders have realised that, with the correct structure and careful cherry-picking of deals, venture debt needs not be as risky as venture equity. For investors, several factors align: Europe is increasingly adopting strategies proven in the U.S.; a shift in equity valuation dynamics amplifies demand; and the revival of IPO and VC markets reduces the risk of venture debt by providing a backstop.

Notably, sophisticated investors are already capitalizing on these dynamics, evidenced by Blackstone's acquisition of Kreos Capital. For those looking to invest, the current market offers unique potential. At Nighthawk Partners, we remain committed to navigating these complex waters, equipped with experience, data, and insights.